Highlights of Canada’s 2023 federal budget

On March 28, 2023 (Budget Day), Finance Minister Chrystia Freeland tabled her third budget in the House of Commons (Budget 2023).

What you need to know

• General anti-avoidance rule (GAAR). Budget 2023 introduced significant changes to the GAAR in section 245 of the Income Tax Act (Canada) (Tax Act), including the introduction of a preamble meant to address interpretive issues, a reduced threshold for identifying an avoidance transaction, a new economic substance test, a 25% penalty levied on the amount of a tax benefit and an extension of the normal reassessment period in certain cases. Interested parties can provide written submissions on these proposals until May 31, 2023. Following this consultation period, the government intends to publish revised proposals and announce the effective date of these changes.
• Tax on repurchases of equity. Budget 2023 proposes legislation to implement a 2% tax on the net value of share repurchases by certain publicly traded entities, beginning on January 1, 2024, and subject to a de minimis threshold of $1 million.
• Dividend received deduction by Canadian financial institutions. Budget 2023 proposes to deny the inter-corporate dividend deduction in respect of dividends received by financial institutions on shares that are held as mark-to-market property.
• Clean technology and green energy measures. Budget 2023 introduces or expands on a number of proposed measures in respect of clean technology and green energy initiatives, including tax credits for clean hydrogen, clean technology investment, carbon capture utilization and storage, clean electricity, clean technology manufacturing and processing and critical mineral extraction and processing. Budget 2023 also expands on certain tax advantages for zero-emission technology manufacturers and lithium producers.
• Intergenerational business transfers. In 2021, pursuant to a private member’s bill in the 43^rd Parliament (Bill C-208), the anti-surplus stripping rule in section 84.1 of the Tax Act was amended to add a new exception to facilitate intergenerational business transfers between non-arm’s length parties. According to Budget 2023, this exception contained insufficient safeguards to ensure that a “genuine” intergenerational business transfer had occurred, and accordingly, Budget 2023 proposes further amendments to section 84.1 (and consequential amendments to other provisions of the Tax Act) to address these perceived shortcomings.
• Employee Ownership Trusts (EOTs). Budget 2023 announces the introduction of an EOT, a form of employee ownership that can be used to facilitate the purchase of a Canadian-controlled-private corporation (CCPC) meeting certain additional conditions by its employees and as an additional option for succession planning to employees. In order to facilitate the establishment and use of EOTs to acquire and hold shares of a corporation, Budget 2023 proposes to create an exception to the current shareholder loan rule, to exempt EOTs from the 21-year deemed disposition rule applicable to certain trusts, and to extend the capital gains reserve to ten years for qualifying sales to an EOT. These rules will apply to transactions that occur on or after January 1, 2024.
• Alternative minimum tax (AMT). Budget 2023 proposes to expand the AMT, which is generally applicable to individuals (including certain trusts), to better target high-income individuals. The changes include raising the AMT flat rate from 15% to 20.5%, increasing the basic exemption amount under the rules and expanding the AMT base by further limiting the deductions, exemptions and tax credits currently available under the AMT regime. These changes will apply beginning in the 2024 taxation year.
• GST/HST treatment of payment card clearing services. Budget 2023 proposes to amend the GST/HST definition of “financial service” retroactively, to legislatively overrule the decision of the Federal Court of Appeal in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10. This decision had held that payments made by CIBC to Visa in respect of CIBC-Visa credit cards were consideration for an exempt supply of a financial service, rather than consideration for a taxable supply of an administrative services. The proposed amendments apply unless the credit card company never charged, collected or remitted GST/HST from credit card issuers.
• Industry-specific coverage of Budget 2023: See also our extended discussions on the impact of the budget for financial institutions and the mining industry.

Click below or use the in-page navigation menu for analysis on key measures included in Budget 2023.

Business income tax measures

Personal income tax measures

Status of previously announced tax measures

GST/HST treatment of payment card clearing services

Business income tax measures

General anti-avoidance rule

Budget 2023 introduced significant legislative proposals to amend the GAAR. The GAAR is designed to negate the tax benefits arising from abusive tax avoidance transactions that may satisfy the technical requirements of the Tax Act but are found to misuse or abuse the underlying policy.

Although the GAAR was introduced 35 years ago, the government announced a comprehensive review of the GAAR in the 2020 Fall Economic Statement. The 2022 federal budget (Budget 2022) proposed to continue that review and on August 9, 2022, a consultation paper titled Modernizing and Strengthening the General Anti-avoidance Rule (Consultation Paper) was released. Following this release, there was a consultation period from August 9 to September 30, 2022, where interested parties had the opportunity to make submissions on the approaches outlined for modernizing the GAAR. Budget 2023 proposes legislation intended to address several of the concerns and suggested approaches outlined in the Consultation Paper.

For the GAAR to apply under the current Tax Act rules, the following three elements must be present: (i) there must be a tax benefit; (ii) an avoidance transaction; and (iii) the avoidance transaction or a series of transactions that includes the avoidance transaction leads to a misuse or abuse of particular provisions of the Tax Act.

The legislative proposals in Budget 2023 amend the GAAR to introduce: a preamble to address interpretative issues, a modified standard for identifying an avoidance transaction, a new economic substance test as part of the misuse and abuse analysis, a 25% penalty levied on the amount of a tax benefit resulting from transactions subject to the GAAR and an extension of the normal reassessment period in certain cases.

The government is currently holding a consultation period allowing interested parties to make submissions on these proposals until May 31, 2023. When the consultation period ends, the government intends to publish revised legislative proposals and announce the effective date for these amendments.

The GAAR has received significant judicial interpretation since its enactment 35 years ago. These legislative proposals introduce considerable uncertainty as to the validity of current GAAR jurisprudence, and if enacted could lead to new tax disputes to clarify the meaning and impact of the amendments.

