Canada’s Cannabis Taxation Regime

photo-1503262167919-559b953d2408There has been much speculation on how Canada will tax cannabis, which is expected to be legalized for retail sale in Canada by July 2018.  The much anticipated draft tax legislation was released by the Department of Finance on Friday November 10, 2017, and is out for consultation until December 7, 2017.

Proposed Tax Regime

Under the proposed cannabis tax regime, most supplies of cannabis will be subject to GST/HST (at rates currently ranging from 5-15% across Canada).  Cannabis, both for recreational or medical use, will also be taxed under the Excise Act, 2001 (Canada) (the “Act”), which currently imposes federal excise duty on spirits, wine and tobacco product made in Canada.  Both taxes on cannabis will be administered by the Canada Revenue Agency.

Similarly to the current GST/HST regime, the provinces and territories will be offered the option of joining the federal tax regime for cannabis taxation, in which case the excise duty on cannabis will be made up of the federal rate, plus an additional rate for the participating province or territory.  The division of tax revenues is currently under discussion between the federal government and the provinces, which will be responsible for controlling the distribution and retail sales of cannabis in each province.  In this regard, the federal government has indicated its goal of setting the maximum total excise duty rate at the greater of $1 per gram or 10 per cent of the sale price of the product.

Licensing, Stamping and Production

The proposed legislation requires cannabis producers to obtain a license from the Canada Revenue Agency under the Act (“Cannabis Tax License”), in addition to the license issued by Health Canada under the Cannabis Act.  The Cannabis Tax License is also required to package or stamp a cannabis product, or to sell, purchase or possess a cannabis product that is not packaged and stamped as required.  The licensee will be subject to a requirement to post security in an amount ranging from $5,000 to $5,000,000, depending on the expected amounts of duty payable, and will be valid for a maximum of two years, unless renewed.

It should be noted that GST/HST registration may also be required, in addition to the foregoing cannabis license registrations, where the small supplier threshold of $30,000 per annum is exceeded.  Provincial sales taxes may also need to be considered, as cannabis would be considered tangible personal property, and therefore may be subject to tax under provincial sales tax legislation in applicable jurisdictions.

Cannabis licensees will also need to apply for cannabis excise stamps, with the intended provincial or territorial market, indicating that duty has been paid.  The possession of counterfeit cannabis excise stamps, the unlawful possession of cannabis excise stamps or unstamped cannabis products, as well as diversions and other contraventions, will be subject to penalties, and may also fall under existing and new cannabis-specific offence provisions.

The proposed legislation also addresses the packaging of cannabis for retail markets, which will be required to include information as prescribed in the regulations.  Regulations will also address additional conditions for the licensing, production and sale of cannabis, including where and what activities may be conducted under a license.

Rates of Excise Duties

Cannabis products produced in Canada will be subject to excise duty at the manufacturing level. The tax will also be applied to both cannabis for medical purposes and to cannabis for non-medical purposes, which was apparently deemed necessary due to the potential compliance and diversion issues that may arise with differing tax treatment.

The federal excise duty will generally apply to fresh and dried cannabis, cannabis oils, and seeds and seedlings for home cultivation at the time that they are packaged, at the higher of the following two amounts:

– a flat rate per gram (50 cents for flowering cannabis, viable seed, vegetative cannabis plant; 15 cents for non-flowering cannabis)

– an ad valorem duty calculated as a percentage (5%) of the sale price of the packaged cannabis at the time of delivery from the federal licensee

The tax will only be payable at the time of delivery to the purchaser, or on certain importations, to the extent they are allowed.  Excise duty will also apply to cannabis that is unaccounted for, or is taken for consumption, analysis or destruction.

Exemptions

The excise duty regime for cannabis generally will not apply to cannabis products that are produced in Canada by an individual for the individual’s own personal use/medical purposes (or by a designated person for the medical purposes of another individual) that is in accordance with the relevant rules in the Cannabis Act or Controlled Drugs and Substances Act, as applicable.  Duty relief is also available in limited cases, including the taking of cannabis destruction in prescribed circumstances.

