The first Conservative Federal Budget to hit the airwaves in a number of years was finally released on May 2, 2006.  Unlike the budgets released in the past decade, the 2006 Conservative Budget has an interesting side-kick: the November 2005 Federal “mini-budget” released by the ousted Liberal government.  So it’s only human nature to compare Jim Flaherty’s budget with the announcements proposed by his Liberal counterpart last fall. 

CORPORATE INCOME TAX PROPOSALS

Corporate Tax Rates

The budget proposes to reduce the general corporate income tax rate as follows: 

• to 20.5 per cent effective January 1, 2008
• 20 per cent effective January 1, 2009
• 19 per cent effective January 1, 2010

Corporate Surtax

The budget also proposes to eliminate the corporate surtax for all corporations effective January 1, 2008, prorated for taxation years that include that date. Its elimination is equivalent to a 1.12 percentage point reduction in corporate income tax rates and will simplify the tax system.

The following chart illustrates the federal corporate income tax rates reflecting the proposed rate reductions:

 

It’s interesting to note that these budget proposals do not differ from the November proposals.

Small Business Limit

One new change in the 2006 budget is the proposed increase to the small business limit up to $400,000 as of January 1, 2007.  In conjunction with this increase is a proposed 1% decrease to the tax rate for small businesses, to be implemented as follows: 

• The rate will be reduced to 11.5% for 2008; and
• The rate will be further reduced to 11% as of January 1, 2009.

The small business deduction will, however, continue to be shared among associated corporations.

Comment

              The following are the tax rates applicable to Ontario corporations, taking the budget   
              proposals into account.

As we get toward the end of the decade, not only will there be a significant deferral from small business rates, but there will be an increase in absolute tax saving (“over-integration”) when dividends are paid out to individual shareholders. 

By the end of the decade, corporate tax rates for qualifying small business income will be just over 1/3 of the top tax bracket for unincorporated individuals, with the annual deferral on the maximum $400,000 of small business income climbing to nearly $120,000. 

Of course, this deferral unwinds to the extent that it is necessary to distribute income from a corporation for personal and living expenses, unless dividends can be paid to low-bracket family members.  But even in this case, there will still be an element of savings: for calendar 2010, the total tax rate when dividends are distributed to a top-bracket taxpayer will be less than 43%, for a tax saving of nearly 4 points (ignoring Employee Health Tax, if applicable).

SR&ED Investment Tax Credit

One converse affect of the increase to the small business limit is that the $2,000,000 threshold for the enhanced investment tax credit relating to SR & ED will be reduced where taxable income for the previous taxation year is between $400,000 and $600,000. This change will apply to taxation years that end after 2006.

Non-Capital Losses & Investment Tax Credits

Similar to the November proposals, the 2006 budget has also proposed to extend the carryforward period for non-capital losses (include farm losses etc) to 20 years from 10 years.  The same extension period will also apply for investment tax credits.

Federal Capital Tax

At the risk of sounding like a broken record, the federal capital tax provisions as announced in November 2005 are still on the slate.  As of January 1, 2006, the budget proposes to eliminate the federal capital (two years earlier than originally scheduled).

Capital Cost Allowance

The budget proposes adjustments to increase CCA rates as follows: 

• Tools: The cost limit for tools eligible for the 100% CCA rate under certain classes is to be increased to $500 from $200 (for tools acquired on or after May 2, 2006); and
• Forestry Bioenergy: The eligibility for accelerated CCA for certain classes is to be extended to certain systems used in the pulp and paper industry.

Apprenticeship Job Creation Tax Credit

In order to encourage the hiring of new apprentices in certain trades, the budget proposes to introduce a non-refundable tax credit equal to 10% of the salaries and wages paid to a qualifying apprentice, to a maximum of $2,000).  So this could be of benefit if you are hiring someone who is in their first two years of a provincially registered contract as an apprentice.

PERSONAL INCOME TAX PROPOSALS

Basic Personal Amount

The budget proposes to effect changes to the lowest income tax rate as follows:  

• Reduced to 15% effective January 1, 2005
• Increased to 15.5% effective July 1, 2006

Comment 

As has been quite apparent from press reports, the 15.5% rate is a rollback of the 15% rate proposed in the November mini-budget.  Viewed from this perspective, this is the only significant income tax increase in the budget.  However, for most taxpayers, the plethora of new tax breaks, summarized below, will more than make up for this increase.