Preamble

The proposed legislation adds a preamble to the GAAR provisions, the purpose of which is to help address interpretive issues and ensure that the GAAR applies in the intended manner. The preamble outlines that: (i) the GAAR applies to deny the tax benefit from avoidance transactions that misuse provisions of the Tax Act while still allowing taxpayers to obtain benefits contemplated by particular provisions; (ii) the GAAR aims to strike a balance between a taxpayer’s need for certainty in planning their affairs and the government’s responsibility to protect the tax base and the overall fairness of the tax system; and (iii) the GAAR can apply regardless of whether a tax strategy is foreseen.

Avoidance transaction

Currently, the GAAR stipulates that a transaction is an avoidance transaction where it results directly or indirectly in a tax benefit, unless it is carried out primarily for bona fide purposes other than to obtain the tax benefit. The proposed amendments lower this threshold and require that, in order to constitute an avoidance transaction, only one of the main purposes of the transaction is to obtain a tax benefit.

This amendment was discussed in the Consultation Paper, as the government stated that the current avoidance transaction standard was too stringent and, in its view, led courts to an inappropriate finding that GAAR did not apply in several instances. This lower threshold is consistent with other anti-avoidance rules in the Tax Act and the principal purpose test in the OECD’s Multilateral Instrument.

Budget 2023 states that the standard is intended to strike a reasonable balance as it would apply to transactions with a significant tax avoidance purpose but would not apply when tax is simply a consideration.

Economic substance

The proposed GAAR amendments include the addition of an economic substance test. According to Budget 2023, this expansion of the GAAR is in response to Supreme Court of Canada jurisprudence that has established a more limited role for economic substance.

The economic substance test will be considered at the misuse and abuse stage of the GAAR analysis. If there is a lack of economic substance it will be seen as an indication that the transaction is abusive tax avoidance. However, a lack of economic substance on its own does not end the analysis as it is still necessary to determine whether there is a misuse or abuse considering the object, spirit and purpose of the relevant provision. If a transaction lacks economic substance but the tax results are consistent with the purpose of the applicable Tax Act provisions, then the transaction would not be considered abusive tax avoidance.

The proposed amendments provide the following non-exhaustive list of factors that should be considered when determining if a transaction has economic substance: (i) whether there is no change in the opportunity for gain or profit and risk of loss; (ii) whether the expected value of the tax benefit exceeds the expected value of the non-tax economic return (which excludes foreign tax benefits); and (iii) whether the transaction is almost entirely tax motivated. The existence of one or more of these factors supports a finding that there is a lack of economic substance.

Budget 2023 notes that these proposed amendments do not supplant the general approach under Canadian income tax law which focuses more on the legal form rather than the substance of an arrangement. Further, Budget 2023 states that this amendment does not require determining the economic substance of a transaction but rather requires consideration of whether there is a lack of economic substance.

Penalty

The proposed GAAR amendments introduce a significant new penalty for transactions subject to the GAAR, equal to 25% of the amount of the tax benefit resulting from such transactions, unless the transaction was disclosed to the Canada Revenue Agency (CRA) voluntarily or under the proposed mandatory disclosure rules. If the tax benefit relates to a tax attribute that has not yet been used, then the amount of the tax benefit is deemed to be nil for purposes of the penalty. The government intends to amend the proposed reportable transaction rules to permit voluntary reporting for these purposes.

Extended reassessment period

The proposed amendments include a three-year extension to the normal reassessment period for GAAR assessments. However, if the transaction has been disclosed to the CRA under the proposed mandatory disclosure rules or under the newly proposed GAAR voluntary reporting rule, then there is no extension to the normal reassessment period.

Tax on repurchases of equity

Further to the announcement in the 2022 Fall Economic Statement, Budget 2023 includes proposed legislation to implement a 2% tax on the net value of share repurchases by the following entities if any of their equity is listed on a designated stock exchange:

• Canadian-resident corporations (other than mutual fund corporations);
• real estate investment trusts;
• specified investment flow-through (SIFT) trusts;
• SIFT partnerships; and
• entities that would be SIFT trusts or SIFT partnerships if their assets were located in Canada.

As stated in the 2022 Fall Economic Statement, this tax is similar to the share buyback tax that was recently enacted in the United States under the Inflation Reduction Act of 2022.

The tax is calculated as 2% of the difference between the total fair market value of equity that is redeemed, acquired or cancelled in the taxation year and the total fair market value of equity that is issued in the taxation year. Certain transactions are not included in the tax calculation, including the issuance and cancellation of debt-like preferred shares and units that have a fixed dividend and redemption entitlement, and the issuance and cancellation of shares or units in certain corporate reorganizations and acquisitions, including certain amalgamations, liquidations, and share-for-share exchanges. For greater certainty, Budget 2023 specifies that normal course issuer bids and substantial issuer bids will be covered by the new tax.

The proposed legislation includes a de minimis threshold of $1 million, such that the tax will not apply if the total fair market value of equity that is redeemed, acquired or cancelled is less than $1 million in a taxation year (the amount is prorated for short taxation years). The de minimis threshold only considers equity repurchases and does not take into account equity issued in the year.

Under the proposed legislation, equity acquisitions by certain affiliates are deemed to be acquisitions by the entity itself, with exceptions for acquisitions that are intended to facilitate certain equity-based compensation arrangements and acquisitions made by registered securities dealers in the ordinary course of business. In addition, if a person or partnership undertakes a transaction or series of transactions to acquire equity of an entity to which these rules apply, and it is reasonable to consider one of the main purposes of the equity acquisition to be the avoidance of the 2% tax, the person or partnership will be considered an affiliate under these rules and the deeming provision described above will apply.

The tax applies to equity repurchases and issuances that occur on or after January 1, 2024, and relevant taxpayers that redeem, acquire or cancel equity will be required to file a return in prescribed form.

The government expects to recover $2.5 billion in revenue over the next five years from this tax.

Dividend received deduction by financial institutions

The proposed dividend denial refers to the inter-corporate dividend deduction and the mark-to-market rules under the Tax Act. As background to the proposal, we provide a brief background to these two regimes.

