The Stikeman Elliott Federal Budget Commentary 2021
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The Stikeman Elliott
Federal Budget Commentary 2021
April 19, 2021
The more things change, the more
Stikeman Elliott's Tax Group
they stay the same has prepared a commentary
on the 2021 federal budget.
Highlights
Business Income Tax Measures
About Stikeman Elliott
• Limitations on Interest Deductibility
– Limiting net interest expense to a fixed ratio of “tax EBITDA” Stikeman Elliott LLP is a global
leader in Canadian business
• Mandatory Disclosure Rules
law, offering creative solutions
– Broadening the scope of what constitutes a “reportable
to clients across Canada and
transaction”
around the world. The firm
– Implementing a mandatory disclosure regime whereby
provides the highest quality
“notifiable transactions” must be reported to the CRA
counsel, decisive advice and
– Requirement to disclose “uncertain tax treatments”
workable solutions through
• Avoidance of Tax Debts offices located in Montréal,
– Strengthening the existing rules in the Tax Act which prevent Toronto, Ottawa, Calgary,
taxpayers from avoiding their tax liabilities by transferring Vancouver, New York, London
assets to non-arm’s length parties
and Sydney.
• Supporting clean energy
International Tax Measures
• Limiting the deduction of payments made by Canadian residents
under “hybrid mismatch arrangements” Follow us
• Consultation on possible changes to transfer pricing rules
Other Tax Measures
• COVID-19 support measures
• Proration of tax on registered investments
• Application of GST/HST to e-commerce
• Proposal to strengthen the general-anti avoidance rule
• Confirmation of proposed changes to stock option rules
Stikeman Elliott LLP / stikeman.comFor months, there has been widespread speculation as to the measures that Budget 2021 would
introduce, given that it has been more than two years since the last federal budget and the COVID-19
pandemic continues to have a significant impact on the economy. One of the most notable aspects of
Budget 2021, however, is that it does not include certain measures that many expected would be
introduced. More specifically, there is:
• No increase in personal tax rates
• No change to the principal residence exemption
• No wealth tax
• No increase to the tax rate applicable to capital gains
• No substantive changes to the taxation of “Canadian-controlled private corporations”
While some may breathe a sigh of relief, Budget 2021 does contain several measures aimed at curtailing
tax avoidance. These measures, as well as other significant proposals contained in Budget 2021, are
discussed below.
Business Income Tax Measures
Limitations on Interest Deductibility
Consistent with the recommendations of the Organisation for Economic Co-operation and Development
(the “OECD”) and previous promises by the Canadian federal government as part of its 2019 pre-election
platform, Budget 2021 proposes to introduce, effective for taxation years commencing on or after January
1, 2023, an “earnings-stripping” rule that would limit the amount of net interest expense that a corporation
(and certain other types of entities, as described below) may deduct in computing its taxable income to no
more than a fixed ratio of the corporation’s “tax EBITDA”. For these purposes, “tax EBITDA” is the
corporation’s taxable income before taking into account interest expense, interest income and income tax,
and tax deductions for depreciation and amortization. Some key aspects of the proposal are as follows:
• The proposed interest deductibility limitations will apply to corporations, partnerships and trusts and
Canadian branches of non-resident taxpayers. Canadian-controlled private corporations that,
together with associated corporations, have taxable capital employed in Canada of less than $15
million will be exempt from the proposed regime, as will groups of corporations or trusts whose net
interest expense among their Canadian members is $250,000 or less.
• The fixed ratio interest deductibility limitation applicable to “tax EBITDA” would apply to new and
existing borrowings and would be phased in, with a fixed ratio of 40% applying to taxation years
beginning on or after January 1, 2023 but before January 1, 2024, and a 30% fixed ratio applying for
taxation years beginning on or after January 1, 2024.
• Canadian members of a group that have a ratio of net interest to tax EBITDA below the fixed ratio
would generally be able to transfer their unused capacity to deduct interest to other Canadian
members of the group whose net interest expense deductions would otherwise be limited by the rule.
