2023 Federal Budget

Budget 2023 proposes to double the maximum employment deduction available for tradespeople's tools from $500 to $1,000, effective for 2023 and subsequent taxation years. Under the current rules, tradespeople can deduct up to $500 of the amount by which the total cost of eligible new tools acquired in a taxation year as a condition of employment exceeds the Canada Employment Credit ($1,368 in 2023).  

Registered Education Savings Plans (RESP) are savings accounts designed to help families save for their children's post-secondary education.  Matching grants for contributions are offered by the government, with the possibility of extra grants for low – and middle-income households.  

Budget 2023 proposes to increase the Educational Assistance Payment (EAP) withdrawal limits for beneficiaries enrolled in post-secondary programs. The limit for full-time students would increase from $5,000 to $8,000 for the first 13 weeks of enrollment. The limit for part-time students would increase from $2,500 to $4,000 per 13-week period.  

Currently, only spouses or common-law partners can open joint RESPs. Budget 2023 also proposes to enable divorced or separated parents to open joint RESPs for one or more of their children. 

These changes will be effective as of March 28, 2023.  

Registered Disability Savings Plans (RDSPs) provide long-term financial support for individuals eligible for the disability tax credit.  

Budget 2023 proposes to extend the temporary measure that currently allows a qualifying family member to be the plan holder for an adult whose contractual competence is in doubt and who does not have a legal representative. The proposed extension is for three years, extending the temporary measure from December 31, 2023, to December 31, 2026. The federal government also encourages provinces and territories to develop appropriate, inclusive, and long-term solutions to address RDSP legal representation issues. 

Additionally, the proposal seeks to broaden the definition of "qualifying family member" to include siblings aged 18 or older, allowing them to establish an RDSP for an adult with mental disabilities who lacks contractual competence and legal representation. This expansion would be effective until December 31, 2026, and siblings who become plan holders before the end of 2026 may continue as plan holders thereafter. 

A retirement compensation arrangement (RCA) is an employer-sponsored plan that is designed to provide supplementary pension benefits to employees.  

An employer can choose to pre-fund supplemental retirement benefits through contributions to a trust established under an RCA (an RCA Trust). A refundable tax is imposed at a rate of 50 per cent on any contributions made to an RCA Trust, in addition to the income and gains earned by the RCA Trust. This tax is generally refunded as the retirement benefits are paid out of the RCA Trust to the employee.  

An employer who does not pre-fund benefits offered under an RCA as outlined above, can instead choose to settle the retirement obligations as they become due. The employer would need to obtain a letter of credit (or a surety bond) issued by a financial institution in order to provide security to their employees. To secure or renew the letter of credit, the employer will typically pay an annual fee or premium. These fees or premiums are subject to the 50 per cent refundable tax outlined above. However, when the retirement benefits become due from a plan that was not pre-funded using an RCA Trust, the employer pays the benefits out of its corporate revenues. As a result, there are no benefit payments made by the RCA Trust that would trigger a refund of the 50 per cent refundable tax paid on the annual fees or premiums. Employers are effectively required to pay the 50 per cent refundable tax paid with no practical mechanism to recover it. 

Budget 2023 proposes an amendment to the legislation such that fees or premiums paid for the purposes of securing or renewing a letter of credit (or a surety bond) for an RCA will not be subject to the 50 per cent refundable tax. This change would apply to fees or premiums paid on or after March 28, 2023. Budget 2023 also proposes to allow employers the ability to request a refund of previously remitted refundable taxes, based on the retirement benefits that are paid by the employer to employees that have RCA benefits secured by letters or credit (or surety bonds). 

Budget 2023 proposes updates intended to facilitate the use of Employee Ownership Trusts (EOT) to acquire and hold shares of a business. An EOT is a form of employee ownership of a business where a trust holds shares of a corporation for the benefit of the corporation’s employees. EOTs are used to facilitate the purchase of a business by its employees, without requiring the employees to pay directly to acquire the shares. An EOT also provides business owners with an alternative exit/succession option.  

