Federal Budget 2023: Individual and business tax measures

Tara: Hi, I'm Tara Benham, National Tax Leader at Grant Thornton. The 2023 federal budget was released on March 28th. In this, we saw a number of individual and business measures introduced and amended. I'm joined by Matt McAdam, Tax Partner at Grant Thornton, who is going to provide some insights on what was included in this year's budget. Matt, thanks for joining me. 

Matt: Hi Tara. It's my pleasure.  

Tara: So, what can you tell me about the changes we saw for individuals in the budget this year? 

Matt: That's a great question Tara. So, one of the more significant changes that we've seen affecting individuals were changes related to the intergenerational transfer rules, also known as Bill C-208. So, these rules first came out in June of 2021, and they're really designed to help businesses transition from one generation to the next generation. Now the concern was with the initial version of the rules as they became law was that finance was concerned that they applied too broadly and could apply to transactions where there wasn't a bona fide transition of a business between generations of a family. So, we were watching very carefully what was going to come out in this budget. And sure, enough, there were some changes. So the most significant change is the adoption of two new tests that really put some limitations or some requirements around the time frame and the extent of the transfer of ownership from the parent to the next generation. So, there is an immediate intergenerational business transfer and a gradual intergenerational business transfer, two concepts which now are the benchmarks on which this rule can apply. As I mentioned these apply timing requirements for a parent to give up control of the business both voting control and practical controls. So, management control of the business, as well as the transfer of the future growth, if you will. The common shares of the business as well. So really designed to limit the scope to address I guess, the concerns that finance had with this being a bit too broad. Now, not all the changes were limiting. In fact, there were some changes that helped taxpayers who are undergoing these transactions. So, one of those changes was the extension of the capital gains reserve from the current five-year maximum to a ten-year maximum. Also, the definition of child for these purposes.

Previously, it only included a child, and a grandchild has now extended to include great grandchildren or nieces and nephews of the transfer. Infact, even descendants of those nieces and nephews, so it's broadened the group of individuals that could potentially take part in one of these transfers. Now the changes here are expected to take effect January 1, 2024. which is interesting because it indicates that at least for the present time, the law as it currently stands is still in effect. So, all of these changes that I just mentioned in terms of limiting the nature of the Bill C-208 planning are really prospective and that their occur 2024 onward. 

Tara: Thanks Matt. I know that these rules were a really welcome change to every small to medium-sized business that was looking to transition to some of their family members. And as you say it’s great that the more restrictive rules are only applicable in 2024. So we do have some time to play with the old rules. So, moving on. What do we see for individuals? 

Matt: So, another interesting change that we see coming out in Budget 2023 is the introduction of a new concept called an employee ownership trust. Now, this is a new type of trust for Canadian tax system at least, and it's designed to allow controlling interest of a business to pass from an owner to employees of that business. So where we saw Bill C-208 centered around intergenerational transfers within family. This new employee ownership trust rule is really designed to facilitate transfers of a business from an owner to its employees. So it's very unique in that regard. The trust essentially acquires control of the business and then holds that for the benefit of the employees. And over time it can pay distributions of income from that business through the trust and out to the employees. Now, as expected, there would obviously be limitations in terms of these rules.

So there's limitations in place for the type of business that an employee ownership trust can hold. There's also limitations on the extent of control or influence that the transferring individual can have in the business or the employee ownership trust going forward and limitations as well on certain employees that might otherwise have a significant influence or significant interest in the business that the that the trust owns. But for all intents and purposes if these rules apply they can be a very significant tool for allowing a business to transfer ownership to its employees. How does it do that? Well there are some certain tax advantages that an employee ownership trust will be given. One of them is similar to Bill C-208 the capital gain reserve that can apply to a transfer of a business to an employee ownership trust will be extended from five years to ten years. But in addition the length of time that a trust may borrow funds from the company to finance the acquisition of the company is very generous for an employee ownership trust. It's 15 years. So to put that into context right now a shareholder can borrow funds from a company. They can only do that temporarily and it must be repaid within two years. Otherwise that borrowing becomes income.

An employee ownership trust under these rules will be able to borrow that money for as long as 15 years. Which can be significant in helping the employee ownership trust, finance the actual acquisition of that business. One other positive tax change in relation to these employee ownership trusts is the exemption from the 21-year rule. The 21-year rule is essentially a rule that requires Canadian trusts to deemed to have disposed of their capital property on the 21st anniversary of their creation.