The amount of the personal tax credits mentioned below must be multiplied by the applicable lowest bracket rates to arrive at the dollar value of the credits.  For example, the basic personal amount increase of $500 is actually worth $75 in 2005 (i.e., 15% of $500), $76.25 in 2006 (i.e., 15.25% of $500) and $77.50 in 2007 (i.e., 15.5% of $500). 

Basic Personal Amount

The budget proposes to increase the basic personal amount by $500 to $8,648 for 2005.  However, you’ll note that there is a bit of a dance for 2006, where the first half of the year will be increased by $200, but the second half of the year will be reduced by $400 to $8,639.  This is to offset the reduction in the GST rate (discussed below). Happily, 2006 still results in an overall increase from 2005, and the personal amounts will continue to increase for 2007 and 2008 until the personal amount reaches $10,000 for 2009.

The amounts on which the personal credits are based in respect of a spouse or common-law partner or a wholly dependent relative will also be increased to $7,344 for 2005 and will slowly increase to $8,500 by 2009.

(These increases to the amounts will be in addition to increases that take effect due to indexation of the tax system.)

Large Corporation Dividends

There was some speculation as to whether the Conservative government would repeal the November proposal relating to the enhanced gross up and dividend tax credit for eligible dividends.  But as this budget seems to be revealing itself, we are continuing to see the Conservatives stay true to the November proposals.  Accordingly, you will be able to include 145% of the eligible dividend amount in income (i.e. a 45% gross-up) and the federal dividend tax credit with respect to eligible dividends will be approximately 19% of the grossed-up amount.  This measure will apply to eligible dividends paid after 2005.

Comment:

This proposal will apply to dividends paid by public corporations resident in Canada and other resident corporations that are not CCPCs and are subject to the general corporate tax rate (about 36% in Ontario), as well as to CCPCs resident in Canada, to the extent that their income (other than investment income) is subject to the general corporate tax rate. 

Budget Resolution 20(c)(i) indicates that a Canadian-resident corporation that would “generally” otherwise not be able to pay an eligible dividend, but that has received an eligible dividend, will be permitted to pay an eligible dividend to the extent of the eligible dividend it has received.   

Budget Resolution 20(c)(ii) indicates that a corporation that would “generally” otherwise be able to pay an eligible dividend, but that has received an ineligible dividend from a Canadian-resident corporation, must first pay the ineligible dividend, to the extent of the ineligible dividend it has received. 

Apparently, the first proposal is intended to apply to Canadian-controlled private corporations - i.e., which are “generally” not able to pay an eligible dividend, whereas the second applies to public and other corporations that are not CCPCs (e.g., a corporation controlled by non-residents) – which are “generally” able to pay an eligible dividend.  The latter proposal is intended to prevent, for example, a public company taking over a CCPC and then receiving dividends from it, which are passed out as eligible dividends.   

Budget Resolution 20(b) indicates that special rules would apply to ensure that eligible dividends are measured correctly where corporations resident in Canada become or cease to be subject to the small business rate or undergo reorganizations involving other corporations resident in Canada. 

Based on discussions with Department of Finance officials, while there is no specific mention that eligible dividends could not be paid out of pre-2006 income (as some advisors have speculated), apparently this issue is still under discussion.  Also, where a Canadian-controlled private corporation earns both eligible and non-eligible income directly, it does not have to first “clear out” the ineligible income.  (In this situation, the primary “tracking mechanism” will be to measure eligible income.)  Of course, the foregoing is subject to specific legislation; until the legislation is finalized, this is subject to change.

Donations

Donations of Publicly-Listed Securities to Public Charities:  The budget proposes to reduce the effective inclusion rate for donations of listed public securities to charitable organizations and public foundations from 25% to 0%.  The same applies where the publicly-traded securities were acquired with employee stock options.

Donations of Ecologically-Sensitive Land:  Donations of ecologically-sensitive lands to a conservation charity will reduce the capital gains inclusion rate from 25% to 0%. 

