Canada government releases significant draft tax legislation – Introduction
On 12 August 2024, the Canadian federal government unveiled several packages of draft legislation aimed at implementing various tax measures, refining previously released draft laws, and introducing technical amendments (collectively referred to as the “August 12 Proposals”).
These proposals build upon the tax measures introduced in the 2024 Federal Budget (Budget 2024) and include updates to earlier draft legislation.
The Canadian government has invited the public to provide feedback on most of these measures by 11 September 2024, with an earlier deadline of 3 September 2024 for comments on the capital gains inclusion rate and lifetime capital gains exemption amendments.
Overview of the August 12 Proposals
The August 12 Proposals encompass a broad range of tax measures, many of which are discussed in this update. Tax changes related to green economy initiatives will be covered in a separate update.
Capital Gains Inclusion Rate
Budget 2024 proposed increasing the capital gains inclusion rate for corporations and trusts from 50% to 66.67%, with a similar increase for individuals on capital gains exceeding $250,000 in a taxation year, net of certain deductions.
On 11 June 2024, the House of Commons approved a Notice of Ways and Means Motion (NWMM) to amend the Income Tax Act (ITA) and implement this proposed increase.
The August 12 Proposals include revisions to the NWMM amendments, and the Department of Finance has provided explanatory notes for these changes.
The impact of the increased capital gains inclusion rate on the calculation of the capital dividend account (CDA) is also addressed, ensuring that taxpayers have clear guidance during transitional periods.
Capital Dividend Account (CDA) Adjustments
The CDA is a notional account that tracks the non-taxable portion of capital gains and losses realized by private corporations, allowing for tax-free distributions to Canadian-resident shareholders.
The proposed increase in the capital gains inclusion rate necessitates adjustments to CDA calculations.
For taxation years that straddle the implementation date (25 June 2024), the August 12 Proposals introduce a “blended” inclusion rate to reflect the timing of dispositions within the transitional year.
This blended rate, while necessary for overall tax calculations, created challenges for CDA assessments, as the exact inclusion rate could not be determined until the year-end. The August 12 Proposals resolve this issue by establishing specific rules for calculating CDA during transitional years.
Hybrid Surplus Adjustments
The hybrid surplus rules, which relate to dividends received by Canadian corporations from their foreign affiliates, are also revised.
The August 12 Proposals introduce separate surplus pools for “legacy hybrid surplus” (pre-25 June 2024) and “successor hybrid surplus” (post-24 June 2024).
These distinctions ensure that the treatment of hybrid surplus dividends aligns with the relevant capital gains inclusion rate at the time of the underlying transactions.
Global Minimum Tax Act Amendments
Amendments to the Global Minimum Tax Act (GMTA), enacted on 20 June 2024, are included in the August 12 Proposals.
These changes implement the undertaxed profits rule (UTPR), provide transitional safe harbours, and address other elements from the OECD’s latest guidance.
The amendments will apply to fiscal years of qualifying multinational enterprise (MNE) groups beginning on or after 31 December 2024.
Trust Reporting Reforms
The trust reporting requirements are updated to reduce the number of bare trusts affected. The August 12 Proposals introduce new exemptions and modify existing ones, making the rules clearer and less burdensome for taxpayers.
The revised rules will apply to taxation years ending after 30 December 2025, with the Canada Revenue Agency (CRA) having already suspended the 2023 reporting obligations.
Anti-Deferral Rules for CCPCs
The August 12 Proposals address concerns raised about the anti-deferral rules targeting Canadian-controlled private corporations (CCPCs) and their controlled foreign affiliates (CFAs).
The revised measures introduce a carve-out for “foreign accrual business income” (FABI), offering some relief to CCPCs engaged in legitimate business activities abroad.
However, the proposals remain complex and may still impose significant compliance burdens on affected companies.
EIFEL Rules
The excessive interest and financing expenses limitation (EIFEL) rules are amended to include exemptions for certain interest and financing expenses related to regulated energy utilities and purpose-built residential rentals.
These exemptions aim to provide relief to businesses in specific sectors, supporting their continued growth and investment.
Application of Hybrid Mismatch Rules
The August 12 Proposals also clarify the application of hybrid mismatch rules to foreign affiliates, ensuring that the rules are applied consistently and preventing instances of double taxation on inter-affiliate dividends.
Canadian Entrepreneurs’ Incentive (CEI)
The CEI, introduced in Budget 2024, is further detailed in the August 12 Proposals.
This incentive reduces the capital gains inclusion rate to one-third for qualifying entrepreneurs, with several conditions relaxed compared to the original proposal.
The CEI aims to support business owners by providing substantial tax relief on the sale of their businesses.
Canadian government releases significant draft tax legislation – Conclusion
The August 12 Proposals represent a comprehensive update to Canada’s tax laws, addressing a range of issues from capital gains to international tax compliance.
While these changes introduce some relief and clarity, they also add layers of complexity, particularly for businesses with international operations.
As the consultation period progresses, further refinements may be made to ensure that the legislation effectively meets its objectives without imposing undue burdens on taxpayers.
Final thoughts
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