To qualify as an EOT, the following conditions must be met: 

• The EOT must be a Canadian resident trust (excluding deemed resident trusts); 
• The EOT must only have two purposes: 

1. To hold shares of qualifying business for the benefit of the employee beneficiaries of the trust; and 
2. To make distributions to employee beneficiaries, where reasonable, under a distribution formula that could only consider an employee’s length of service, remuneration, and hours worked. Otherwise, all beneficiaries must be treated in an identical manner.  

• The EOT must hold a controlling interest in the shares of a qualifying business.  
• For a business to qualify, it must fulfill certain criteria, which includes that all or substantially all of the fair market value of its assets are attributed to assets utilized in an active business carried on in Canada; 
• All or substantially all of an EOT’s assets must be shares of a qualifying business; 
• The beneficiaries must only consist of qualifying employees; and 
• The beneficiaries would elect qualifying Canadian resident trustees at least once every five years. 

An EOT would be a taxable trust and would generally be subject to the same rules as other personal trusts, with certain exceptions.  

Budget 2023 proposes the following tax changes to help encourage the use of EOTs:   

• Extending the capital gains reserve available on the disposition of qualifying share sales by a business owner to an EOT from 5 years to 10 years. All individuals who dispose of shares in a qualifying business transfer would be eligible to utilize the proposed extended capital gains reserve. 
• Extending the repayment period for amounts loaned by a qualifying business to an EOT to fund the purchase of qualifying shares from one year to 15 years (thereby deferring the applicability of the shareholder loan rules). 
• Exempting EOTs from the 21-year deemed disposition rule otherwise applicable to most trusts. 

The EOT changes are proposed to apply as of January 1, 2024. 

The Alternative Minimum Tax (AMT) was designed to ensure that the highest-income Canadians are still subject to a proportionate amount of tax where various deductions, credits and other tax planning strategies are used to lower their taxes. The AMT is calculated similar to regular tax but allows for fewer tax deductions, exemptions and credits in order to derive an AMT base on which the AMT applies. High-income earners are required to pay the higher of the AMT and the regular tax calculated. Additional tax paid under the AMT is generally permitted to be carried forward for seven years and be used as a credit against regular income tax paid to the extent regular tax exceeds AMT in those future years.  

Budget 2023 proposes various amendments to the AMT regime to address the concern that some of the wealthiest Canadians still pay very little income tax. The proposed changes to the AMT regime that are proposed to take effect for taxation years after 2023 are as follows: 

Change in AMT rate: 

• Increase of the AMT rate from 15 per cent to 20.5 per cent 

Change in Basic AMT exemption:

Increase of the AMT exemption amount from $40,000 to the start of the fourth federal tax bracket in each year (approximately $173,000 for 2024), to protect lower and middle-income individuals from the application of AMT.  

Broadening of the AMT Base: 

Increased income inclusions to the AMT base: 

• Capital gains inclusion rate would increase from 80 per cent to 100 per cent 
• Capital loss carry forwards and allowable business investment losses would be reduced to 50 per cent 
• Stock option benefits would be included at 100 per cent rate with no ability to claim a 50 per cent stock option deduction 
• A 30 per cent inclusion rate capital on gains on donations of publicly listed securities
• A 30 per cent inclusion on the full benefit associated with employee stock options, to the extent that a deduction is available because the underlying securities are donated 

A reduction from 100 per cent to 50 per cent on the following deductions to the AMT base: 

• Deduction of employment expenses (excluding expenses incurred to earn commission income) 
• Deduction of Canada Pension Plan, Quebec Pension Plan, and Provincial Parental Insurance Plan contributions 
• Moving expenses 
• Childcare expenses  
• Disability supports deduction 
• Deduction for workers’ compensation payments  
• Deduction for social assistance payments  
• Deduction for Guaranteed Income Supplement and Allowance payments 
• Deduction for Canadian armed forces personnel and police 
• Interest and carrying charges incurred to earn income from property 
• Deduction for limited partnership losses of other years 
• Non-capital loss carryovers  
• Northern resident deductions 

In addition to the above, the government proposes to reduce the rate on which non-refundable tax credits can be credited against the AMT. Currently, most non-refundable tax credits can be credited against the AMT at a rate of 100 per cent. The government is proposing to reduce the rate from 100 per cent to 50 per cent on these tax credits. An exception to this rule would apply for foreign tax credits.  