These measures will apply to donations made on or after May 2, 2006.

Comment

This proposal had previously been championed by the Senate Banking Committee, chaired by Senator Jerry Grafstein.  It is somewhat ironic that it was not proposed in Liberal Budgets.  For illustrations of the benefits of this proposal, see Appendix A.

Credits / Benefits

1.  Canada employment credit: A new Credit was proposed which would provide tax relief on the lesser of $500 and your employment income for the year.  As this credit is to take effect on July 1, 2006, the maximum credit available for 2006 will be $250. This credit will increase to $1,000 for 2007. 

2.  Universal child care benefit: The Universal Child Care Benefit is to be introduced (effective July 2006) which would provide all families with $100 per month for each child under the age of 6 years (to be taxable in the hands of the lower-income spouse or common-law partner).  Although this will not affect Old Age Security or Employment Insurance benefits, amendments will be made to the structure of the Canada Child Tax Benefit (CCTB) (see below).

3.  Child Disability benefit: Two changes were proposed in respect of the CCTB:

·        The annual child disability benefit (CDB) will increase to $2,300 from $2,044 starting July 2006

·        The CDB is to be extended by reducing the rates at which the CDB is reduced as family income rises

4.  Children’s fitness credit: The Children’s Fitness Tax Credit was proposed in respect of eligible fees for the enrollment of a child under 16 years of age in an eligible program of physical activity, up to $500.
 

5.  Student credits:  

·        A new tax credit for textbooks is introduced for 2006 and later years, calculated as $65 for each month the student qualifies for the full-time education tax credit and $20 for each month for students eligible for the part-time education tax credit (unused portions of this credit can be transferred to a spouse or common-law partner, parent or grandparent).

·        For 2006 and subsequent years, all scholarships, fellowships and bursary income will be fully exempt from tax (currently only the first $3,000 is exempt).

6.  Public transit credit: A tax credit is proposed for the cost of monthly or annual public transit passes. This credit can be claimed by you, your spouse or common-law partner in respect of your eligible transit costs, your spouse or common-law partner and your dependent children under the age of 19 years.

7.  Pension tax credit — The maximum amount of pension income eligible for the pension income credit will increase to $2,000 (from $1,000) for 2006 and later years

GST

One expected proposal did materialize: a 1% reduction to the GST.  Effective July 1, 2006, the budget proposed a drop in the GST rate to 6%, while also proposing to maintain the GST credit at current levels for low- and modest-income individuals and retaining the existing GST rebate rates for new housing and purchases made by public service bodies.  There are certain transitional rules relating to the rate reduction:

·        If GST becomes payable, or is paid without becoming payable, before July 1, 2006, the 7% rate applies.

·        If GST becomes payable on or after July 1, 2006, without having been paid before that day, the 6% rate applies.

·        If GST is paid on or after July 1, 2006, without having become payable before that day, the 6% rate applies

Also introduced were specific transitional rules relating to certain transactions, including transfers of real property, deemed supplies, imported goods and imported taxable services and intangibles, passenger vehicles and aircraft and employee/partner rebates. 

However, some may find the joy of the GST reduction tempered by the introduction of increased levies on tobacco and alcohol excise duties, introduced to offset the impact of the GST rate reduction.

Comment

Transitional rules pertaining to real estate/leasing are discussed in Appendix B.

MISCELLANEOUS PROPOSALS

Tax Relief for Fishers

The budget proposes to extend the $500,000 lifetime capital gains exemption to dispositions of property used in a fishing business occurring (occurring on or after May 2, 2006).  Also introduced in the budget is an intergenerational tax-free rollover of fishing property transferred to your child or grandchild (similar to the transfer of farm property to a child or grandchild).  The rules relating the ten year reserve applicable to the transfer of farm property to your child or grandchild will also be extended to the transfer of fishing property.

Tradespeople’s Tool Expenses

The total cost of eligible new tools acquired by an employed tradesperson, in excess of $1,000, is proposed to be deductible up to a maximum of $500 for that year.  This measure is to apply for new tools acquired on or after May 2, 2006.

