2004 Federal Budget Report
March 23, 2004
Highlights
- Pension Fund Investments in Income Trusts Restricted Small Business
- Deduction Increase Accelerated New Measures for Education Assistance CCA
- Rates Increased for Technology Assets
- Non-Capital Loss Carry-forward Period Extended
Overview
"New Agenda for Achievement"
Today, Ralph Goodale tabled his first budget as Finance Minister in anticipation of an election call expected in the near future. With the cloud of the sponsorship scandal hanging over the current government, Mr. Goodale started his speech by announcing measures designed to restore financial responsibility and integrity to government spending. To do this, the government will re-establish the Office of the Comptroller of Canada to oversee government spending, appoint professional comptrollers to approve all new spending initiatives in every government department, reorganize and bolster the government's internal audit function, introduce real-time reporting systems and introduce new corporate governance rules for Crown corporations. It will be interesting to see if this convinces the Canadian public that the current government will be more accountable and transparent.
The government announced that despite lower growth than expected over the last fiscal year, a surplus of $1.9 billion is expected for the 2003-04 fiscal year. This will be used to pay down government debt. Balanced budgets are forecast for 2004-05 and 2005-06 with contingency reserves of $3 billion and reserves for economic prudence of $1 billion. However, the 2004-05 budget is being supplemented by the government's sale of its investment in Petro-Canada, expected to produce net revenues of $2 billion. The budgeted reserves will be used to pay down government debt if they are not needed. Mr. Goodale also proposed that Canada set a goal of lowering its federal debt-to-GDP ratio to 25% within 10 years. The budget did contain some targeted spending increases with new money for health care, education, innovation and communities. As far as tax measures were concerned, the budget contained no new tax cuts and focused on addressing specific issues. In a surprising move, the government moved to limit the ability of pension funds to invest in income trusts - something that was not expected until there had been more study of the issue. RRSPs and RRIFs will be unaffected by this change. The following is a summary of the more important items of interest to our clients.
Key Economic Statistics
Surplus (in billions $) |
2003-2004
Revised |
2004-2005
Projected |
2005-2006
Projected |
Budgetary Revenue |
181.1 |
187.2 |
195.8 |
Program Spending |
(143.4) |
(147.8) |
(156.1) |
Operating Balance |
37.7 |
39.4 |
39.7 |
Public Debt Charges |
(35.8) |
(35.4) |
(35.7) |
Contingency and Prudence Reserves |
(1.9) |
(4.0) |
(4.0) |
Surplus |
-- |
-- |
-- |
Net Public Debt (with contingency reserve applied) |
508.7 |
505.7 |
502.7 |
Personal Tax Measures
Education
The budget proposes to introduce a new Canada Learning Bond (CLB). Each child born on or after January 1, 2004 will be eligible for a CLB in each year that the child's family is entitled to the National Child Benefit (NCB) supplement, up to and including the year in which the child turns 15 years of age. An initial CLB of $500 will be provided for the first year of entitlement for the NCB supplement and, in subsequent years in which the family is entitled to the NCB supplement, the CLB will be in the amount of $100. A child's family will generally be entitled to the NCB supplement in 2004 if the family's income level is below $35,000 in 2003. A child in a low income family can receive CLB payments totaling up to $2,000. The CLB will be payable into an RESP of which the child is a beneficiary.
The budget also proposes to change the Canada Education Savings Grant (CESG) rate for contributions made to RESPs by low and middle-income families. Currently all eligible RESP contributions qualify for a 20% CESG. The first $500 contributed to the RESP each year on or after January 1, 2005 will result in a CESG of 40% rather than 20% if the child's family has net income of $35,000 or less, and 30% rather than 20% if the child's family has net income greater than $35,000 but not exceeding $70,000. All other eligible RESP contributions will continue to qualify for a 20% CESG.
The education tax credit is provided in recognition of non-tuition costs of post-secondary education, such as the cost of textbooks and is calculated on the amount of $400 per month of full-time study and $120 per month of part-time study. This credit cannot currently be claimed by students who pursue post-secondary education that is related to their current employment. The budget proposes to remove this restriction for 2004 and subsequent years.
