October 2007
Release No: 07-05

On October 30, 2007, Federal Finance Minister Jim Flaherty announced several tax cuts as part of his fall Economic Statement. As was widely anticipated, the GST rate will be lowered from 6% to 5% on January 1, 2008. In addition, Minister Flaherty announced another round of significant reductions to the corporate income tax rate that applies to business income that does not qualify for the small business deduction. Under these cuts, the general corporate tax rate will eventually be reduced to 15%. More modest personal tax reductions were announced as well as an acceleration of a previously announced reduction to the corporate small business income tax rate.

The following is a summary of the more important items of interest to our clients.

Corporate Income Tax Reductions

Reduction to the General Corporate Rate

Building on previously announced general corporate rate tax reductions, the Government will further strengthen Canada’s business tax advantage. A new round of tax reductions will apply, beginning on January 1, 2008 and ending on January 1, 2012, when the rate falls to 15%. In addition to the elimination of the corporate surtax, the general corporate tax rate will now fall by an additional 1.5% next year. This means that the rate will fall from 22.12% to 19.5% on January 1, 2008. The chart below sets out the general corporate rate that would apply under existing rules and the changes announced today.

The Minister also announced that the Government will be seeking the collaboration of the provinces and territories to reach a 25% combined federal-provincial-territorial general corporate income tax rate. As this will require a 10% provincial/territorial rate, such a move will entail reductions to the general rate in all provinces and territories other than Alberta (and some reductions would be significant).

Finally, the government acknowledged that it will be necessary to adjust dividend tax credit rates for individuals and trusts to reflect the lower corporate tax burden.

Small Business Rate Reduction Accelerated

In addition to the general rate reduction, there will be a slight acceleration to previously announced changes to the corporate small business income tax rate (on income qualifying for the small business deduction). On January 1, 2008, the rate will now be reduced from 13.12% to 11%. Under the previously announced cut, the rate was to fall from 13.12% in 2007 to 11.5% in 2008 and to 11% in 2009.

Personal Tax Reductions

The government announced today that the personal income tax rate for the lowest tax bracket (taxable income not exceeding $37,178) will be reduced from 15.5% to 15% for 2007 and subsequent years.

In addition, the basic personal amount will be increased to $9,600 for 2007 and 2008, and to $10,100 for 2009, from its current 2007 value of $8,929. The personal amount will be indexed in 2010. Given that personal amount increases had already been announced, this change is effectively an acceleration of the previously announced changes. There will be corresponding increases to the spouse or common-law partner and wholly dependent relative credit amounts (as these credit amounts are equal to the basic personal amount).

Goods and Services Tax Measures

When the Conservatives were elected in 2006, they promised to reduce the GST rate from 7% to 5% before the end of their mandate. In their first budget in May 2006, the government reduced the GST by 1% to 6% effective July 1, 2006. With the large surpluses the government currently has, the Minister of Finance announced that the remaining 1% reduction to bring the GST rate to 5% would be effective for tax paid or payable on or after January 1, 2008. (To keep things simple, references to the GST should be thought of as also referring to the federal component of the HST).

While seemingly straightforward, this 1% reduction impacts many provisions of the Excise Tax Act. The good news is that Canadian businesses have been through this before. The transition to the 5% GST rate will apparently work in the same way as it did when the rate was reduced to 6%.

Note that the reduction to the GST rate was not tied to the harmonization of the GST with provincial sales tax (PST), in the five provinces that still have a PST, as was speculated in the media. The government did announce its desire to work with these provinces to facilitate a transition to a harmonized sales tax which would substantially improve business tax competitiveness in those provinces.

Transitional Rules

The general transition rule to determine whether the 5% rate applies to a transaction will again be based upon the time at which the GST becomes payable, as follows:

• If GST becomes payable, or is paid without having become payable, before January 1, 2008, the rate of 6% will apply.
• If GST becomes payable on or after January 1, 2008, without having been paid before that day, the rate of 5% will apply.
• If GST is paid on or after January 1, 2008, without having become payable before that day, the rate of 5% will apply.

In general, the GST on consideration for a supply is payable on the earlier of the day payment is made and the day the supplier issues an invoice. Further, if either the date of an invoice, or the payment date under a written agreement, is earlier than the day the invoice is issued, GST becomes payable on the earlier date. The Excise Tax Act has other provisions that may apply to determine when GST becomes payable in certain situations.

Specific Transitional Rules

Sales of Real Property – For sales of real property, where ownership and possession of the property is transferred under the agreement of purchase and sale before January 1, 2008, the current rate of 6% will apply. The 5% rate will apply if both ownership of the property and possession of it under the agreement are transferred on or after January 1, 2008.

