BUDGET HIGHLIGHTS

On the spending front, the government funded in advance its $ 2.5 billion Canadian Millennium Scholarships Program. The ten year program is scheduled to start in 2000, and will provide some 100,000 scholarships averaging $ 3,000 per year to low and middle income students. In addition, the Canada Student Loans Program will provide a tax credit to partially cover interest payments on student loans; tax-free (but repayable) withdrawals will be allowed from RRSPs for "lifelong learning"; and grants of up to $ 400 per child per year will be provided for registered education savings plans.

Canada Health and Social Transfer payments to the provinces will be partially restored by funding increases of $ 7 billion between 1997-98 and 2002-03 and increased funding for the Medical Research Council.

While the new Budget does not bring across-the-board tax cuts as hoped, it does deliver targeted tax-relief measures to low and middle income families.

The significant proposed tax changes as well as other recent developments of interest are discussed below.

Supplementary Personal Credit

Low income earners may be entitled to an increase of up to $ 500 in their basic personal tax credit. Individuals entitled to a spousal credit or an equivalent-to-spouse credit will be entitled to an additional credit of up to $500 depending on the other person's income. The measure will come into effect on July 1, 1998. The benefit will be gradually reduced as income rises and will be completely eliminated for people who earn more than about $ 20,000 per annum.

Individual Surtax

The Budget proposes to reduce the amount of the 3% surtax for people with income of up to about $ 50,000. The reduction will be equal to $250 less 6% of federal tax payable in excess of $8,333. The measure will come into effect on July 1, 1998.

RRSP Deductions and Alternative Minimum Tax

The Budget proposes that all deductions for RRSP and registered pension plan rollovers and contributions will also be allowed in computing alternative minimum tax. This proposal avoids additional taxes being incurred in situations such as where an individual receives a large retiring allowance and transfers it to an RRSP. This change is proposed to commence for 1998 and subsequent taxation years. Where alternative minimum tax has arisen in these circumstances in 1994 or subsequent years and has not been recovered, such tax will be refunded once the legislation is passed.

Child Care

Many taxpayers will benefit from the proposed increases in the maximum amounts deductible for child care expenses. Commencing with the 1998 taxation year, the maximum amounts deductible will be increased by $2,000 to $7,000 for each child under age 7 at the end of the year (or in respect of whom a disability credit was claimed), and by $1,000 to $4,000 for other eligible children (between the ages of 7 and 16 at the end of the year or mentally or physically infirm).

Canada Child Tax Benefits

A new system will replace the Child Tax Benefit and Working Income Supplement programs with an enriched and simplified program. The major difference is that the payments under the new plan that will replace the existing Working Income Supplement program will not be based on the earned income of the family. Benefits will be phased out for families with combined income over $ 20,921.

Caregiver Tax Credit

The Budget proposes a new caregiver tax credit that will reduce federal taxes by up to $ 400 for those who care for an elderly parent or a family member with disabilities. The credit will be reduced by 17% of the elderly or infirm person’s income in excess of $11,500.

Home Buyers’ Plan

The Budget proposes to modify the Home Buyers’ Plan ("HBP") so that disabled individuals and persons related to them who previously owned a home may again participate in the HBP by withdrawing RRSP funds after 1998 to buy a home that is more accessible for, or better suited for the care of, the disabled individual.

Caregiver Training

The Budget proposes, commencing for the 1998 taxation year, that the costs incurred for training courses related to the care of dependent relatives with mental or physical infirmities will be eligible for the medical expense tax credit.

The disability tax credit applies to individuals with severe and prolonged mental or physical impairment that markedly restricts their ability to perform basic activities of daily living. Previously, only a medical doctor, an optometrist or an audiologist could provide the necessary certification.

As of February 24, 1998, a person can be certified as eligible for the disability tax credit by an occupational therapist in respect of mobility impairments, and by a psychologist in respect of intellectual impairments.

Donations of Certified Cultural Property

Property certified as Canadian cultural property and donated to designated institutions is eligible for enhanced tax incentives. The Budget proposes changes related to donations of Certified Cultural Property. The fair market value of a property certified by the Canadian Cultural Property Export Review Board will be used for all income tax purposes related to charitable donations and gifts for a period of two years after certification. As well, property received by a designated institution after February 23, 1998, must be held by the institution for a period of at least ten years, before it can be disposed of without the imposition of tax on the institution.