An employee ownership trust will be exempt from that rule which means essentially that an employee ownership trust will not pay capital gains tax on the shares of the business unless there is an actual transaction involving those shares.So very interesting rule indeed.  

One other personal tax measure, aside from the employee ownership trust trust that has caught our attention is the changes to the alternative minimum tax system. So, finances are changing the alternative minimum tax system to make it narrower in its application but more impactful to the individuals that it will apply to. How it’s doing that is changing first the exemption from AMT from $40,000 where it currently sits to $173,000 going forward. What that exemption relates to is the calculation of tax for purposes of this alternative minimum tax. So obviously the higher that exemption is, the less likely that a taxpayer is going to be affected by alternative minimum tax. However, those that are affected by alternative minimum tax will pay a higher rate.

The tax rate that will apply is going to change from 15% to 20.5% a full five and a half percentage points. So, the cost of the alternative minimum tax will be potentially higher and what goes into the formula of calculating the taxable income for this alternative minimum tax is also changing. So, there will be reduced tax benefit from certain deductions. There will be a reduction or elimination of certain personal tax credits from the formula and the impact of certain tax favorable types of income like capital gains and employee stock options. Hey will be essentially a higher inclusion rate in terms of calculating that taxable income.

So overall, The result should be that fewer taxpayers are subject to AMT. But those that are subject to it will pay a higher tax. The Government has indicated that they expect with these changes 99% of the AMT that will be paid will be paid by taxpayers who earn more than $300,000. 

Tara: That's fascinating Matt. At least it is for me as a tax geek. So, I do know that in the small and medium-sized enterprises, more than 75% of those businesses are set to transition within the next ten years. So that employee ownership trust is going to be key in that planning and creating an opportunity for so many more. And the AMT we did see that or think that we were going to see some changes targeted to the wealthier individuals in Canada and I think that's one of them. So, moving on, what measures did we see that affect businesses? 

Matt: Yeah, so for businesses, there are a number of measures that were fairly narrow in scope including you know, there were lots of tax credits that are being offered in terms of green technology and green energy for instance. But one of the more impactful things that we see and that's impactful to businesses but is really impactful to any taxpayer in Canada are some changes to the general anti-avoidance rule or the GAAR provision as it's called in the tax world. So, this is essentially a rule that allows the CRA the ability to reassess the tax outcome if they feel that the transaction as a whole was an avoidance transaction, a misuse and abuse of the tax and really achieved an outcome that was not intended in the spirit of the act.

So, this rule is going to be broadened in terms of its application through a number of means. So, the first is in determining whether or not there is an avoidance transaction. The current rule says that you have to look at what the primary purpose of the transaction was. If the primary purpose can be demonstrated to have been a tax avoidance transaction, then you're proceeding down the down the lines of these rules. That is changing from a primary purpose to a lower benchmark, which is one of the main purposes. And although the wording there might seem subtle, it is very significant and that change in wording will catch many more transactions where it can be demonstrated that at least one of the main purposes was an avoidance transaction. 

Matt: In addition to that there's also going to be a consideration of whether there is a lack of economic substance to a transaction in determining whether there's a misuse or abuse of the Act. But perhaps the most impactful change that’s proposed under the GAAR system is the introduction of a 25% penalty. Now right now, if there is an assessment under GAAR the outcome is that the taxpayer's income increases, they owe the tax on that income and they may owe interest as well, for the time period that's passed. But there's not been a penalty.

The proposal here is that there will be a 25% penalty on the amount of any advantage in a GAAR transaction, and that obviously is a significant change. In addition, the time period that CRA has the ability to evaluate and reassess under GAAR is increasing from the normal reassessment period to three years beyond the normal reassessment period for the taxpayer. So, these will be significant changes obviously to the GAAR rule as we as we currently see it. Now, these proposals are subject to consultation, so, we have to await the outcome of that, and it'll be interesting to see how that evolves over the next little while. 

Tara: Thanks Matt, for sharing your thoughts. And I think all the changes are interesting, both positive and negative. And I think the thing that I noticed about them was that they are not effective immediately,highly unusual. The Bill C-208 we have until 2024. The GAAR changes not until after the consultation period. So, it is very unusual for restrictive legislation to come into force on a future basis, which is, I would think, a positive in and of itself.