Generally, the inter-corporate dividend deduction permits a taxable Canadian corporation to deduct, in computing its taxable income, taxable dividends received on shares of other taxable Canadian corporations. This inter-corporate dividend deduction recognizes and is part of achieving a fundamental principle of Canadian taxation referred to as corporate integration. The inter-corporate dividend deduction is intended to recognize that the dividend was paid out of after-tax earnings and to prevent earnings being taxed more than once at multiple corporate levels.

The mark-to-market rules apply in respect of certain properties held by financial institutions. In very general terms, these rules require financial institutions to mark to market their holdings of certain securities and other instruments held as mark-to-market property. The mark-to-market rules also generally require that gains and losses on such securities and instruments be recognized by the financial institution on income account and not as capital gains and losses. For purposes of these rules, a financial institution includes a Schedule I or II bank under the Bank Act (Canada) and an insurance corporation. A mark-to-market property is defined to mean, among other types of property, a share of a corporation representing less than 10% of all the shares of the corporation by votes or value.

Budget 2023 proposes to deny any inter-corporate dividend deduction otherwise available to a financial institution in respect of taxable dividends received by the financial institution on shares held by the financial institution as mark-to-market property. The government explains the change by asserting that, “The policy behind the dividend received deduction conflicts with the policy behind the mark-to-market rules”. And further that, “The tax treatment of dividends received by financial institutions on portfolio shares held in the ordinary course of their business is inconsistent with the tax treatment of gains on those shares under the mark-to-market rules”.

It is submitted that, in fact, there is no conflict between the inter-corporate dividend deduction on a share that is held as mark-to-market property and the mark-to-market rules. The market-to-market rules have been part of the Tax Act for nearly three decades and the inter-corporate dividend deduction and the mark-to-market regime have lived harmoniously with one another since that time. There are in fact specific rules that ensure this result, such as a stop-loss rule that deals only with deductible dividends and losses realized by a financial institution on shares held as mark-to-market property. In fact, not only do the two regimes not conflict with one another, they could not conflict because they address two separate and distinct matters.

It is submitted that the Budget 2023 proposal to deny the inter-corporation dividend deduction for financial institutions on shares held by them as mark-to-market property represents a fundamental policy shift and an erosion of a core principle of the Tax Act, namely, corporate integration. There already exist in the Tax Act a myriad of rules that police the use of the inter-corporate dividend deduction in circumstances determined by the government to be abusive. These include the dividend rental arrangement rules in the Tax Act which in turn encompass rules dealing with synthetic equity arrangements. If the government perceives problems with those rules, it should be possible to address their deficiencies without a wholesale abandoning of a fundamental principle of Canadian taxation.

There is also concern that this legislative measure singles out Canadian financial institutions. While financial institutions are required to hold certain shares as mark-to-market property, mark-to-market treatment is not restricted to financial institutions. Other corporations whose ordinary business includes trading or dealing in securities are usually required to report gains and losses on their securities on income account and may report such gains and losses annually under a mark-to-market treatment. It is not clear why the inter-corporate dividend deduction and mark-to-market treatment is not problematic for the government for these corporations. The current proposal is a continuation of a pattern of singling out financial institutions, a pattern that includes the 15% Canada recovery dividend and the 1.5% additional annual tax on the income of financial institutions.

Clean technology and green energy measures

Consistent with the focus on the environment and what is described as the “clean economy”, Budget 2023 introduces (or in some cases expands on) a number of proposed measures in respect of clean technology and green energy initiatives, including:

• providing further details on the tax credit for clean hydrogen (CH Tax Credit);
• expanding the tax credit for clean technology investment to include equipment for geothermal energy projects (CTI Tax Credit);
• providing further details on the tax credit for carbon capture utilization, and storage (CCUS Tax Credit);
• introducing a refundable 15% tax credit for clean electricity (CE Tax Credit);
• introducing a refundable 30% tax credit for clean technology manufacturing and processing and critical mineral extraction and processing (CTM Tax Credit);
• expanding the eligible activities and extending the reduced tax rates in respect of zero-emission technology manufacturers; and
• expanding the flow-through share treatment (and expanding the critical mineral exploration tax credit) for producers of lithium from brines.

Of note is that businesses are only able to claim one of the CH Tax Credit, the CCUS Tax Credit, the CTI Tax Credit, the CE Tax Credit or the CTM Tax Credit in respect of a particular property even if such property is eligible for more than one of these tax credits. However, multiple tax credits could be available in respect of the same project, if such project includes different types of eligible property.

The introduction and expansion of the various refundable tax credits suggests that the government recognized that the use of refundable tax credits is often more valuable to businesses looking at investing in these growth areas as opposed to enhanced capital cost allowance (CCA) rates for manufacturing and processing and clean energy equipment. This is not surprising due to the fact that businesses in the “clean energy” industry are often in the development phase and less able to take advantage of the enhanced CCA rates.

Although Budget 2023 provides businesses with the opportunity to plan investments with the various tax credits in mind, many of the details regarding the application of the tax credits are yet to be released, including the interaction of the tax credits in the context of partnerships with taxable and tax-exempt members. Moreover, the refundable nature of these credits can assist with current financing, with the additional funding potentially tipping the scale towards making such projects financially viable.

Tax credit for clean hydrogen

The CH Tax Credit was first announced in the 2022 Fall Economic Statement. As expected, Budget 2023 sets out additional details regarding the CH Tax Credit, which is proposed to apply in respect of the cost of purchasing and installing eligible equipment for projects that produce hydrogen from: (i) electrolysis; or (ii) natural gas, provided emissions are abated using carbon capture utilization, and storage (CCUS). The rate of the CH Tax Credit varies between 5-40%, depending on carbon intensity of the hydrogen that is produced and whether certain labour conditions are met.

The CH Tax Credit will be available in respect of the cost of purchasing and installing eligible equipment, which will include:

• equipment required to produce hydrogen from electrolysis, if all or substantially all of the use of that equipment is to produce hydrogen through electrolysis of water, including electrolysers, rectifiers and other ancillary electrical equipment, water treatment and conditioning equipment, and equipment used for hydrogen compression and on-site storage; and
• equipment required to produce hydrogen from natural gas with emissions abated using CCUS, excluding equipment that is already described in Class 57 or Class 58 (which is eligible for the CCUS Tax Credit).