On June 29, 2021, Bill C-208 was introduced with the intention of facilitating intergenerational transfer of shares of small business corporations or farm/fishing corporations in circumstances where section 84.1 of the Income Tax Act otherwise would have applied. Section 84.1 is an anti-avoidance rule that has the effect of re-characterizing capital gains into dividends where certain criteria are met. The purpose of section 84.1 is to mitigate transactions that allow an individual to convert dividends into capital gains, since capital gains are generally taxed at more favorable tax rates, and bring with it the potential availability of the lifetime capital gains exemption to shelter all or a portion of the capital gain. 

Prior to the introduction of Bill C-208, section 84.1 would re-characterize a capital gain incurred by a parent that sold their shares of a small business corporation or farm/fishing corporation to an acquisition company owned by their adult child, into a dividend. With the introduction of Bill C-208, where certain criteria were met, the re-characterization rule would not apply such that the parent could retain a capital gain on the disposition of their shares to an acquisition company owned by their adult child, and potentially be able to claim the lifetime capital gains exemption on the sale. 

Bill C-208 contained insufficient safeguards in which taxpayers could avoid applying section 84.1 in situations not in line with Bill C-208's intentions.  

As part of Budget 2023, the federal government proposes to amend the rules of Bill C-208 such that only “genuine” intergenerational share transfers are excluded from the application of section 84.1, effective for transactions that occur on or after January 1, 2024. To do so, the government proposes to add further conditions where the exclusion of the applicability of section 84.1 only applies if one of the following alternatives are met: 

a. An immediate intergenerational business transfer (three-year test) based on arm’s length sale terms (the “Immediate Business Transfer Alternative”); or

b. A gradual intergenerational business transfer (five-to-ten-year test) based on traditional estate freeze characteristics ^[1] (the “Gradual Business Transfer Alternative”)

Under the Immediate Business Transfer Alternative, various conditions would need to be met:

a. the parents must immediately and permanently transfer both legal and factual control of the company, including an immediate transfer of a majority of voting shares, and a transfer of the balance of voting shares within 36 months; 

b. the parents must immediately transfer a majority of the common growth shares, and transfer the balance of the common growth shares within 36 months;  

c. the parents must transfer management of the business to their child within a reasonable time based on the particular circumstances (a 36-month safe harbor rule will be available); 

d. the child or children must retain legal (not factual) control for a 36-month period following the initial sale time; and  

e. At least one child remains actively involved in the business for the 36-month period following the share transfer.  

Under the Gradual Business Transfer Alternative, various conditions would need to be met:

a. the parents must immediately and permanently transfer only legal control of the company, including an immediate transfer of a majority of voting shares, and a transfer of the balance of voting shares within 36 months; 

b. the parents must immediately transfer a majority of the common growth shares, and transfer the balance of the common growth shares within 3 years, and within 10 years of the initial sale, the parents reduce the economic value of their debt and equity interest in the company to: 

i. 50 per cent of the value of their interest in a farm or fishing corporation at the initial sale time; or  

ii. 30 per cent of the value of their interest in a small business corporation at the initial sale time.  

c. the parents must transfer management of the business to their child within a reasonable time based on the particular circumstances (a 36-month safe harbor rule will be available);  

d. the child or children must retain legal (not factual) control for the greater of 60 months or until the business transfer is fully completed; and  

e. At least one child must remain actively involved in the business for the greater of 60 months or until the business transfer is fully completed. 

The transferor and the child (or children) would be required to jointly elect for one of the above alternatives to apply. If the transfer does not meet the conditions, the child (or children) and the transferor will be held jointly and severally liable for any taxes arising as a result of the application of section 84.1. The limitation period for reassessing the transferor’s liability for tax is proposed to be extended by three years for immediate business transfers, and by 10 years for gradual business transfers.  

In addition, where there is a subsequent arm’s length share transfer or when there is a death or disability of a child, the government proposes to add new relieving rules such that the lifetime capital gains exemption may be available to the child in these situations.  