Canada Opportunities Strategy

Interest on student loans

A student may claim, as a non-refundable federal tax credit, 17% of all interest (but not principal) in respect of new or outstanding loans approved under the Canada or provincial student loans programs. The credit may be claimed in the year the interest is paid or the five succeeding taxation years and is not transferable (unlike the tuition fee and education tax credit).

Tax-free RRSP withdrawals for education

A Canadian resident may withdraw funds tax-free from an RRSP to finance full-time education for the taxpayer and/or his or her spouse in a qualifying educational program of at least three months. Commencing in 1999, a maximum of up to $ 10,000 can be withdrawn in a particular year, up to an overall maximum of $ 20,000 over four years. Contributions made to an RRSP less than 90 days before a withdrawal are not eligible under this plan.

Withdrawals are generally repayable, without interest, in equal installments over a period of ten years. The first repayment must generally be made no later than 60 days after the fifth year following the year of the first withdrawal. An amount not repaid in the year as required will be included in computing the individual's income for the year.

Part-time students

Commencing with the 1998 calendar year, the Budget proposes two additional income tax relief measures for part-time students.

Part-time students will be eligible to claim a non-refundable tax credit for part-time education, equal to 17% of $60 per month for each month the part-time student is enrolled at an educational institution in Canada, in an eligible program lasting at least three consecutive weeks, and involving a minimum of 12 hours of courses each month. If not utilized, the credit may be carried forward for future use by the student or transferred to a supporting person.

Part-time students will also be able to claim the child care expense deduction. The deduction is currently generally available only in respect of child care services which enable an individual either to earn income or to study on a full-time basis.

An RESP is a plan which allows Canadians to save for their children’s education by making non-deductible contributions that earn income on a tax-deferred basis until withdrawn by the child for his/her post-secondary education. The annual contribution limit of $4,000 and the lifetime contribution limit of $42,000 will remain unchanged. The Budget proposes that the government will make a Canada Education Savings Grant ("CESG") of 20% on the first $ 2,000 of annual contributions made after January 1, 1998 to RESP’s for beneficiaries up to age 18. The maximum CESG is therefore $400 per child per year. Where the contributions made in a year are less than $ 2,000, the unused CESG contribution room will carryforward to future years. The maximum carryforward that can be used in a particular year is $ 2,000.

Relocation Expenses

For expenses incurred after 1997, deductible moving expenses will include certain costs of maintaining a vacant former residence where reasonable efforts are made to sell the old residence. The deduction will be limited to a maximum of $ 5,000 for a period of up to three months. Maintenance costs include mortgage interest, property taxes, insurance premiums and costs associated with maintaining heat and power.

Other moving costs such as the costs of changing the address on legal documents, replacing automobile permits and driver’s licenses and obtaining utility hook-ups and disconnections will become deductible.

A number of tax court cases have held that employees are not taxable on payments received in respect of work-related moves to compensate for the loss on the sale of a former residence or for the higher cost of financing the new residence. The Budget requires that, where an employer provides any reimbursements to a relocated employee to assist in the financing of their new residence, the amount received will be taxable. Where amounts are paid to employees to reimburse for a loss or impairment on the disposition of a former residence, the first $ 15,000 received by the employee will be non-taxable and any amount above $ 15,000 will be only half-taxable. These provisions apply to employees who commence employment at their new work locations after June, 1998, in respect of payments made after February 23, 1998. The provisions apply for 2001 and subsequent years where the employee commences work at the new location before July, 1998.

Finally, in respect of loans made after February 23, 1998, the Budget proposes to clarify that an employee is required to include the interest benefit on a home relocation loan (to the extent related to a loan amount in excess of $ 25,000) where the loan is made as a result of the borrower’s employment.

Health and Dental Premiums

The Budget proposes that self-employed individuals will be allowed to deduct amounts paid for their private health services plan ("PHSP") provided they are actively engaged in their business, either alone or as a partner, and provided that the individual’s business income is more than 50% of his/her total income in the year, or their income from other sources does not exceed $10,000.

The PHSP premiums will be deductible only if equivalent coverage is provided to arm’s length employees (and such arm’s length employees represent at least half of the employees in the business). Otherwise, the annual deduction is limited to $1,500 for each of the individual and spouse, and $750 for each child.

These proposals are effective for fiscal periods commencing after 1997.