The CH Tax Credit is proposed to be available when eligible equipment becomes available for use in Canada after Budget Day. The CH Tax Credit is proposed to be phased-out beginning in 2034 such that the CH Tax Credit in respect of property that becomes available for use in 2034 will be subject to a 50% reduction and the CH Tax Credit will be completely phased out for any property that becomes available for use in subsequent years.

Tax credit for clean technology investment includes geothermal energy systems

Budget 2023 also announced new details regarding the CTI Tax Credit, which was proposed in the 2022 Fall Economic Statement. The CTI Tax Credit is a 30% refundable credit available to businesses investing in eligible property that is acquired and that becomes available for use on or after Budget Day, where it has not been used for any purpose before its acquisition.

Budget 2023 proposes to expand eligibility of the CTI Tax Credit to include geothermal energy systems that are eligible for Class 43.1. Eligible property includes equipment used primarily for the purpose of generating electrical energy or heat energy, or both electrical and heat energy, solely from geothermal energy, that is described in subparagraph (d)(vii) of Class 43.1 (which generally includes piping, pumps, heat exchangers, steam separators, and electrical generating equipment). Unfortunately, equipment used for geothermal energy projects that will co-produce oil, gas or other fossil fuels would not be eligible for the CTI Tax Credit.

The phase-out of the CTI Tax Credit announced in Budget 2023 differs from the previous phase-out in the 2022 Fall Economic Statement. Rather than starting the phase-out in 2032, as previously announced, the CTI Tax Credit rate would remain at 30% for eligible property that becomes available for use in 2032 and 2033 and would be reduced to 15% in 2034. The CTI Tax Credit would be unavailable after 2034.

Tax credit for carbon capture, utilization and storage

Budget 2023 proposed an expansion and additional design details of the CCUS Tax Credit that was originally proposed in Budget 2022 to be available to businesses that incur eligible expenses starting on January 1, 2022.

Budget 2023 proposes that dual use equipment that produces heat and/or power or uses water, that is used for carbon capture, utilization, and storage as well as another process (i.e., has a dual purpose), be eligible for the CCUS Tax Credit (as capture equipment), provided that such equipment satisfies all other conditions for the CCUS Tax Credit. The cost of such dual purpose equipment would be eligible for the CCUS Tax Credit on a pro-rated basis in proportion to the expected energy balance or material balance supporting the carbon capture, utilization, and storage process over the first 20 years of the project. Dual use power or heat production equipment would be eligible for the CCUS Tax Credit only if the energy balance is expected to be primarily used (i.e., more than 50%) to support the CCUS process or hydrogen production that is eligible for the proposed CH Tax Credit. Note that for equipment producing both heat and power, only one of the heat or power energy balance would need to meet this requirement. Carbon dioxide emissions from power and/or heat production equipment would need to be captured and stored or used for the equipment to be eligible.

Following the Minister of Environment and Climate Change Canada’s recommendation, Budget 2023 proposed that British Columbia be added to the list of eligible jurisdictions for dedicated geological storage, applicable to expenses incurred on or after January 1, 2022.

Budget 2023 also proposed certain requirements for storage in concrete to be considered an eligible use, including confirmation by way of a third-party validation statement before any CCUS Tax Credit relating to carbon dioxide storage in concrete could be claimed.

There were also details released in Budget 2023 regarding how CCUS Tax Credits related to eligible refurbishment costs incurred once the project is operating would be calculated and certain limits on such CCUS Tax Credits (e.g., CCUS Tax Credits would not be available in respect of costs incurred after the first 20 years of the project and would be limited to a maximum of 10% of the total pre-operational costs that were eligible for the CCUS Tax Credit).

The measures surrounding the CCUS Tax Credit would apply to eligible expenses incurred after 2021 and before 2041. Budget 2023 indicated that further details with respect to the CCUS Tax Credit will be included in legislative proposals to be released in the coming months.

Tax credit for clean electricity

Budget 2023 proposed a new CE Tax Credit, which would be a 15% refundable tax credit for eligible investments (which would include both new projects and the refurbishment of existing facilities) in:

• non-emitting electricity generation systems: wind, concentrated solar, solar photovoltaic, hydro (including large-scale), wave, tidal, nuclear (including large-scale and small modular reactors);
• abated natural gas-fired electricity generation (which would be subject to an emissions intensity threshold compatible with a net-zero grid by 2035);
• stationary electricity storage systems that do not use fossil fuels in operation, such as batteries, pumped hydroelectric storage, and compressed air storage; and
• equipment for the transmission of electricity between provinces and territories.

Importantly, the CE Tax Credit would be available for taxable and non-taxable entities such as Crown corporations and publicly owned utilities, corporations owned by Indigenous communities, and pension funds. Another key feature of the proposed CE Tax Credit is that, unlike the majority of the other proposed tax credits, the CE Tax Credit is proposed to be available in respect of the refurbishment of existing facilities.

The CE Tax Credit is proposed to be available as of the day of the 2024 federal budget for projects that did not begin construction before the day of Budget 2023 and is slated to be phased out by 2035.

Tax credit for clean technology manufacturing and critical mineral extraction and processing

Budget 2023 proposes the CTM Tax Credit, which is a refundable tax credit that applies in respect of clean technology manufacturing and processing, as well as critical mineral extraction and processing. The CTM Tax Credit rate is proposed to be equal to 30% of the capital cost of eligible property associated with eligible activities.

Eligible property will generally include machinery and equipment, including certain industrial vehicles, used in manufacturing, processing, or critical mineral extraction, as well as related control systems. Businesses that are interested in acquiring eligible property in order to receive the tax credit should note that there are proposed tax integrity rules dealing with situations where eligible property is subject to a change in use or sold within a certain period of time. These rules propose to recover a portion of the CTM Tax Credit in such cases.