TAX ADMINISTRATION

The budget proposes the following administrative provisions:

·        Penalties & Interest:  Where the Minister extends the deadline to file a return or remit an amount,
late-filing penalties and interest will not apply until after the extension expires (this is applicable for both GST and income tax).

·        Late Filing Penalties: A late-filing penalty is to be introduced for GST returns, similar to the penalty for income tax, at a rate of 1% of the outstanding balance plus an additional 0.25% for each complete .month the return remains outstanding (to a maximum of 12 months).

·        Collection Restrictions: The budget proposes to remove the 90 day waiting period from the date of a notice of assessment before the Minister may commence collection by way of deduction or set-off against amounts owing to the person. 

These measures are to apply on or after the implementation date of the proposals.

Comment and Summary:

To my mind, perhaps the most significant aspect of the budget is that it may help to reveal the attitude of the new Tory government.  It certainly does not have the flavour of a far-to-the-right Bush-type administration – far from it.  There is no hidden agenda for the wealthy.  The only corporate tax cuts are those which were previously proposed by the Liberals themselves.  There are no reductions for high-bracket taxpayers.  In fact, with the array of tax breaks for workers, students, fishers, and those who rely on transit, the focus is more on low-income taxpayers than the wealthy.   While it is apparent that a wealthy individual will likely pocket more money in absolute dollars as a result of the GST decrease, it is also apparent that low-income taxpayers will receive relatively more benefit. 

While it is true that the value of the credits are only a fraction of the stated amounts (because they must be multiplied by the lowest tax bracket percentage), I think that Canadians will be encouraged to take advantage of the various new credits.  Will the fitness tax credit mean that, one day, there will be more Canadians on the podium?  Our country’s outstanding showing in this year’s winter Olympics may be support for the contention that government action may have positive results.   

It is unfortunate that, while the Conservatives have gone out of their way to be inclusive, both the Liberals and NDP have indicated a non-supportive attitude toward the budget.  In the former case, this is ironic since the budget not only confirms most of the changes proposed in the November mini-budget, but introduced a key initiative on charitable donations championed by one of their own.  The NDP’s lack of support reveals their inflexibility, notwithstanding the significant assistance to their constituents.  

Appendix A

Donations of Publicly-Listed Securities to Public Charities

The following tables illustrate, in round numbers, the benefit of the charitable donation proposals relating to donations of publicly-traded securities:

Case #1: Cost base of securities is 50% of value

* Compared to after-tax proceeds from a sale, which would be about $875, less H

Case #2: Cost base of securities is NIL (Note: shares with very low cost base could include flow-through shares, shares of a key shareholder of a corporation that has gone public; public company shares received on a share swap.)

* Compared to after-tax proceeds from a sale, which would be about $750, less H

Appendix B

The GST Reduction – Sales of Real Estate and Leases

As many of our clients are involved in real estate/leasing, the following is a summary of special rules in this area.

Sales of Real Property 

Under the proposed measures, the following specific transitional rules will apply in respect of sales of real property. 

Ownership or Possession Transferred before July 1, 2006: The 7 per cent rate will apply to all of the consideration for a supply by way of sale of real property if ownership of the property, or possession of it under the agreement of purchase and sale, is transferred to the buyer before July 1, 2006. 

Ownership and Possession Transferred on or after July 1, 2006: The 6 per cent rate will apply to all of the consideration for a supply by way of sale of real property if under an agreement of purchase and sale entered into after May 2, 2006, both ownership of the property, and possession of it under the agreement, are transferred to the buyer on or after July 1, 2006. 

Sales of Residential Complexes - Agreement Entered Into on or before
May 2, 2006: For sales of residential complexes (including houses and apartment buildings) made pursuant to a written agreement entered into on or before May 2, 2006, GST will apply at the rate of 7 per cent, even if ownership and possession of the real property are both transferred on or after July 1, 2006.  In these circumstances, where transfer of ownership and possession both take place on or after July 1, 2006, the purchaser will be entitled to file a claim with the CRA to be paid a Transitional Adjustment that reflects the GST rate reduction to 6 per cent net of any corresponding rebate adjustment.

Leases   

It appears that the wording of the most commercial net leases would provide that the tenant to would benefit from GST reductions, by a reduction of Additional Rent, as typically defined in the lease.