Underground Economy: Reporting of Federal and Construction Contracts

The Budget proposes mandatory reporting for the construction industry for payments made after 1998. Individuals, partnerships, trusts and corporations whose principal business is construction will be required to report, annually, payments made to contractors for construction services. This reporting requirement will be extended to include service and mixed service and goods contracts. Goods-only contracts will be exempt from these reporting requirements.

Federal government departments and agencies will begin issuing information slips for contract payments made after 1997, as will federal Crown corporations for contract payments made after 1998.

Revenue Canada will continue their consultation process with the construction industry regarding the specifics of the reporting requirements and to determine if mandatory reporting is needed for other sectors of the economy.

Meal Expenses

The Budget proposes to restrict the full deductibility of meals and entertainment provided by employers for the benefit of all employees to occasional events not exceeding six such events per year.

This Budget measure applies to meal expenses incurred after February 23, 1998.

Scientific Research & Experimental Development ("SR & ED")

The Budget proposes that both materials consumed, as well as materials that will be transformed into another product in the course of performing SR & ED, will qualify as SR & ED. These changes are effective after February 23, 1998.

Co-ordination with Treaties

Canada has over 60 income tax treaties with other countries. This large and growing network of tax treaties is an essential tool for Canadian business.

The Budget proposes several measures designed to harmonize Canada’s domestic tax rules with the rules in our tax treaties, and to ensure that the treaties themselves are applied appropriately. Although a detailed analysis of these measures is beyond the scope of this analysis, several of the proposals will be highlighted herein.

The rules for computing foreign tax credits will be amended so that treaty-protected foreign income is excluded from foreign income in determining the ratio of income from that country to total income. This measure prevents taxpayers subject to high foreign tax on one type of income from generating treaty-exempt income in the same jurisdiction to utilize the excess foreign tax credits.

A non-resident may no longer include in his/her taxable income earned in Canada amounts which are treaty-exempt in Canada. Typically, taxpayers took advantage of the treaty exemption to exclude income, but often chose not to utilize the treaty to exclude otherwise exempt losses.

Finally, for taxation years after 1998, the Budget proposes to require that non-resident corporations file an information return where they claim a treaty exemption from tax on their Canadian-source business income. This situation commonly arises where Canadian business income of a non-resident corporation is treaty exempt because the corporation does not have a permanent establishment in Canada. The new reporting requirements will provide Revenue Canada with the ability to administer such treaty-based claims.

GST/HST Issues for Direct Sellers

The Budget proposes, effective immediately, that direct sellers and independent sales contractors will no longer be required to apply GST/HST on shipping, handling, or order processing fees, where such fees are charged by the direct seller or distributor to an independent sales contractor.

As well, direct sellers will now be eligible to claim bad debt relief for the GST/HST portion of a bad debt related to an account receivable of an independent sales contractor.

GST/HST Visitors’ Rebate Program

The Budget proposes to expand this program in respect of foreign conventions to include a 50% rebate of the GST/HST paid on food, beverages and catering expenses related to such conventions. As well, after February 24, 1998, there will be no restrictions on the frequency that non-residents can file visitors’ rebate claims.

Tobacco Tax Increase

As announced previously, effective February 14, 1998, excise taxes on tobacco products have been increased. For example, for retail sales in Ontario, the Federal Excise Tax was increased by $0.60 per carton of 200 cigarettes.

Foreign Reporting

If a Canadian taxpayer, after 1995, transfers or loans any amount to a foreign trust or a controlled foreign affiliate of a foreign trust, reporting is required. Similarly, Canadian taxpayers or partnerships that receive a distribution from, or are indebted to, a foreign inter-vivos trust in which they have a beneficial interest must also satisfy reporting requirements.

For more information or guidance on how to prepare for the foreign reporting requirements, please call your contact at Goldfarb, Shulman, Patel & Co.

International Transfer Pricing

Where goods and services are exported from or imported into Canada, the government is concerned that fair prices are used so that income is not shifted out of Canada and into other jurisdictions (often having a lower tax rate).

Employer Health Tax Changes – Employers

Beginning in 1999, the first $400,000 of an employer’s Ontario payroll will be exempt from Employer Health Tax. The exemption is being phased in over three years, as follows:

- For 1997, the first $200,000 of payroll is exempt from tax.

- For 1998, the first $300,000 of payroll will be exempt from tax.

- For 1999 and later years, the first $400,000 of payroll will be exempt from tax.

Effective for 1997 and subsequent years, the one-year tax holiday on increases in payroll is eliminated.

Employer Health Tax Changes - Self-Employed Individuals