Eligible activities for the purpose of the CTM Tax Credit would include:

• manufacturing of certain renewable energy equipment (e.g., solar, wind, water, or geothermal);
• manufacturing of nuclear energy equipment;
• processing or recycling of nuclear fuels and heavy water;
• manufacturing of nuclear fuel rods;
• manufacturing of electrical energy storage equipment used to provide grid-scale storage or other ancillary services;
• manufacturing of equipment for certain heat pump systems;
• manufacturing of zero-emission vehicles, including conversions of on-road vehicles;
• manufacturing of batteries, fuel cells, recharging systems, and hydrogen refueling stations for zero-emission vehicles;
• manufacturing of equipment used to produce hydrogen from electrolysis; and
• manufacturing or processing of upstream components, sub-assemblies, and materials provided that the output would be purpose-built or designed exclusively to be integral to other eligible clean technology manufacturing and processing activities, such as anode and cathode materials used for electric vehicle batteries.

In addition, eligible activities would also include the extraction and certain processing activities related to six critical minerals that are essential for clean technology supply chains: lithium, cobalt, nickel, graphite, copper, and rare earth elements. This would include activities both before and after the prime metal stage or its equivalent (generally, the point where the production processes have produced a marketable, saleable commodity which meets the specifications of its consumers).

Application and phase-out

The CTM Tax Credit would be phased-out after 2034. Notably, Budget 2023 did not outline whether or not the CTM Tax Credit would be refundable to entities that are tax-exempt.

Labour requirements related to certain investment tax credits

The 2022 Fall Economic Statement announced the intention to attach prevailing wage and apprenticeship requirements (Labour Requirements) to the CTI Tax Credit and the CH Tax Credit. Budget 2023 confirms that the Labour Requirements would also apply to the CE Tax Credit and the CCUS Tax Credit.

The prevailing wage requirement is designed to ensure that covered workers are compensated at a level that meets or exceeds the relevant wage, plus the substantially similar monetary value of benefits (i.e., health and welfare and vacation benefits) and pension contributions (converted into an hourly wage format), as specified in an “eligible collective agreement”. Generally, outside Québec an eligible collective agreement would be a comparable collective agreement for the relevant industry and type of work performed aligning with workers’ duties and location. In Québec, eligible collective agreements would be those negotiated in accordance with relevant provincial law.

To meet the apprenticeship requirement, a business would need to ensure that for a given taxation year, not less than 10% of the total labour hours performed by covered workers engaged in subsidized project elements be performed by registered apprentices. Covered workers are those whose duties correspond to those performed by a journeyperson in a Red Seal trade.

Reduced tax credits are proposed to be available if the Labour Requirements are not met:

During the phase-out periods of the CTI Tax Credit and CH Tax Credits, the tax credit rate available would be reduced by 10% (to a minimum of zero), if the Labour Requirements are not met.

The Labour Requirements will apply to work performed on or after October 1, 2023 and will apply only with respect to workers whose duties are primarily of a physical or manual nature (e.g., labourers and tradespeople) and not to workers whose duties are primarily administrative, clerical, supervisory, or executive. Certain exemptions from the Labour Requirements apply in respect of the CTI Tax Credit. Businesses can choose to pay corrective remuneration to workers (including interest) and certain penalties in order to resolve non-compliance and be deemed to have satisfied the requirements.

Zero-emission technology manufacturers

Following up on the temporary measures introduced in the 2021 federal budget (Budget 2021), which reduced corporate income tax rates for qualifying zero-emission technology manufacturers by 50%, Budget 2023 proposes to apply reduced tax rates on eligible zero-emission technology manufacturing and processing income of 7.5% (where that income would otherwise be taxed at the 15% general corporate tax rate) and 4.5% (where that income would otherwise be taxed at the 9% small business tax rate). In addition, Budget 2023 proposes that income from certain nuclear manufacturing and processing activities would qualify for the reduced tax rates for zero-emission technology manufacturers for taxation years beginning after 2023.

The reduced tax rates applying to eligible zero-emission technology manufacturing and processing income have effectively been extended by two years and will begin to be phased out in 2032 with a full phase-out occurring in 2035.

Flow-through share treatment (and expansion of the critical mineral exploration tax credit) for lithium from brine

Budget 2023 proposes to include lithium from brines as a mineral resource for the purposes of the flow-through share rules in the Tax Act, which would allow:

• relevant principal-business corporations that undertake certain exploration and development activities to issue flow-through shares and renounce expenses to their investors; and
• individuals (other than trusts) who invest in flow-through shares to claim the Critical Mineral Exploration Tax Credit (a 30% non-refundable tax credit) in respect of specified critical mineral exploration expenses incurred by the corporation and transferred to the individual under a flow-through share agreement.

These measures should result in a meaningful premium in offering proceeds for those corporations that qualify and choose to raise equity through flow-through shares, providing support for the development of activities of this type.

Personal income tax measures

Strengthening the intergenerational business transfer framework

Background

Section 84.1 of the Tax Act contains an anti-surplus stripping rule that is applicable to a taxpayer resident in Canada, other than a corporation, in the context of certain non-arm’s length share transfers. More specifically, section 84.1 of the Tax Act can apply when:

• an individual taxpayer transfers shares of a Canadian-resident corporation (subject corporation);
• the purchaser is another Canadian-resident corporation (purchaser corporation) with which the taxpayer does not deal at arm’s length; and
• following the transfer, the subject corporation and the purchaser corporation are “connected” within the meaning of subsection 186(4) of the Tax Act.

If the basic conditions in section 84.1 of the Tax Act are satisfied, the provision generally operates to limit the tax “paid-up capital” of the shares of the purchaser corporation received by the taxpayer as consideration, and if the taxpayer also receives non-share consideration from the purchaser, the rules could apply to deem the taxpayer to receive a dividend, as calculated under detailed rules.