Disability Supports Deduction
In order to reduce barriers to employment and education for persons with disabilities, the current Attendant Care Deduction will be replaced with a Disability Supports Deduction for 2004 and subsequent years. This deduction will broaden amounts previously eligible for the Attendant Care Deduction to include the cost for sign-language interpretation services, voice recognition software, talking textbooks as well as other similar expenses.
Caregiver Expenses
Medical expenses incurred on behalf of a dependent relative can be claimed as a medical expense credit by a supporting person, subject to a reduction based on the dependent relative's income. The budget proposes that for 2004 and subsequent years, the reduction based on the dependent relative's income be reduced so that more of the expense is eligible for the medical expense credit.
Affiliated Persons Rules and Trusts
For many purposes under the Income Tax Act, it is necessary to identify persons who have economic interests in common. For example, a person is prevented from realizing a tax loss on the transfer of property to a corporation controlled by the person, since the person indirectly has retained an economic interest in the property. Effective March 23, 2004, these rules will be amended so that they will deal more appropriately with trusts and their beneficiaries.
Tax Relief for Canadian Forces Personnel
Currently Canadian Forces personnel receive special non-taxable allowances when serving on high-risk international missions, but the full amount of their regular pay is subject to tax. For 2004 and subsequent years, the budget proposes to exclude from income subject to tax the regular pay that these individuals earn while serving on high-risk military or police missions outside Canada.
Business Tax Measures
Small Business Deduction
Canadian controlled private corporations (CCPCs) with less than $15 million of taxable capital currently enjoy a reduced tax rate on the first $250,000 of annual income. This limit will now increase to $300,000 on January 1, 2005. Years that straddle January 1, 2005 will have the limit prorated based on the number of days before and after that date.
CCA Rates
The Capital Cost Allowance (CCA) rate for computer equipment acquired after March 22, 2004 will be increased to 45% from 30%. The current exemption for computers from the specified leasing property rules will be extended to computer equipment eligible for this higher CCA rate, other than any individual item with a capital cost in excess of $1 million.
The separate class election will be eliminated for computer equipment eligible for the new higher CCA rate. To accommodate planned purchases, the separate class election will be available for computer equipment acquired before 2005, where the taxpayer elects to have the property included in the old 30% class instead of the new class. Currently, data network infrastructure equipment is generally depreciated at a 20% CCA rate. Data network infrastructure equipment acquired after March 22, 2004 will be included in a new class, with a 30% CCA rate.
Carry-Forward Period for Business Losses
The budget proposes to extend from 7 to 10 years the time that a taxpayer can carry-forward and apply any non-capital loss, unused foreign tax credit or a life insurer's Canadian life investment loss, for amounts incurred in taxation years that end after March 22, 2004.
Income Trusts
Income trusts have become an increasingly important investment vehicle. They have been used for many years for real estate and resource royalty assets. In recent years, businesses in other sectors of the economy have begun to use the income trust structure.
Currently, the impact on tax revenues caused by the use of income trusts is modest as reduced tax revenues at what would be the corporate level are largely offset by increased tax revenues at the unitholder level, and in particular, most of the larger pension funds have not been active investors in the business income trust market. However, pension funds may become more active in this market once liability issues are clarified (which may occur soon).
As the government is concerned about the impact of pension fund participation on tax revenue, two measures to limit the level of investment that a pension fund can place in business income trusts have been proposed. First, restricted investment property holdings of pension funds (RPPs and tax-exempt pension investment corporations) will be limited to no more than 1% of the book value of the fund's assets. Restricted investment property would include direct holdings of business income trusts and indirect investments through mutual funds and other entities. Second, investments by a pension fund will be limited to no more than 5% of the units of any business income trust. Excess holdings under either rule will be subject to a 1% per month penalty tax. These changes will apply after 2004 and transitional rules will apply for existing holdings. The proposals will not apply to investments in resource royalty trusts and REITs. Deferred income plans that are not RPPs, such as RRSPs and RRIFs, are not affected.
