Federal Budget Report
Highlights
- GST Rate Reduced to 6% on July 1st
- Small Business Deduction Limit Increased to $400,000 in 2007
- Small Business Tax Rate to Fall to 11% by 2009
- Taxation of Dividend Proposals Announced
- Several New Personal Credits Announced or Enhanced
- Corporate Tax Cuts Previously Proposed to be Implemented
Overview
“Focusing on Priorities"
Today, the Honourable Jim Flaherty tabled the first budget of the new minority government. With all the speculation in the media recently about what the Conservatives would do to put its stamp on the federal government, there was quite of bit of interest in Mr. Flaherty’s plan.
The projected surplus for the 2005-06 fiscal year, originally forecast to be $4 billion before contingency and prudence reserves, is now expected to be $8 billion – all of which will go to debt reduction. Small surpluses are forecast for 2006-07 and 2007-08 respectively, which include budgeted debt reduction payments of $3 billion each year.
Not surprisingly, the budget focused on the main priorities outlined in the recent throne speech, including a cut to the GST rate, the introduction of the new $1,200 Universal Child Care Benefit, and increases in equalization payments to the provinces to reduce health care wait times. In addition, the budget included a number of new spending initiatives to fund other priorities of the government, including $5.3 billion for the military over the next five years and new money for the RCMP.
As rumoured prior to the budget speech, tax relief for businesses and individuals was included. The GST rate will be cut by 1% effective July 1st. The cuts to the general corporate tax rate, originally introduced by the Liberals in the 2005 budget, were reintroduced. The government also announced new tax cuts for small businesses, in the form of a reduction of the federal corporate tax rate that applies to active business income up to the small business limit, which the government is also increasing to $400,000 annually.
On the personal side, the Conservatives partially reversed the Liberal’s cuts to the personal tax rates, raising the lowest personal income tax rate to 15.5% from 15% effective July 1st. A number of tax credits for individuals were also announced, including the Canada Employment Credit in recognition of work-related expenses incurred by employees.
The following is a summary of the more important items of interest to our clients.
Key Economic Statistics
Surplus (in billions $) |
2005-2006 Revised |
2006-2007 Projected |
2007-2008 Projected |
| Budgetary Revenu |
220.9 |
227.1 |
235.8 |
| Program Spending |
179.2 |
188.7 |
196.6 |
| Operating Balance |
41.7 |
38.4 |
39.2 |
| Public Debt Charges |
33.7 |
34.8 |
34.8 |
| Planned Debt Reduction |
8.0 |
3.0 |
3.0 |
| Surplus |
-- |
0.6 |
1.4 |
| Net Public Debt |
486.4 |
483.4 |
480.4 |
Personal Tax Measures
Personal Tax Rates
For the 2005 tax year, individual taxpayers enjoyed the benefit of the Liberal government’s proposal made in November 2005 to reduce the lowest personal income tax rate to 15% from 16%. While the proposals were introduced in the House of Commons last year, they did not become law before the federal election was called. The Canada Revenue Agency (CRA), however, collected tax for 2005 based on the proposed changes. The Finance Minister confirmed the tax rate change was effective for 2005. However, he also announced today that the 15% tax rate has been partially reversed and announced a proposal to increase the lowest personal income tax rate to 15.5% effective July 1, 2006 so that the rate is effectively 15.25% for 2006. For 2007 and subsequent years, the rate will be 15.5%. No other changes to the personal income tax rates were announced.
For personal tax credit purposes, federal tax credits, including the new credits discussed below, will be obtained by multiplying the credit amount by 15.25% for 2006 and by 15.5% for 2007 and subsequent years.
Personal Credits Increased
In 2005, the Liberal government announced increases over the next several years to the basic personal credit and the spousal/common-law partner/wholly dependant relative credit. These increases were in addition to the annual inflation adjustment and were implemented to ensure the credit amounts would be at least $10,000 and $8,500 respectively for the 2009 taxation year. The Finance Minister today confirmed that the 2006 credit amounts will be $8,839 and $7,505 for the basic personal credit and spousal/partner credit respectively and that the credits will reach the amounts originally proposed by the Liberal government for the 2009 taxation year, though on a different timeline. Note that the personal tax credit for 2007 is proposed to be $8,739 plus indexing.
New Personal Credits
Canada Employment Credit – A new non-refundable tax credit, in recognition of work-related expenses incurred by employees, will take effect July 1, 2006. Taxpayers will be provided relief on the lesser of $1,000 and the taxpayer’s employment income for the year. For 2006, the maximum amount for credit calculation will be $250.
Textbook Tax Credit – Tax relief is finally here for the cost of textbooks to post-secondary students in the form of a non-refundable tax credit that will be in addition to the existing education tax credit. The textbook tax credit will be calculated on an amount of $65 for each month for which the student qualifies for the full-time education tax credit and $20 for each month the student qualifies for the part-time education tax credit amount. Similar to the existing tuition and education non-refundable tax credits, the unused amounts can be transferred to a spouse or common-law partner, parent or grandparent, or carried forward to a future year.