• In circumstances where a taxpayer is able to demonstrate that the ratio of net third party interest to
book EBITDA of its consolidated group implies that a higher deduction limit would be appropriate, the
proposed measure also includes a “group ratio” rule that would allow a taxpayer to deduct interest in
excess of the fixed ratio of tax EBITDA. The consolidated group, for purposes of the group ratio rule,
would generally encompass all of the corporations that are fully consolidated into a parent
corporation’s audited consolidated financial statements. Such audited consolidated financial
statements would generally be used to measure net third party interest expense and book EBITDA for
these purposes, subject to “appropriate adjustments” including, among other things, in respect of
Stikeman Elliott LLP 2certain interest payments to creditors that are outside the consolidated group but are related to, or are
significant shareholders of, Canadian group entities.
• Interest denied under the earnings-stripping rule would be able to be carried forward for up to 20
years and may be carried back up to 3 years, subject to a number of complex constraints and
limitations.
• “tax EBITDA” would exclude dividends to the extent they qualify for the inter-corporate dividend
deduction or the deduction for certain dividends received from foreign affiliates.
• Interest expense and interest income would include not only amounts that are legally interest, but
also certain payments that are economically equivalent to interest, and other financing-related
expenses and income.
• Existing thin-capitalization rules in the Income Tax Act (Canada) (the “Tax Act”) will continue to apply,
but any interest denied under that regime would not be included as interest expense under the
proposed regime.
• Interest expense and interest income related to debts owing between Canadian members of a
corporate group would generally be excluded from the proposed regime.
• Budget 2021 also notes that the application of the proposed earnings-stripping regime to financial
institutions raises a number of challenges, and accordingly, indicates that (i) banks and life insurance
companies will not be permitted to transfer their unused capacity to deduct interest to other members
of their corporate groups that are not also regulated banking or insurance entities, and (ii) further
consideration will be given to whether there are targeted measures that could address base erosion
concerns associated with excessive interest deductions by regulated banks and life insurance
companies.
The proposed earnings stripping regime, if enacted, will implement the most significant change to the
legislative landscape for the deductibility of interest in modern Canadian history. Draft legislation on the
proposal is expected to be released for comment later this year and, undoubtedly, many interpretive
issues and areas of uncertainty will be identified upon a detailed review of that draft legislation.
However, it is noteworthy that the Budget materials state that: “Consistent with the rationale of the group
ratio rule, it is expected that standalone Canadian corporations and Canadian corporations that are
members of a group none of whose members is a non-resident would, in most cases, not have their
interest expense deductions limited under the proposed rule.” Further, Budget 2021 promises that
measures “to reduce the compliance burden on these entities and groups will be explored.”
Mandatory Disclosure Rules
Budget 2021 proposes to significantly expand the circumstances in which taxpayers or their advisors may
be required to report certain aggressive transactions or uncertain tax positions to the Canada Revenue
Agency (the “CRA”). The stated purpose of these proposed changes is to allow the government to quickly
respond to aggressive tax planning strategies through informed risk assessments, audits and changes to
legislation. The proposed rules are in part influenced by or modeled after recommendations made in the
Base Erosion and Profit Shifting Project, Action 12: Final Report of the OECD and the Group of 20, as
well as some similar rules introduced in other jurisdictions.
There are three specific disclosure regimes that are proposed to be implemented or expanded, each of
which is described below. There are two main consequences of failing to comply with any of these
proposed disclosure requirements. First, a taxpayer, or if applicable, a tax promoter or advisor, may be
subject to material penalties for failing to file the required disclosure by the applicable deadline. Second,
the normal reassessment period whereby the CRA may reassess a taxpayer will not start running until the
disclosure has been made. Accordingly, the CRA would have an unlimited amount of time to reassess a
taxpayer that has failed to properly disclose a transaction or position that should have been disclosed.