Non-Resident Investment in Mutual Funds
Non-residents are generally taxable in Canada on gains arising from the disposition of Canadian real estate, resource properties and certain other properties described as Taxable Canadian Property (TCP). However, non-residents investing in TCP through a mutual fund are generally not taxed in Canada on distributions of gains realized by the mutual fund on dispositions of TCP. For distributions of gains made after March 22, 2004, a 25% withholding tax will apply on such distributions (often reduced to 15% under a tax treaty). Further, all distributions to non-residents by mutual funds that are listed on a prescribed stock exchange that invest primarily in Canadian real estate or resource property will also be subject to a 15% withholding tax. Distributions subject to withholding will be reduced by certain eligible mutual fund losses realized by the non-resident
Fines and Penalties
Expenses incurred for the purpose of earning income are generally deductible in calculating income for tax purposes. Recent jurisprudence has extended deductibility to most fines and penalties incurred in the ordinary course of earning income. It is proposed that no deduction be allowed for most fines and penalties incurred after March 22, 2004. Deductions would continue to be allowed for fines imposed under the Excise Act, the Air Travellers Security Charge Act and the GST legislation.
Mineral Exploration Tax Credit
The budget proposes to extend the expiry date for the mineral exploration tax credit to December 31, 2005 in order to provide companies with ample time to plan their transition from the credit. Under the current look-back rule, this will allow eligible expenses to be incurred up until the end of 2006.
Trading Charitable Donations
The Income Tax Act contains provisions that prevent the sale or trading of accumulated losses and other tax pools after control of a corporation is acquired. Undeducted charitable donations will now be subject to similar restrictions. The amendments will apply to donations made after March 22, 2004.
Patronage Dividends
Credit Unions and Cooperatives distribute a portion of their earnings as "Patronage Dividends". Patronage distributions are computed by reference to business done with a member or customer and are deductible within certain limits. Patronage payments may also be deducted by any other corporation. To prevent possible abuses of the system, particularly with respect to patronage payments to non-residents, patronage payments to non-arm's length persons will no longer be deductible by the payor.
General Anti-Avoidance Rule
The General Anti-Avoidance Rule ("GAAR") was introduced in 1987 to prevent abusive tax avoidance planning. GAAR does not apply if the transaction does not result in a misuse or abuse of the Income Tax Act. For greater certainty, the provision will be amended to also refer to the Income Tax Regulations, the Income Tax Application Rules, as well as an abuse or misuse of a tax treaty.
Other Measures
Registered Charities - Regulatory Reforms
The budget contains numerous proposals related to the administrative regime and regulatory framework for registered charities. The proposals are in response to the March 2003 Joint Regulatory Table report "Strengthening Canada's Charitable Sector: Regulatory Reform", which included 75 recommendations for improvements to the rules governing charities under the Income Tax Act. The budget proposals include measures to provide a new and more accessible compliance regime, increased transparency and greater accessibility to information by charities and the public, and revisions to the disbursement quota rules.
Goods and Services Tax
Confirming announcements in the Speech from the Throne on February 3, 2004 and in a release on March 9, 2004, the GST/HST rebate for municipalities will be extended from 57.14% to 100% for acquisitions made on or after February 1, 2004. Consequential to this enhanced rebate, supplies of tangible personal property and real property by municipalities will no longer be exempt. As a result, purchasers and lessors of municipal property where the consideration becomes due after March 9, 2004 will have to pay the GST/HST. However, these provisions will be subject to grandfathering rules for agreements in writing entered into before March 10, 2004. Services and property supplied in the normal course of providing municipal services to ratepayers will remain GST/HST exempt.
Taxation Arrangements with First Nations
In 1997, the government expressed a willingness to enter into taxation arrangements with interested First Nations. Since then arrangements have been made with certain First Nations to allow the taxation on reserves of sales of tobacco, fuel and alcohol. The government has also entered into income tax collection and tax sharing arrangements and legislation has been introduced to allow for a First Nations Goods and Services Tax. The government has expressed a willingness to facilitate similar arrangements between First Nations and the provinces.
Air Travellers Security Charge Reduced
Travellers and the airline industry will benefit from a reduction in the Air Travellers Security Charge for tickets purchased on or after April 1, 2004. The charge for domestic air travel will be reduced from $7 to $6 for one-way travel and from $14 to $12 for round-trip travel. Transborder and other international rates will also be reduced.
Federal Budget Report 2004 is a publication of BDO Dunwoody LLP on developments in the area of taxation. This material is general in nature and should not be relied upon to replace the requirement for specific professional advice. Additional information can be obtained from your nearest BDO Dunwoody LLP office or through our Internet World Wide Web home page at www.bdo.ca.