The Budget also proposes to provide a 10-year capital gains reserve to the transferor for “genuine” intergenerational share transfers only.

[1] An estate freeze typically involves a parent exchanging their common shares for fixed value interest in the corporation to allow future growth to accrue to their children while the parent’s fixed value interest is then gradually diminished by the corporation repurchasing the parent’s interest.  

• Clean Hydrogen Investment Tax Credit (CH Tax Credit)
  
  The proposed CH Tax Credit under Budget 2023 would apply to expenses incurred for buying and setting up eligible equipment utilized in projects that generate hydrogen through electrolysis or natural gas. The CH Tax Credit is a refundable tax credit that can equal 15 to 40 per cent of the cost of eligible equipment that becomes available for use on or after March 28, 2023, based on assessed carbon intensity of the hydrogen that is produced. The credit would gradually be phased out starting in 2034.

• Clean Technology Investment Tax Credit – Geothermal Energy (CT Tax Credit)
  
  The CTI Tax Credit is a 30 per cent refundable credit available to businesses investing in eligible property that is acquired after March 28, 2023. Equipment that would qualify for this credit would include equipment used to generate electricity from solar, wind and water energy, non-fossil fuel stationary electricity storage equipment, active solar heating equipment, air-source heat pumps, and ground-source heat pumps. Budget 2023 proposes to expand eligibility of the CTI Tax Credit to include geothermal energy systems that are eligible for inclusion in Class 43.1 for capital cost allowance purposes. Budget 2023 also proposes to modify the phase-out of the CTI Tax Credit; rather than having the phase-out begin in 2032, the credit rate would remain at 30 per cent for property that becomes available for use in 2032 and 2033 and would be reduced to 15 per cent in 2034. The credit would be unavailable after 2034. 

• Clean Technology Manufacturing Investment Tax Credit (CTM Tax Credit)
  
  Budget 2023 proposed to introduce the CTM Tax Credit. The CTM Tax Credit is a refundable investment tax credit for clean technology manufacturing and processing, and critical mineral extraction and processing. The CTM Tax Credit will be equal to 30 per cent of the capital cost of eligible property associated with eligible activities. Eligible property would generally include machinery and equipment, including certain industrial vehicles, used in manufacturing, processing, or critical mineral extraction, as well as related control systems. 

• Carbon Capture, Utilization, and Storage Investment Tax Credit (CC Tax Credit)
  
  The CC Tax Credit was proposed in 2022. The CC Tax Credit is a refundable tax credit for carbon capture, utilization, and storage that would be available to businesses that incur qualifying expenses beginning on January 1, 2022. Budget 2023 proposes additional design details in respect of the CC Tax Credit. Further details are expected to be released in the coming months.  

• Zero-Emission Technology Manufacturers
  
  A temporary measure was introduced in 2021 to reduce corporate income tax rates for qualifying zero-emission technology manufactures by 50 per cent. Budget 2023 proposes that income from the following nuclear manufacturing and processing activities would also qualify for the reduced tax rates for zero-emission technology manufacturers: 
  • manufacturing of nuclear energy equipment; 
  • processing or recycling of nuclear fuels and heavy water; and 
  • manufacturing of nuclear fuel rods 

  This expansion of eligible activities would apply for taxation years beginning after 2023. 

  Budget 2023 also proposes to extend the availability of the reduced corporate income tax rates by three years, such that the phase-out would begin in taxation years that begin in 2032 (as opposed to 2029). This measure would be fully phased out for taxation years that begin after 2034. 

The 2022 Fall economic statement introduced the government’s intention to introduce a two per cent tax on share buybacks by Canadian public corporations. Budget 2023 provided further details on the proposals: 

• The proposed tax would apply in respect of buybacks and issuances of equity that occur on or after January 1, 2024. 
• The tax would apply to Canadian-resident entities listed on a designated stock exchange (including real estate investment trusts, specified investment flow through (SIFT) trusts and SIFT partnerships but excluding mutual fund corporations).^[1] 
• The tax would be calculated at two per cent of the net value of an entity’s repurchase of equity (i.e., the fair market value (FMV) of the equity repurchased, less the FMV of equity issued from treasury). This “netting rule” would apply on an annual basis.^[2] 
• The tax will not apply to an entity in a taxation year if it repurchased less than $1 million of equity (on a gross basis) during the taxation year.  
• The acquisition of equity by certain affiliates of an entity would be deemed to have been a repurchase of equity by the entity itself (with certain exceptions to this rule available). 