New Residential Housing – A special transitional rule applies for new residential housing. For sales of houses, apartment buildings and other residential complexes made pursuant to an agreement, evidenced in writing, entered into on or before October 30, 2007 but after May 2, 2006, the 6% rate will apply, even if ownership and possession is transferred on or after January 1, 2008. For agreements entered into on or before May 2, 2006, the 7% rate will continue to apply to these sales. However, in both these circumstances, even though the purchaser will pay the higher tax rate on closing, they will be entitled to file a claim directly with the Canada Revenue Agency to be paid a transitional rebate that reflects the GST rate reduction to 5%, net of any corresponding rebate adjustment. If the agreement of purchase and sale is signed after October 30, 2007 and ownership and possession are transferred on or after January 1, 2008, the 5% rate applies. The maximum GST rebate on new housing will be reduced from $7,560 to $6,300 (which is 36% of the GST paid at the 5% rate on a $350,000 home).

Deemed Supplies – Where supplies are deemed to have been made on or after January 1, 2008, the reduced rate of 5% applies.

Imported Goods, Imported Taxable Services and Intangibles – Goods imported or released from Customs’ control and services and intangibles imported on or after January 1, 2008 will be subject to the reduced rate of 5%.

Financial Institutions – Under draft legislation released January 26, 2007, financial institutions will be required to self-assess GST on certain cross-border transactions using a special set of rules. GST on these transactions will be determined on an annual basis and in general, will become payable six months after the end of the financial institution’s taxation year. If a financial institution’s taxation year begins before January 1, 2008 and ends on or after that date, special transitional rules apply to that taxation year.

Taxable Benefits – Taxable benefit calculations for passenger vehicles and aircraft will also reflect the rate reduction. The 4% rate applicable to the automobile operating expense benefit will be reduced by 1% to 3% for the 2008 and subsequent taxation years. The GST content of stand-by benefits and other automobile benefits currently deemed collected at 5/105 will reduce to 4/104 for 2008.

Streamlined Accounting Methods – Streamlined accounting and special quick methods will reflect the rate reductions for reporting periods that begin on or after January 1, 2008. For reporting periods that straddle January 1, 2008, the existing percentages will apply to consideration that becomes due, or is paid without having become due, before January 1, 2008, and the new percentages will apply to the remaining consideration.

Anti-Avoidance – A special anti-avoidance provision will apply on transactions between related parties if they are done to obtain a benefit from the rate reduction, rather than being done primarily for commercial purposes.

Effect of GST Rate Change on Various Rebates

Many public service bodies receive rebates of the GST, in addition to input tax credits they may receive related to their commercial activities. All these rebate percentages, as well as those for the New Housing and the Residential Rental Rebate, will remain unchanged.

Effects of GST Rate Reduction on Consumers

It remains to be seen if consumers will react to the rate savings by delaying their purchases until January. Christmas shoppers won’t see any benefit this holiday season.

After December 31, 2007, a purchaser of a new home costing $200,000 plus GST will save $1,280 after receipt of the new housing rebate. While you might expect the buyer to have saved $2,000 as a result of the 1% GST reduction, application of the new housing rebate dilutes the amount saved. However, a purchaser of a $500,000 house after 2007 will save $5,000 in GST. Similar savings should be expected on other big ticket items.

The GST credit for low and modest-income Canadians will be maintained at its current level even though the GST rate is being reduced.

What Businesses Need to Do

Businesses will need to adjust their systems to account for the rate reduction effective January 1, 2008. These system changes could include accounting records, purchase order systems, sales systems, payroll systems (for benefit calculations etc.) and any other systems relying on or referring to the 6% rate.

Though it hits retailers especially, businesses of all kinds will have to make substantial changes to their systems. For example:

• Cash registers/sales systems will have to account for the 1% tax reduction. (Keep in mind that sales tax in Québec and PEI are based upon the GST-included price.);
• Employee expense reimbursements must be adjusted to account for the tax-included input tax credits;
• Where there are employee and shareholder benefits (such as automobile operating expenses), the standard remittance rate must be changed;
• Journal entries automatically programmed to journalize GST plus a standard amount will have to be changed;
• New leases quoting a GST rate will have to refer to the new rate;
• Electronic and paper purchase order systems will have to refer to the new rate, as will signage and websites;
• Systems will have to be altered to key off of the date when GST is paid or payable for the tax change;
• Automatic GST reconciling systems will have to refer to the new rate.

We will issue a Fast Fact in the near future with further information for businesses on transitional and implementation considerations in preparation for January 1, 2008.

Excise Taxes and Duties

Tobacco excise duties will increase effective January 1, 2008 to offset the GST reduction. Additionally, any vendor of tobacco with inventory in excess of 30,000 units as at December 31, 2007 will be required to pay a specific per unit additional tax levy. Inventory in vending machines will not be subject to this additional levy.

Air Travellers Security Charge (ATSC) Rates

ATSC rates will be revised so that consumers will receive the full benefit of the GST rate reduction. The ATSC rate for international air travel will not change as it is not subject to the GST. The new rates will apply to tickets purchased on or after January 1, 2008.

Conclusion

Although many business analysts and economists would have preferred larger reductions to corporate and personal income tax rates, the government did manage to combine a meaningful reduction in corporate taxes with the GST cut they previously promised.