Children’s Fitness Tax Credit – The budget proposes allowing parents to claim a
non-refundable tax credit in respect of up to $500 in eligible fees for the enrollment of a child under sixteen years old in an eligible program of physical activity. This measure will apply to the 2007 and subsequent taxation years. To be eligible for the credit, fees must be paid in respect of eligible expenses in an eligible program of physical activity. Eligible expenses will include those for the operation and administration of the program, instruction, renting facilities, equipment used in common (e.g. team jerseys), referees and judges and incidental supplies (e.g. trophies). Claims for the Children’s Fitness Tax Credit will need to be supported by a tax receipt that contains information sufficient for the CRA.
Tax Credit for Public Transit Passes – The cost of monthly, or longer duration, public transit passes will qualify for a non-refundable tax credit in respect of the portion of transit costs incurred on or after July 1, 2006. The credit will be claimable in respect of costs incurred by the individual, the individual’s spouse or common-law partner and the individual’s dependent children that are under 19 years of age.
Pension Income Credit
The current pension income credit provides a non-refundable credit in respect of the first $1,000 of eligible pension income. This will be increased to $2,000 for 2006 and subsequent years. For individuals aged 65 and over, eligible pension income includes lifetime annuity payments under an RRSP or a DPSP and payments out of or under a RRIF. For individuals under 65 years of age, eligible pension income includes lifetime annuity payments under an RPP and certain other payments received as a result of the death of the individual’s spouse or common-law partner.
Large Corporation Dividends
The budget confirms the government’s intention to proceed with measures to enhance the dividend gross-up and dividend tax credit mechanism for eligible dividends. Eligible dividends will generally include dividends paid after 2005 by public corporations (and other corporations that are not Canadian-controlled private corporations (CCPCs)) that are resident in Canada and subject to the general corporate income tax rate. In addition, CCPCs will be able to pay eligible dividends to the extent that their income (other than investment income) is subject to tax at the general corporate income tax rate.
For eligible dividends, shareholders will include 145% of the dividend amount in income and the federal dividend tax credit with respect to the dividend will be approximately 19% of the grossed-up amount which reflects the general corporate income tax rate that will apply beginning in 2010. This change will reduce the top federal tax rate on dividends from 19.6% to 14.6% and will apply to eligible dividends paid after 2005. For complete integration, each of the provinces and territories will have to introduce similar measures.
Universal Child Care Benefit (UCCB)
Effective July 2006, all families will be provided with a $100 per month benefit for each child under the age of six years ($1,200 per year). The amounts received will be taxed in the hands of the lower income spouse or common-law partner but the amounts will not affect the calculation of income-tested benefits delivered through the income tax system. This benefit will also not reduce the amount of claimable expenses for the child care expense deduction or Employment Insurance and Old Age Security benefits. Although the federal government says the UCCB will not affect other income-tested benefits, the structure of the Child Care Tax Benefit (CCTB) program will be amended. The current enhancement offered under the CCTB for children under the age of seven years will be eliminated because of the UCCB.
Capital Gains of Fishers
The $500,000 lifetime capital gains exemption currently available for farm property and small business shares will be extended to property used in a fishing business effective May 2, 2006. Intergenerational rollovers applicable to farming property will also be extended to fishing property.
Mineral Exploration Tax Credit For Flow-Through Share Investors
Since October 2000, a temporary 15% tax credit has been available on mineral exploration costs renounced to investors in flow-through shares. The credit expired for flow-through agreements entered into after December 31, 2005. The credit will be reintroduced for flow-through share agreements entered into on or after May 2, 2006 and before April 1, 2007.
Tradespeople’s Tool Expenses
The federal government will now provide tax recognition for the costs that many employed tradespeople incur to provide their own tools in their employment duties. A deduction (up to a maximum of $500 per year) will be allowed for the total cost of new tools acquired by an employed tradesperson in a tax year in excess of $1,000. Employers will need to certify that the employee is required to obtain those tools for use in employment activities. New tools acquired on or after May 2, 2006 will qualify. Electronic communication devices and electronic data processing equipment will not qualify as eligible tools. Apprentice vehicle mechanics will be able to claim this new tradespeople’s tool expenses deduction in addition to the existing apprentice vehicle mechanic’s tools deduction – however, parameters surrounding the existing deduction will be modified.
Scholarship and Bursary Income Currently, the first $3,000 of scholarship, fellowship or bursary income received by a taxpayer in a taxation year with respect to post-secondary education or occupational training is not included in income. For 2006 and subsequent years, this income will be exempt from tax.