Stikeman Elliott LLP 3Reportable Transactions
The Tax Act already contains rules that require taxpayers to disclose certain “reportable transactions” to
the CRA by June 30th of the calendar year following the year in which the transaction first became a
reportable transaction. Stated very broadly, a reportable transaction is an “avoidance transaction” which
includes two of the following general hallmarks:
• a promoter or advisor receives a contingent fee that is tied to the tax benefit or number of participants
participating in the transaction;
• a promoter or tax advisor requires confidential protection in respect of the transaction; and
• the taxpayer, or a person who entered into the transaction for the benefit of the taxpayer, receives
certain forms of contractual protection (such as an indemnity) with respect to the tax benefit.
For this purpose, “avoidance transaction” is defined as a transaction that results in a tax benefit, unless
the transaction may reasonably be considered to have been undertaken or arranged primarily for bona
fide purposes other than to obtain a tax benefit.
Budget 2021 proposes to amend the existing reportable transaction rules in the following ways:
• The scope of the rules would be expanded so that only one of the three hallmarks listed above must
be met for a transaction to become a “reportable transaction”. As well, the definition of “avoidance
transaction” will be expanded to cover transactions where it can reasonably be considered that one of
the main purposes of entering into the transaction was to obtain a tax benefit.
• The reporting deadline will be accelerated so that transactions must be reported within 45 days of the
earlier of the day the taxpayer becomes contractually required to enter into the transaction or the day
the taxpayer actually enters into the transaction.
• Currently tax advisors or promoters are only required to disclose “reportable transactions” in which
they receive certain contingent fees. It is proposed that tax advisors and promoters will also be
required to report all reportable transactions (subject to an exception for solicitor-client privilege).
Notifiable Transactions
Budget 2021 proposes to implement a new concept of “notifiable transactions”, like the U.S.’s notifiable
disclosure regime. These would be specific types of “abusive” transactions which have been designated
by the Minister of National Revenue, with the concurrence of the Minister of Finance, as notifiable. It is
proposed that the CRA would provide a description of a notifiable transaction that would include the fact
patterns or outcomes that would allow taxpayers to determine whether a particular transaction is
considered “notifiable”. Examples will be provided as part of an upcoming consultation process.
As with “reportable transactions” discussed above, “notifiable transactions” must be reported within 45
days of the earlier of the day the taxpayer becomes contractually required to enter into the transaction or
the day the taxpayer actually enters into the transaction. As well, reporting requirements will apply to tax
advisors and promoters (subject to an exception for solicitor-client privilege).
Uncertain Tax Treatments
Finally, Budget 2021 proposes to implement mandatory disclosure for uncertain tax positions, again
similar to existing regimes in the U.S. and Australia. These rules would apply to corporations which have
assets of at least $50 million (determined based on the carrying value of assets on the corporation’s
balance sheet at the end of the financial year) and which have audited financial statements prepared in
accordance with IFRS or other country-specific GAAP relevant for domestic public companies (such as
U.S. GAAP). Accordingly, the rules would generally not apply to most private corporations, which typically
would not be required to maintain financial statements in accordance with IFRS.