Historically, section 84.1 of the Tax Act could apply on an intergenerational business transfer, that is, when an individual sold shares of a subject corporation to a purchaser corporation controlled by the individual’s children. However, effective June 29, 2021, Bill C-208 added, among other things, a relieving rule in section 84.1 of the Tax Act for the stated purpose of facilitating intergenerational business transfers. In general, the Bill C-208 relieving rule applies to deem persons to be dealing at arm’s length for purposes of section 84.1 of the Tax Act (with the result that section 84.1 of the Tax Act would not apply) if: (i) the shares of the subject corporation being transferred are shares of a qualified small business corporation (QSBC) or of a family farm or fishing corporation (FFFC); (ii) the purchaser corporation is controlled by one or more children or grandchildren of the transferor; and (iii) the purchaser corporation holds the shares for at least 60 months following the acquisition.

Shortly after the enactment of the Bill C-208 relieving rule, in 2021, the government announced that while it was committed to facilitating genuine intergenerational business transfers, it intended to bring forward amendments to safeguarding against any unintended tax avoidance loopholes that may have been created by the Bill C-208 relieving rule¹.

Proposed amendments

Further to the 2021 announcement, Budget 2023 includes amendments intended to address shortcomings that the government perceived in the Bill C-208 relieving rule to ensure that it applies only to “genuine” intergenerational business transfers. These proposals amend the Bill C-208 relieving rule to deem parties to deal at arm’s length for purposes of section 84.1 of the Tax Act provided that the transfer of shares of the subject corporation occurs under the “Immediate Intergenerational Business Transfer” rule, a three-year test based on arm’s length sale terms, or under the “Gradual Intergenerational Business Transfer” rule, a five to ten year test which has traditional estate freeze characteristics.

These amendments will apply to transactions that occur on or after January 1, 2024.

Basic conditions to qualify for Immediate and Gradual Intergenerational Business Transfer rules

The following requirements are common to the Immediate Intergenerational Business Transfer rule and the Gradual Intergenerational Business Transfer rule:

• the transferor must be an individual (other than a trust);
• the subject corporation must be controlled by the transferor and/or the transferor’s spouse or common law partner (Permitted Transferors) prior to the transfer;
• the purchaser corporation must be controlled by a “child” (which for purposes of these rules includes grandchildren, step-children, children-in-law, nieces, nephews, grandnieces and grandnephews) or children of the Permitted Transferors;
• the shares of the subject corporation being transferred must be QSBC shares or FFFC shares;
• following the share transfer, the Permitted Transferors must not own, directly or indirectly, 50% or more of any equity (other than non-voting preferred shares) in the subject corporation, the purchaser corporation or any other person or partnership (relevant group entity) that carries on a business that is relevant for determining whether the subject corporation is a QSBC or FFFC (relevant business);
• after 36 months following the share transfer, the Permitted Transferors cannot hold any equity (other than non-voting preferred shares) in the subject corporation, the purchaser corporation, or any relevant group entity; and
• the Permitted Transferees and the child or children must jointly elect in prescribed form, on or before the transferor’s tax filing deadline for the year of the transfer, for the relieving rule to apply.

Immediate Intergenerational Business Transfer rule

The criteria specific to the Immediate Intergenerational Business Transfer rule are:

• immediately following the share transfer, the Permitted Transferors do not have de jure or de facto control over the subject corporation, the purchaser corporation, or any relevant group entity;
• for 36 months after the transfer: (i) the child or children who own the purchaser corporation control the subject corporation and the purchaser corporation; (ii) at least one of them is sufficiently engaged in a relevant business of the subject corporation or a relevant group entity; and (iii) each relevant business of the subject corporation and any relevant group entity is an “active business” within the meaning of the Tax Act (Engagement Test); and
• within 36 months of the share transfer, or a greater period of time as is reasonable in the circumstances, the Permitted Transferors take reasonable steps to: (i) transfer management of the various relevant businesses to the child or children engaged in such businesses; and (ii) cease managing the relevant businesses (Management Test).

Gradual Intergenerational Business Transfer rule

The criteria specific to the Gradual Intergenerational Business Transfer rule are:

• immediately following the share transfer, the Permitted Transferors do not have de jure control (but may have de facto control) over the subject corporation, the purchaser corporation, or any other relevant group entity;
• within ten years of the share transfer, the Permitted Transferors do not own interests (which for these purposes include any debt or equity, including non-voting preferred shares) in the subject corporation, the purchaser corporation or any relevant group entity with a fair market value that exceeds 50%, in the case of FFFCs, and 30%, in the case of QSBCs, of the fair market value of the interests in the subject corporation they held prior to the transfer;
• the timeline for the Engagement Test is extended to the later of 60 months from the time of the transfer and the time that the Permitted Transferors meet the immediately preceding ownership threshold; and
• the timeline for the Management Test is extended to within 60 months of the share transfer, or a greater period of time that is reasonable in the circumstances.

Deeming rules

Proposed amendments to section 84.1 of the Tax Act will deem the Engagement Test and/or Management Test to be met if the child or children who control the purchaser corporation sell, or cause to be sold to arm’s length parties, all of the shares of the purchaser corporation, the subject corporation or any relevant group entities, or if the child or children engaged in the relevant business for purposes of the Engagement Test die or become disabled.

Capital gains reserve

Budget 2023 also proposes to amend the capital gains reserve to extend it from five years to ten years in respect of the sale of the shares of a subject corporation under either the Immediate Intergenerational Business Transfer rule or the Gradual Intergenerational Business Transfer rule.

Reassessment period

Given that the new rules involve conditions to be met over a period of years, proposed amendments will also extend the timeline for the CRA to reassess a taxpayer in respect of a disposition to which either the Immediate Intergenerational Business Transfer rule or the Gradual Intergenerational Business Transfer rule applied. The extension is three years past the normal reassessment period for share transfers under the Immediate Intergenerational Business Transfer rule and ten years past the normal reassessment period for transfers under the Gradual Intergenerational Business Transfer rule.

Joint and several liability

The Tax Act will also be amended to provide that the taxpayers who jointly elect to use the Immediate Intergenerational Business Transfer rule or the Gradual Intergenerational Business Transfer rule will be jointly and severally liable for any tax that arises (i.e., in respect of a deemed dividend under section 84.1 of the Tax Act) if the requirements of the applicable rule are not met.