Child Disability Benefit
The Canada Child Tax Benefit (CCTB) is the primary federal instrument for the provision of financial assistance to families with children. The CCTB has three components: the CCTB base benefit, the National Child Benefit (NCB) supplement, and the Child Disability Benefit (CDB). The CDB is payable in respect of children, in low-and modest-income families, who meet the eligibility criteria for the Disability Tax Credit (DTC). Two changes are proposed. First, the maximum annual CDB will be increased to $2,300 from $2,044 starting in July 2006. The benefit will continue to be indexed for inflation thereafter. Second, the CDB will be extended to more families caring for a child eligible for the DTC by reducing the rates at which the CDB is reduced as family income rises. Effective July 2006, the CDB will be reduced based on the family income and the number of children in the household.
Refundable Medical Expense Supplement
The refundable medical expense supplement (RMES) improves work incentives for Canadians with disabilities by helping offset the loss of coverage for medical and disability-related expenses when individuals move from social assistance to the paid labour force. The maximum amount of the RMES will be increased from $767 to $1,000 for the 2006 taxation year.
Donations of Securities and Ecologically-Sensitive Land
Since 1997 only one-half of the standard capital gains inclusion rate has applied to the gain realized when publicly listed securities are donated to charitable organizations and public foundations. For donations of eligible securities made on or after May 2, 2006 there will be no tax on any capital gains. Capital gains tax will also be eliminated on donations of ecologically-sensitive land made on or after May 2, 2006.
Business Tax Measures
Corporate Tax Rate Cuts
Small Business Tax Changes – Under new proposals contained in the budget, the small business limit (the annual amount of active business income eligible for the small business tax rate) will be increased from $300,000 to $400,000 as of January 1, 2007. There will continue to be a requirement to allocate the small business limit among associated corporations, and access to the small business deduction will continue to be phased out on a straight-line basis for CCPCs having between $10 million and $15 million of taxable capital employed in Canada.
With the increase in the small business limit, the $2 million scientific research and experimental development expenditure limit for CCPCs eligible for ITCs at the enhanced rate of 35% will be reduced where taxable income for the previous taxation year is between $400,000 and $600,000. The phase-out based upon taxable capital from $10 million to $15 million will not change.
There was more good news. The small business rate will be cut – from 13.12% to 11.5% effective January 1, 2008 (including the elimination of the surtax discussed below), and to 11% effective January 1, 2009.
Previously Announced Cuts – Previously announced general corporate rate cuts and the elimination of the surtax will proceed on schedule:
- The general corporate income tax rate will be reduced from 21% to 20.5% effective January 1, 2008, to 20% effective January 1, 2009, and to 19% effective January 1, 2010.
- The corporate surtax will be eliminated effective January 1, 2008.
Amounts and rates will be prorated for corporations with non-calendar taxation years. The chart below highlights the impact of these tax changes.
| |
Current Rates For 2006/07 |
2008 |
Proposed Rates 2009 |
2010 |
| Small business rate |
13.12% |
11.5% |
11% |
11% |
| General corporate rate |
22.12% |
20.5% |
20% |
19% |
| Investment income |
35.79% |
34.67% |
34.67% |
34.67% |
Apprenticeship Job Creation Tax Credit
The budget is introducing an Apprenticeship Job Creation Tax Credit program for employers hiring new apprentices in eligible trades. Eligible employers will receive a non-refundable tax credit equal to 10% of the salaries and wages paid to qualifying apprentices, to a maximum credit of $2,000 per year per apprentice. Special rules will ensure that where an apprentice works for two or more related employers in a year, the combined credit does not exceed $2,000.
A qualifying apprentice will be someone working for an eligible employer in a qualifying trade in the first two years of his or her provincially registered apprenticeship contract. Qualifying trades will be prescribed and will include the 45 trades currently included in the Red Seal trades. Regulations prescribing other trades may be forthcoming.
Employers can carry unused credits back three years and forward twenty years to reduce federal income taxes otherwise payable in those years. The Apprenticeship Job Creation Tax Credit will be available to eligible employers in respect of salaries and wages paid to qualifying apprentices on or after May 2, 2006.
Capital Cost Allowance for Tools
The budget proposes increasing the cost limit for access to the 100% CCA rate for tools to $500 (from $200). Electronic communication devices and electronic data processing equipment are specifically excluded from this treatment. The cost limit for kitchen utensils and medical or dental instruments eligible for the 100% rate also will be increased to $500. These provisions apply to tools and utensils and instruments acquired on or after May 2, 2006.
Minimum Tax on Financial Institutions The budget proposes increasing the threshold above which the federal capital tax on financial institutions applies to $1 billion. As well, it proposes a single tax rate of 1.25% on taxable capital employed in Canada rather than the current tiered rates. These changes will apply starting July 1, 2006, prorated for financial institutions with taxation years that include that date.