^{[1] Publicly traded entities that would be SIFT trusts or SIFT partnerships if their assets were located in Canada would also be subject to the tax.  
[2] There are certain exceptions to the netting rule that are also proposed.} 

The General Anti-Avoidance Rule (GAAR) is an anti-avoidance rule in the Income Tax Act that is intended to prevent tax avoidance by denying any tax benefits realized by a taxpayer in situations where abusive tax avoidance exists. 

To make the GAAR more effective, the government is proposing the following changes:  

• Adding a pre-amble to provide more clarity on the interpretation of the provision, and to ensure that it applies in cases where there is a misuse or abuse of the tax rules to obtain unintended benefits, regardless of whether such benefits were foreseen or not.  
• The threshold for the “avoidance transaction” test would be reduced from a “primary purpose” test to “one of the main purposes” test, such that it could apply where there is a significant tax avoidance purpose, even if such a purpose was not the “primary purpose” of the transaction.  
• The introduction of an “economic substance” test such that the GAAR could be applicable in situations where a transaction lacks economic substance, where the other conditions for the GAAR to be applicable are also met. The amendments would provide the following indicators for determining whether a transaction lacks economic substance (note that this is not intended to be an exhaustive list): 

a. Whether there is a potential for pre-tax profit; 

b. Whether the transaction has resulted in a change of economic position; and 

c. Whether the transaction is entirely (or almost entirely) tax motivated.  

• A penalty would be introduced, equal to 25 per cent of the amount of the tax benefit. The penalty could be avoided if the CRA is notified of the transaction, either through the proposed mandatory disclosure rules or voluntarily.  
• A three-year extension to the normal reassessment period would be introduced. However, the CRA would not be able to extend the normal reassessment period where the transaction is disclosed to the CRA by the taxpayer. 

Budget 2023 includes an update on recent developments and upcoming implementation steps in relation to the two-pillar international tax reform plan that is part of the OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing. 

Pillar One is intended to reallocate a portion of taxing rights over the profits of the largest and most profitable multinational enterprises (MNEs) to market countries (i.e., where their users and customers are located). Pillar Two is intended to ensure that the profits of large MNEs are subject to an effective tax rate of at least 15 per cent, regardless of where they are earned. 

Pillar One - Reallocation of Taxing Rights

Canada and its international partners are working towards completing multilateral negotiations so that the convention for implementing Pillar One can be signed by mid-2023, with the aim of it coming into force in 2024. 

The government also intends to release a revised draft of the legislative proposals for a Digital Services Tax (DST) that could be imposed as of January 1, 2024. The DST would be payable as of 2024 in respect of revenues earned as of January 1, 2022. The DST will only be imposed if the multilateral convention implementing Pillar One has not yet come into force by January 1, 2024.  

Pillar Two - Global Minimum Tax

Consistent with the announcement in Budget 2022, Budget 2023 announces the government's intention to introduce legislation implementing the Income Inclusion Rule (IIR) and a domestic minimum top-up tax applicable to Canadian entities of MNEs. This would come into effect for fiscal years of MNEs starting on or after December 31, 2023. The government also intends to implement the Undertaxed Profits Rule (UTPR) effective for fiscal years of MNEs that begin on or after December 31, 2024. 

The IIR imposes a top-up tax on the ultimate parent entity with respect to income from the MNE's operations in any jurisdiction where it is taxed at an effective tax rate below 15 per cent. The government intends to release draft legislative proposals for the IIR in the coming months.  

The UTPR would impose the top-up tax on the group entities located in their jurisdiction if the parent jurisdiction of an MNE has not been implemented for IIR. This ensures that MNEs whose parent entities are located in non-implementing jurisdictions are nonetheless subject to top-up tax in respect of their low-taxed income. 

The government will continue to monitor international tax developments as it moves forward with the implementation of Pillar Two.