Employee ownership trusts

In Budget 2021, the government noted that the United States and the United Kingdom encouraged employee ownership of a business through employee ownership trusts and that it intended to engage with stakeholders to examine what barriers existed to the creation of this type of trust in Canada and how employees and owners of private businesses in Canada could benefit from the use of this type of trust.

Further to Budget 2021, Budget 2023 announces the introduction of the EOT, a new form of employee ownership and new type of trust that holds shares of a corporation for the benefit of the corporation’s employees. The government notes that an EOT can be used as a mechanism to enable employees to purchase a corporation, without requiring the employees to pay directly for the shares, and for business owners, an EOT can be used as an additional option for succession planning.

Central to the EOT rules is the new concept of “qualifying business”. A “qualifying business” is defined as a corporation controlled by a trust where the corporation is a CCPC that satisfies a number of conditions, including that all or substantially all of the fair market value of its assets are attributable to assets used in an active business carried on in Canada and it does not carry on its business as a partner of a partnership. In addition, where a qualifying business is sold to the trust, individuals and their related or affiliated persons who hold a significant economic interest in the qualifying business prior to the sale cannot account for more than 40% of the directors of the qualifying business.

To qualify as an EOT, a trust must satisfy the following conditions regarding its residency, assets, beneficiaries and trustees, as follows:

• the trust must be a Canadian resident trust (excluding deemed resident trusts);
• all or substantially all of the fair market value of the property of the trust must be attributable to shares of one or more qualifying businesses that the trust controls (directly or indirectly) and by which the beneficiaries are employed;
• the beneficiaries of the trust must consist exclusively of employees of one or more qualifying businesses that the trust controls, and cannot include employees: (i) who are significant economic holders in the qualifying business; (ii) who prior to a “qualifying business transfer” (discussed below) to the trust were significant economic holders in the qualifying business; or (iii) who have not completed a probationary period not exceeding 12 months;
• a beneficiary’s interest in the trust must be determined in the same manner, based solely on a reasonable application of any combination of the following criteria: (i) hours of employment services, (ii) total salary, wages and other remuneration; and (iii) period of employment services;
• the shares of a qualifying business held by the trust cannot be distributed to the beneficiaries;
• each trustee of the trust must: (i) be a corporation resident in Canada that is licensed to act as a trustee or an individual (other than a trust); (ii) be elected for a period not exceeding five years; and (iii) have an equal vote in the conduct of the affairs of the trust; and
• where a qualifying business is sold to the trust, individuals and their related or affiliated persons who hold a significant economic interest in the qualifying business prior to the sale cannot account for more than 40% of: (i) the trustees of the trust; or (ii) the directors of the board of a corporation acting as trustee of the trust.

An EOT will be a taxable trust and will generally be subject to the same rules as other personal trusts. For example, undistributed trust income will be taxed in the EOT at the top personal marginal tax rate whereas beneficiaries will be taxed (at their respective rates) on any income distributed by the EOT. Additionally, an EOT will be permitted to designate dividends distributed to beneficiaries such that they retain their character and will be eligible for the dividend tax credit. However, the 21-year deemed disposition rule (applicable to certain trusts) that deems a trust to dispose of its capital property will not apply to EOTs.

Budget 2023 further proposes additional changes to existing rules under the Tax Act in an effort to better facilitate the establishment and use of EOTs. Specifically, these changes extend the five-year capital gains reserve period to a ten-year period where shares are disposed of in a “qualifying business transfer”. A “qualifying business transfer” generally means a disposition of shares to an EOT (or a CCPC wholly owned by an EOT) with whom the vendor deals at arm’s length and in which the EOT (or CCPC) acquires control of the corporation. There are also additional conditions imposed to ensure that the vendor does not retain any right or influence following the sale and to ensure that the vendor remains at arm’s length at all times (including following the sale).

Additionally, under the Tax Act a shareholder is generally required to include the amount of a shareholder loan in income unless the loan is repaid within a year. However, the proposed changes to the Tax Act also create a new exception to the shareholder loan rule in respect of a qualifying business transfer, provided that: (i) following the sale, the lender is a qualifying business and the borrower is the EOT that controls the lender; (ii) the sole purpose of the loan is to facilitate the qualifying business transfer; and (iii) bona fide arrangements are made for the repayment of the loan within 15 years of the qualifying business transfer. This new exception would facilitate the borrowing of funds by an EOT from a qualifying business to finance the purchase of shares in a qualifying business transfer.

These rule will generally apply to transactions that occur on or after January 1, 2024.

Alternative minimum tax

The AMT applies to individuals (including certain trusts) and is aimed at ensuring that high-income earners pay a minimum amount of tax notwithstanding the availability of deductions, exemptions and tax credits in calculating ordinary income tax levied under general rules and the progressive tax rate structure. To achieve this, the AMT provides a parallel tax calculation to the ordinary rules and imposes a flat tax rate of 15%, with a standard exemption of $40,000, in circumstances where ordinary income tax on an individual’s income would be less than the AMT. Generally, a taxpayer is required to pay either the AMT or ordinary income tax, whichever is higher. Where AMT exceeds ordinary income tax, the excess paid can generally be carried forward for seven years to offset ordinary income tax to the extent the ordinary income tax exceeds the AMT in those years.

In the 2022 Budget, the government announced that it was examining the AMT regime as there was concern that thousands of “wealthy” Canadians continued to pay little or no personal income tax each year. Budget 2023 now proposes to amend and expand the AMT to better target high-income individuals through three main proposals.

First, the government proposes to increase the federal AMT flat rate from 15% to 20.5%. Second, the government proposes to increase the basic exemption from $40,000 to the minimum threshold for the fourth federal tax bracket. Based on expected indexation, the basic exemption for 2024 would be approximately $173,000.