Goods and Services Tax Measures
As widely anticipated, the Minister of Finance announced a 1% reduction of the GST/HST rate effective for tax paid or payable after June 30, 2006. (To keep things simple, references here to the GST should be thought of as also referring to the federal component of the HST.) This reduction – though seemingly straightforward – impacts many provisions of the Excise Tax Act.
Specific Transitional Rules
For sales of real property, where ownership and possession of the property is transferred after June 30, 2006, if the agreement was entered into after May 2, 2006 the reduced rate of 6% will apply. Where the agreement was entered into before May 2, 2006 the purchaser will pay the higher tax rate on closing but will be entitled to file a claim with the CRA for the 1% rate reduction. The maximum GST rebate on new housing will be reduced from $8,750 to $7,560 and the New Housing Rebate for Building Only will also be reduced.
Where supplies are deemed to have been made after June 30, 2006, the reduced rate will apply. Goods imported or released from Customs’ control and services and intangibles imported after June 30, 2006 will be subject to the reduced rate.
Financial institutions will be required to self-assess GST on certain cross-border transactions under a special set of rules, as announced on November 17, 2005. The tax will be payable annually and become payable six months after the taxation year end. Transitional rules will apply to taxation years beginning before July 1, 2006.
Taxable benefit calculations for passenger vehicles and aircraft will also reflect the rate reduction. The 5% rate applicable to the automobile operating expense benefit will be reduced to 4.5% for the 2006 taxation year and to 4% thereafter. The GST content of stand-by benefits and other automobile benefits currently deemed collected at 6/106 will reduce to 5.5/105.5 for 2006 and to 5/105 thereafter.
A special anti-avoidance provision will apply on transactions between related parties if they are done to obtain a benefit of the rate reduction, rather than for commercial purposes.
Other Measures
Public service bodies that revoke their election to treat exempt real property as taxable after May 1, 2006 will no longer be able to claim a rebate for the resultant deemed tax paid on revocation.
Streamlined accounting and special quick method rates will reflect the rate reductions for reporting periods that begin after June 30, 2006.
Additional provisions address changes required to such things as the tax fractions of a coupon and manufacturers rebates, returned merchandise and volume rebates and employee and partner rebates.
Effect of GST Rate Change on Various Rebates
Many of the various 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
After June 30, 2006, 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 June 30, 2006 will save $5,000 in GST. Similar savings should be expected on other big ticket items.
It remains to be seen if consumers will react to the rate savings by delaying their purchases until July. Correspondingly, vendors using GST-included pricing (e.g. vending machine operators, membership providers and parking authorities) might not change the amount they charge.
General Business Changes
Businesses will need to adjust their systems to account for the rate reduction effective
July 1, 2006. 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 7%.
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 taxes in Quebec and PEI are dependent upon the GST-included price.);
- Employee expense reimbursements must be adjusted to account for the tax-included input tax credits – currently 7/107ths (or 6/106ths and for deemed tax where PST and/or tips are included);
- Where there are employees 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 web sites;
- 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.
Excise Taxes and Duties
Tobacco excise duties will increase effective July 1, 2006 to offset the GST rate reduction. Additionally, any vendor of tobacco with inventory in excess of 30,000 units as at June 30, 2006 will be required to pay specific per unit additional tax levies. Inventory in vending machines will not be subject to this additional levy.
Similar to tobacco products, alcoholic beverages will also be subject to an increase in duty to offset the GST rate reductions.
On the other hand, Canadian vintners and small brewers will benefit from a reduction, and in some cases, elimination of excise duties on specified products.
Deliveries of jewellery, clocks and articles made of semi-precious stones after May 1, 2006 will no longer be subject to Excise Tax.
Status of Previously Announced Measures
A number of changes announced in the 2005 federal budget and the economic statement last fall were not enacted. The Finance Minister confirmed today that most previously announced changes will be formally passed into law. These include:
- The elimination of the federal capital tax on January 1, 2006 (the rate will be prorated for non-calendar year-ends);
- A tax deferral in respect of certain dividends paid after 2005 by agricultural cooperatives, which applies for the 2005 and subsequent taxation years;
- The extension of the carry-forward period for business losses and investment tax credits from 10 to 20 years;
- CCA revisions effective February 23, 2005 to set new CCA rates for certain electricity assets, transmission pipelines, and telecommunications cables plus CCA enhancements for efficient and renewable energy generation equipment;
- The extension of eligibility for the increased capital cost allowance rate for renewable energy equipment to cogeneration systems that use a type of biomass used in the pulp and paper industry called "black liquor".
Other changes relating to a personal credit for adoption expenses, revised tax rules for the disabled and medical expense changes are already being applied by the CRA.
Federal Budget Report 2006 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. For additional information, contact your BDO advisor or visit us at www.bdo.ca.