Stikeman Elliott LLP 4A corporation that meets the foregoing requirements would be required to report any uncertain tax position if it is required to reflect that position in its audited financial statements in accordance with applicable accounting rules. Accordingly, a corporation that is subject to IFRS will be required to report a transaction whereby it concludes that it is not probable that the CRA will accept a particular uncertain tax treatment. Reporting would be due with the corporation’s tax return for the year. Conclusion on Mandatory Disclosure Rules The Department of Finance will be implementing a consultation period with respect to these proposed changes and will be accepting comments until September 3, 2021. Draft legislation is expected to be released in the coming weeks. The proposals would apply to taxation years that begin after 2021 and to transactions entered into on or after January 1, 2022, provided that penalties would not apply to any transactions that occur before the applicable legislation receives Royal Assent. Avoidance of Tax Debts Section 160 is a provision in the Tax Act that assists the CRA in collecting tax debts. Quite simply, the provision creates joint and several liability for a person who receives property from another person who has a tax liability. For the provision to apply, the transferee must be the transferor’s spouse or common law partner, a person who is under the age of 18 or a person with whom the transferor was not dealing at arm’s length. If the provision applies, the transferee has joint and several liability for the tax debt of the transferor to the extent any amount paid for the property transferred is less than its fair market value. Despite its simplicity, the provision has been the subject of a fair amount of tax jurisprudence. The cases have focused on issues such as whether there has been a transfer of property and when a tax debt arises. A recent case that addressed these and other issues pertaining to section 160 was Damis Properties Inc. v. The Queen in which the Tax Court of Canada held that section 160 did not apply. The case involved what has become a somewhat common tax planning scheme in which a corporate seller transfers a property with an accrued gain to a new corporation which then sells the property to a third- party purchaser. The gain is realized in the new corporation the shares of which are then sold to another person. The price paid for the shares does not fully reflect the potential tax liability in the new corporation because the purchaser expects to inject shelter into the new corporation that will reduce the tax liability. The effect of the transactions is that the seller has sold the property and avoided the tax that would otherwise have been paid on the gain. The CRA has attacked similar transactions on various bases. In this case, while it assessed the new corporation on the basis that the shelter injected did not reduce the tax liability, apparently, the new corporation did not have funds to satisfy the liability. As a result, the CRA looked to impose liability on the corporate seller under section 160. To do so, the CRA needed to establish that the new corporation was a tax debtor that had transferred property to the corporate seller and that the amount received by the corporate seller exceeded the value of the shares it had sold. In a long judgement, the Tax Court held that while there had been a transfer of property, because the corporate seller received not more than fair market value for its shares of the new corporation, the joint liability of the corporate seller was nil. The Court also held that while there was a transfer, the transfer occurred between parties dealing at arm’s length at the relevant time and therefore, section 160 was not applicable. To counter this and other judgements in which the CRA has been thwarted in its attempt to impose liability under section 160 in similar transactions, Budget 2021 proposes certain amendments to section 160. These amendments take the form of anti-avoidance rules that will attempt to counter transactions that cause a tax liability to arise in a taxation year following the year in which property is transferred or that ensure that parties are dealing with each other at arm’s length at the time of the transfer. In particular, the avoidance rule will deem a tax liability to arise in the year in which property is transferred if the transferor knew that a tax liability would arise after the end of the taxation year and one of the purposes of the transfer is to avoid the payment of the tax liability. The second avoidance rule would deem the transferor and transferee not to be dealing with each other at arm’s length at the time of the Stikeman Elliott LLP 5