Third, the government proposes to broaden the AMT base by further limiting the deductions, exemptions and tax credits available. In summary, key changes to the AMT base are as follows:

• increasing the AMT capital gains inclusion rate from 80% to 100%, while applying capital loss carry forwards and allowable business investment losses at the current 50% rate;
• including 100% of the benefit associated with employee stock options;
• including 30% of the capital gains on donations of publicly listed securities;
• disallowing 50% of certain deductions, including interest and carrying charges incurred to earn income from property; limited partnership losses of other years, and non-capital loss carryovers; and
• denying 50% of non-refundable tax credits, except the dividend tax credit.

The government further noted that it would continue to examine whether other trusts (in additional to those already exempt) should be exempt from the AMT.

Proposed changes to the AMT are set to come into force for taxation years beginning after 2023 and are expected to generate approximately $3 billion in government revenue over the next five years. Budget 2023 states that the government will release additional details on the new AMT regime later this year.

Status of previously announced tax measures

International measures

In Budget 2023, the government reaffirms its commitment to proceed with the domestic implementation of the Inclusive Framework’s proposed two-pillar model of international tax reform that aims to address tax challenges caused by the digitization of economies. For a detailed overview of the mechanics of the two-pillar model, see our commentary to Budget 2022.

Pillar One and the digital services tax

Pillar One is intended to ensure that the largest and most profitable multinational enterprises (MNEs) pay a fair share of tax in the countries where their users and customers are located. It will reallocate taxing rights over MNEs that conduct significant value-generating activities (i.e., where their users and customers are located) in jurisdictions in which it they do not have traditional physical business presence. Budget 2023 indicates that the government hopes for the convention to implement Pillar One to be signed by mid-2023, with entrance into force internationally in 2024.

Budget 2023 indicates that the government will continue to plan for the implementation of a domestic digital services tax (DST) as a substitute measure in the event that Pillar One has not been implemented. The first draft of the DST legislative proposals was released in December 2021, at which time the government indicated the DST would apply retroactively to revenues earned as of January 1, 2022. The government intends to release revised proposals for public comment, with the intent that the DST may be imposed as of January 1, 2024, if Pillar One has not been implemented by that time.

Pillar Two

Pillar Two is intended to impose a global minimum tax of at least 15% on large MNEs. It aims to end a “race to the bottom” among nations in international corporate taxation by setting a floor on tax competition primarily through the use of two rules: (i) the Income Inclusion Rule (IIR); and (ii) the Undertaxed Profits Rule (UTPR), which acts as a backstop.

Budget 2023 states that the government intends to introduce draft legislative proposals to implement the IIR, as well as a domestic minimum top-up tax applicable to Canadian entities of in-scope MNEs, for public consultation “in the coming months”, with a view for the legislation to come into effect for fiscal years of MNEs that begin on or after December 31, 2023. The government also intends for the UTPR to be effective for fiscal years of MNEs that begin on or after December 31, 2024.

Budget 2023 notes that the draft legislation will take into account comments received during the previous public consultation on Pillar Two, and will closely follow the model rules, commentary, and administrative guidance agreed to by the Inclusive Framework.

Revenue Sharing

The government also announced its intention to share a portion of the revenue earned through the international tax reform with provinces and territories, and will engage with the provincial and territorial governments “in the coming months” on this point.

Income tax measures

In Budget 2023, the government confirmed its intention to proceed with a number of other proposals that were previously announced, as modified to take into account consultations and deliberations since their release, including in particular:

• legislative proposals released on November 3, 2022 in respect of the excessive interest and financing expenses limitations and reporting rules for digital platform operators;
• the measures announced in the November 3, 2022 Fall Economic Statement in respect of which legislative proposals have not yet been released, including the investment tax credit for clean technologies;
• legislative proposals released on August 9, 2022 in respect of:
  • borrowing by defined benefit pension plans and fixing contribution errors in defined contribution Pension plans;
  • reporting requirements for registered retirement savings plans and registered retirement income funds;
  • the investment tax credit for carbon capture, utilization and storage;
  • hedging and short selling by Canadian financial institutions;
  • substantive CCPCs;
  • mandatory disclosure rules; and
  • the electronic filing and certification of tax and information returns;
• legislative proposals released on April 29, 2022 in respect of hybrid mismatch arrangements;
• legislative proposals released on February 4, 2022 in respect of the GST/HST treatment of cryptoasset mining;
• the Budget 2021 measure to have a consultation on Canada’s transfer pricing rules; and
• measures confirmed in the 2016 federal budget relating to the GST/HST joint venture election.

GST/HST treatment of payment card clearing services

The longstanding policy of Canada’s value-added tax is to exempt the supply of a “financial service” from GST/HST. The Federal Court of Appeal in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10, held that credit-card companies (such as Visa and MasterCard) provide an exempt supply of a financial service to credit card issuers, such that payments by card-issuers to card-companies are exempt from GST/HST.

Budget 2023 proposes to amend the definition of “financial service” in the Excise Tax Act (Canada)to legislatively overrule the CIBC decision and to tax payments for card-clearing services.

The definition of “financial service” in the Excise Tax Act (Canada) includes certain items that constitute exempt supplies, and excludes certain services that constitute taxable supplies. Budget 2023 proposes to add new paragraph (r.6) to the list of services that constitute taxable supplies. New paragraph (r.6) will apply to a service that is supplied by a “payment card network operator” in respect of a “payment card network” (as those terms are defined in section 3 of the Payment Card Networks Act) and that is:

• a service in respect of the authorization of a transaction in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument;
• a clearing or settlement service in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument; or
• a service provided in conjunction with the foregoing services.

This measure appears to apply retroactively to the introduction of the GST/HST in the early 1990s. The only exclusion to retroactive application is where the credit-card network never charged, collected or remitted any GST/HST in respect of the relevant services on or before Budget Day

Unless the exclusion applies, Budget 2023 gives the Minister at least an additional year to assess, reassess or make an additional assessment of GST/HST in respect of payment and card processing services referred to in new paragraph (r.6) from the date of Royal Assent, regardless of whether the registrant had commenced any relevant judicial proceedings. Notably, Budget 2023 does not propose to extend the time for claiming input tax credits for payment card network operators that, due to the retroactive nature of this proposal, are now considered to have provided services that are not exempt from GST/HST.