The federal government has signalled it wants to close tax loopholes and crack down on tax avoidance and has targeted specific strategies used by life insurers, private corporations and some registered products in its latest federal budget.
Budget 2017, released in March, proposed rules to prevent Canadian life insurance companies from shifting income from the insurance of Canadian risks to foreign branches in lower-tax jurisdictions.
Foreign branch income
In general, Canadian corporations are taxed on worldwide income, including income from foreign branches, but this is not the case with Canadian life insurers, says Tina Korovilas, a partner at Toronto-based Grant Thornton.
Foreign branch income of a Canadian life insurer is not taxable either when it’s earned or when it’s repatriated back to Canada. Prior to the budget proposals, Canadian life insurers benefited from insuring Canadian risks through foreign branches, rather than as part of their Canadian business. No specific rules restricted them from shifting the insurance of these risks to lower-tax jurisdictions.
Other Canadian companies, however, are taxable on income from the insurance of Canadian risks earned through a foreign branch or foreign subsidiary. Generally, income from the insurance of such risks earned by a foreign subsidiary is taxable to Canadian shareholders, but with relief for foreign taxes, said Korovilas.
“[Currently] there are no restrictions to prevent the shifting of income from the insurance of Canadian risks to foreign branches in lower or low-tax jurisdictions [for Canadian life insurers],” she said.
The federal government now wants to eliminate that benefit and make sure Canadian life insurers are paying their fair share of taxes in Canada on income generated from insuring Canadian risks.
Closing the gap
Proposals designed to close the gap include taxing Canadian life insurers in relation to their income from the insurance of Canadian risks carried on through a foreign branch. These rules will apply where 10 per cent or more of the gross premium income earned by a foreign branch of a Canadian life insurer is premium income in respect of Canadian risks.
The budget also proposed rules to prevent the avoidance of Canadian tax by swapping income from Canadian risks with income from foreign risks.
Removal of this strategy is seen as more of a housekeeping chore from government than anything else, said Noeline Simon, vice president, taxation, pension and reporting with the Canadian Life and Health Insurance Association (CLHIA). “Policy-wise, it’s consistent with government’s policy on taxation of Canadian life insurers with branch operations,” said Simon.
Ottawa also announced that it has set aside more than half a billion dollars in the budget to hire more auditors for increased audit and compliance measures.
It is expected to release a consultation paper in the next few months to prevent wealthy individuals from using private corporations to reduce their taxes payable. This will affect mostly family-owned businesses that have been able to “sprinkle” earnings to lower-earning family members.
“A business owner who has a family trust or has multiple family members as owners within the company now has the ability to distribute those after-tax corporate earnings as dividends to family members” such as a child who is in university or a non-working spouse, said Sterling Rempel, a certified financial planner and wealth and estate planning specialist in Calgary. “If that’s taken away, that’s certainly one major private company tax planning strategy that would need to be reconsidered.”
The consultation paper will also look at holding a passive investment inside a private corporation, a tax advantage not available to all Canadians.
Other tax loopholes Ottawa wants to close are anti-avoidance rules for Registered Education Savings Plans and Registered Disability Savings Plans similar to ones for Tax-free Savings Accounts and Registered Retirement Savings Plans. The purpose here is to help ensure that the plans don’t allow tax advantages not related to their objectives.
Budget 2017 also saw mutual funds given the green light to allow tax-deferred mergers of mutual fund corporations into mutual fund trusts. The last federal budget eliminated deferring the capital gains tax for those investors who were switching from one fund to another within a mutual fund corporation.
The Investment Funds Institute of Canada (IFIC) said it had been working with federal finance officials to develop transition rules that would allow for an orderly restructuring.
“This provision enables mutual fund corporations to meet their fiduciary obligations to investors and permits funds to be reorganized in a tax-efficient manner,” Paul Bourque, president and CEO of IFIC, said in a statement.
The budget also proposed allowing tax-deferred mergers of segregated funds.
Lower drug prices
There was some good news when it came to the drug prices in Canada. The budget said Ottawa wants to improve access to prescription medications as well as lower drug prices plus make an investment of $140.3 million over five years to Health Canada, the Patented Medicine Prices Review Board and the Canadian Agency for Drugs and Technologies in Health.
“High drug costs have been an issue for private group plans for several years and for the employers who provide the benefits,” said Karen Voin, assistant vice president, group benefits and anti-fraud with the CLHIA. “In the last several years, the high cost of drugs has created concern about the sustainability of the plans. Drug prices in Canada are relatively high compared to other developed countries, so there are lots of opportunities to lower them.”
Other proposals in the budget include expanding e-prescribing and virtual care initiatives and investing in the Canadian Foundation for Healthcare Improvement to help spur health-related innovations in all provinces and territories.
It also proposes to add nurse practitioners to the list of medical practitioners that can certify eligibility for the disability tax credit.
The much-talked about increase in the inclusion rate on capital gains failed to materialize. Rempel said it may have been because U.S. President Donald Trump has long stated his desire to lower taxes south of the border. “To move Canada to a higher tax regime would be negative on a competitive standpoint.”
Currently, 50 per cent of a capital gain is subject to tax. Speculation had been that the inclusion rate would jump to as high as 75 per cent.
Getting rid of some ineffective strategies was also in the budget. Soon gone will be: the Canada Savings Bonds program, the public transit tax credit effective July 1 and the tax credit for those making their first charitable donation.
Going up are Employment Insurance premiums, rising five cents to $1.69 for every $100 of insurable earnings, excise duty rates on alcohol products up 2% and the excise tax on cigarettes rising 2.5% on every 200 cigarettes. The government said taxes on alcohol and liquor prices will be adjusted every April starting next year and will be based on the consumer price index.