transfer if they were not dealing at arm’s length at any time during the series of transactions that included the transfer of property and one of the purposes of any transaction or event within the series was to cause the transferor and transferee to be dealing with each other at arm’s length at the time of the transfer. In addition, Budget 2021 will add a rule that, for purposes of a transfer of property as part of a series of transactions, the value of the property transferred and the value of consideration given for the transfer is to be determined taking into account the overall result of the series rather than simply using those values determined at the time of the transfer. Finally, Budget 2021 proposes to impose penalties on planners and promoters of tax debt avoidance schemes equal to the lesser of 50 per cent of the tax that is attempted to be avoided and $100,000 plus the promoters’ fee for the scheme. Supporting Clean Energy Budget 2021 includes tax measures to support investment in clean technologies. Specifically, Budget 2021 proposes to expand the existing accelerated capital cost allowance (“CCA”) (i.e. depreciation) for specified clean energy generation and energy conservation equipment currently provided in Class 43.1 and 43.2 of the Regulations to the Tax Act. The expansion includes certain hydroelectric equipment, equipment used to produce certain solid and liquid fuels from waste materials (e.g. wood pellets) and certain hydrogen related equipment. Certain intangible project start-up expenses associated with projects of this type may be fully deductible as “Canadian Renewable and Conservation Expenses”. Budget 2021 also proposes to eliminate the accelerated CCA for some existing equipment and systems, including (i) fossil-fuelled cogeneration and combined cycle systems and (ii) certain heat production equipment and electrical generation systems that use specified waste-fuels (with more than 25% energy input from fossil fuels). Budget 2021 also proposes an investment tax credit for capital invested in carbon capture, utilization and storage with targeted emission reductions of at least 15 megatonnes of CO2 annually. A consultation period with stakeholders will commence shortly, and the credit is intended to come into effect in 2022. Immediate Expensing Budget 2021 proposes to provide temporary immediate expensing in respect of "eligible property" (which includes capital property that is subject to the CCA rules, other than property included in CCA classes 1 to 6, 14.1, 17, 47, 49 and 51) acquired by a Canadian-controlled private corporation (CCPC) on or after Budget Day and that becomes available for use before January 1, 2024, up to a maximum amount of $1.5 million per taxation year. International Tax Measures Hybrid Mismatch Arrangements The Action 2 report of the OECD’s Base Erosion and Profit shifting plan recommends detailed rules for countries to adopt in their domestic legislation to ensure that multinational enterprises cannot derive tax benefits from the use of “hybrid mismatch arrangements”. In general terms, a hybrid mismatch arrangement refers to an arrangement whereby due to the difference in tax treatment of an entity or financial instrument under two or more countries, there is a deduction in one country in respect of a cross- border payment, the receipt of which is not included in income in the other country. A similar concern occurs if there is a deduction in two or more countries in respect of a single economic expense. Hybrid mismatch arrangements can be implemented using a variety of types of entities and instruments including what is commonly referred to as a “imported mismatch” or a branch. Budget 2021 proposes to implement rules consistent with the Action 2 report recommendations, with appropriate adaptations to the Canadian income tax context. Stikeman Elliott LLP 6
In its simplest form, the proposed rules would operate as follows:
• Payments made by a Canadian resident under a hybrid mismatch arrangement would not be
deductible for Canadian income tax purposes to the extent that it gives rise to a further deduction in
another country or is not included in income of the non-resident recipient.
• To the extent that a payment made under a hybrid mismatch arrangement by an entity that is not
resident in Canada is deductible for foreign income tax purposes, no deduction in respect of the
payment would be permitted against the income of a Canadian resident.
• Any amount of the payment received by a Canadian resident under a hybrid mismatch arrangement
would be included in income, and, if the payment is a dividend, it would not be eligible for the
deduction otherwise available for certain dividends received from foreign affiliates.
Budget 2021 proposes to introduce two separate legislative packages to address hybrid mismatch
arrangements. The first package includes those items listed in Chapters 1 and 2 of the Action 2 report,
which would address more of the straightforward deduction/non-inclusion mismatches arising from a
payment in respect of a financial instrument. These rules would apply as of July 1, 2022.
The second legislative package would be released for stakeholders’ comment after 2021, and those rules
would apply no earlier than 2023. This package would presumably encompass some of the other items
referenced in the Action 2 report, including the structures utilizing imported mismatches, dual-resident
payers and reverse hybrids.
Consultation on Possible Changes to Transfer Pricing Rules
In response to the Federal Court of Appeal’s decision in Her Majesty The Queen v. Cameco Corporation
which, in effect, rejected the CRA’s interpretation of the Tax Act’s existing transfer pricing rules, in Budget
2021, the government has announced its intention to consult with stakeholders on ways in which these
rules can be “improved”. Presumably the improvements the government has in mind will seek to
legislatively broaden the courts’ interpretation of scope of the existing transfer pricing rules and, in
particular, the recharacterization provisions in paragraphs 247(b) and (d) of the Tax Act.
Other Tax Changes
COVID-19 Support
A range of taxable benefits have been made available to qualified individuals in response to the COVID-
19 pandemic. With respect to certain COVID-19 benefits that are repaid (for example, where an individual
determines that they were not eligible for the benefit in question), Budget 2021 proposes amendments to
allow individuals to claim a deduction in respect of the repayment of a COVID-19 benefit in computing
their income for the year in which the benefit amount was received rather than the year in which the
repayment was made. Furthermore, Budget 2021 proposes to extend the Canada Emergency Wage
Subsidy, the Canada Emergency Rent Subsidy and the Lockdown Support until September 2021. The
subsidy rates will gradually decline over the July-to-September period. In addition, Budget 2021 proposes
to introduce a new Canada Recovery Hiring Program to provide eligible employers with a subsidy of up to
50% on the incremental remuneration paid to eligible employees between June and November 2021.
Taxes Applicable to Registered Investments
Budget 2021 proposes that tax imposed under Part X.2 of the Tax Act, which applies where a registered
investment that is subject to certain investment restrictions holds property that is not a qualified
investment for the type of registered plans for which it is registered, be pro-rated based on the proportion
of shares or units of the registered investment that are held by investors that are themselves subject to
the qualified investment rules. This measure would apply in respect of months after 2020 and to
Stikeman Elliott LLP 7taxpayers whose liability under Part X.2 in respect of months before 2021 has not been finally determined
by the CRA as of Budget Day.
Application of the GST/HST to E-commerce
In its 2020 Fall Economic Statement, the Government of Canada announced (1) the implementation of a
new and parallel mandatory GST/HST registration system for certain non-resident vendors, (2) the
application of the GST/HST with respect to goods supplied through fulfillment warehouses in Canada,
and (3) the application of the GST/HST on all supplies of short-term rental accommodation facilitated
through a digital platform (the “2020 Proposal”). For a more detailed discussion on the 2020 Proposal,
expected to come into force on July 1, 2021, please refer to the following article published by our
colleagues Jean-Guillaume Shooner and Vanessa Clusiau : Canada Imposes GST/HST Registration
Requirements on Certain Non-Resident Suppliers | Stikeman Elliott.
In its Budget 2021, the Government of Canada proposes the following amendments to its 2020 Proposal:
• Safe Harbour Rules: Platform operators reasonably relying in good faith on information provided by
third-party suppliers will not be held liable for failing to collect and remit taxes. Instead, third-party
suppliers that provide false information to the platform operators will be held liable for any taxes not
collected as a result thereof.
• Eligible Deductions: Though non-resident vendors and distribution platform operators registered
under the simplified framework will not be entitled to claim input tax credits to recover any GST/HST
paid on their business inputs, Budget 2021 clarifies that such registrants will nonetheless be entitled
to deduct amounts for bad debts and certain provincial HST point-of-sale rebates from the tax they
are required to remit.
• Threshold Amount Determination: For purposes of determining whether a non-resident vendor or
distribution platform operator is required to register under the simplified framework, Budget 2021
clarifies that the registration threshold of $30,000 over a 12-month period should not take into account
zero-rated taxable supplies.
• Platform Operator Information Return: Budget 2021 clarifies that the requirement to file an annual
information return is limited to platform operators that are registered, or otherwise meet the criteria to
be registered, for the GST/HST.
• Authority for the Minister of National Revenue: Under Budget 2021, the Minister of National
Revenue’s existing authority to register persons it believes are required to be registered is now
expanded to include registrations under the simplified framework.
Proposal to Strengthen the General Anti-Avoidance Rule
Budget 2021 indicates that the government wants to “strengthen and modernize” the Tax Act’s general
anti-avoidance rule, although no details about what would be involved with this process were announced.
Changes to Stock Option Rules Confirmed
Budget 2021 confirms that the Federal Government intends to move forward with the proposed changes
to the employee stock option rules previously announced on November 30, 2020, and currently intended
to apply to stock options granted on or after July 1, 2021. These rules would limit the availability of the
110(1)(d) deduction for employees of non-Canadian controlled private corporations with consolidated
group revenue of $500 million or more.
This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal
advice and must not be treated or relied on as such. Please read our full disclaimer at www.stikeman.com/legal-notice
© Stikeman Elliott LLP 2021-04-19
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