Entry into force

The cannabis tax regime is proposed to come into force on commencement day (when adults will be able to legally purchase and possess cannabis for non-medical purposes).  Certain provisions, including licensing and stamping requirements, are proposed to come into force as at an earlier date.  Cannabis products that are delivered to a purchaser before commencement day, for sale and distribution after that day, will be subject to excise duty.

GST/HST

Cannabis products will also be subject to GST/HST, with limited exception.  In this regard, the proposed amendments exclude from the zero-rated supplies in Part III of Schedule VI to the Excise Tax Act (Canada), food and beverages that are cannabis products, and viable seeds that are cannabis. The foregoing does not apply to viable grains or seeds that are industrial hemp for purposes of the Cannabis Act, which will continue to be zero-rated.

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New Proposals on the Taxation of Private Corporations can result in Double Taxation

ottawa-815375_1920Much has been written regarding the proposals released by the Department of Finance on July 18, 2017 to limit income splitting and holding passive investments inside a private corporation.[1]  A third measure, namely, placing limits on the conversion of income to capital gains is aimed at preventing an individual selling shares of a corporation to a non-arm’s length person followed by a sale by the non-arm’s length person to a connected corporation.  The foregoing transaction would result in the individual realizing a capital gain based on the fair market value of the transferred share followed by the tax-free extraction of corporate surplus of the transferred corporation.  This is considered an inappropriate conversion of what would otherwise be a payment of dividend income into a capital gain.  The difference in tax rates is about 14%.

The problem is in the application.  Discussions with officials from the Department of Finance indicate that these proposals will prevent some normal post death tax planning aimed at preventing double taxation of the same economic gain (the “pipeline plan”).

The pipeline plan is illustrated in the following example:  Taxpayer A incorporates a company and invests $100 for shares of the company.  The company starts a business or buys investments for $100.  Ten years later the shares of the company are worth $5 million.  Taxpayer A dies, a capital gain of $4,999,900 is realized.  However, the cost of the assets or investments in the company remains at $100.  Thus, if the assets or the investments are sold for $5 million, there is a gain of the same $4,999,900, i.e., the same gain is taxed twice, once in the hands of the deceased taxpayer and once in the hands of the company.  To prevent this economic double taxation, the shares of the company are sold by the estate of Taxpayer A to a new corporation for the same $5 million which then is amalgamated with the company.  The tax result is that the cost base of the assets in the amalgamated company and paid-up capital of the shares of the amalgamated company is increased to $5 million.  This prevents double taxation of the same gain.

Yet, the Department of Finance officials have indicated that the pipeline plan is not available because the transfer of the shares from the deceased Taxpayer A to his estate is a non-arm’s length transfer that is caught by the new proposal.  It is a stretch to think of death as a “specific type of avoidance transaction”.

There is a procedure available to deal with the double taxation issue but there is a stringent time requirement which often causes such a procedure to not be available.[2]

The Minister of Finance should heed the words of Shakespeare “Striving to do better, oft we mar what’s well”.  At a bare minimum, the Minister should announce that these rules will not affect pipeline transactions.

 

[1]       See also our commentary on the proposal, “Targeting Private Corporation Tax Planning: the Canadian Federal Government’s Proposal“.

[2]       Namely, making an election pursuant to subsection 164(6).

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Five Fasken Martineau Partners make the 2017 Tax Controversy Leader’s list

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The 7th edition of the International Tax Review guide mentioned five partners of Fasken as leading tax dispute resolution lawyers in Canada. This prestigious recognition is based on their outstanding success in the past year and consistently positive feedback from peers and clients.

The five partners that made the Tax Controversy Leader’s list of 2017 are :

Congratulations to the listed partners!

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Cinq associés Fasken Martineau figurent dans la liste des chefs de file en litige fiscal

businessman-2056022_1920La 7e édition du répertoire International Tax Review fait mention de cinq associés de Fasken à titre de chefs de file dans le domaine du contentieux fiscal au Canada. Cette reconnaissance prestigieuse est basée sur leur succès remarquable au cours de la dernière année et des commentaires positifs de pairs et de clients.

Les cinq associés figurant dans la liste des chefs de file en litige fiscal de 2017 sont :

Félicitations aux associés nommés!

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Targeting Private Corporation Tax Planning: the Canadian Federal Government’s Proposal

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(The full version of this bulletin was originally published on Fasken.com – “The Federal Government’s Proposals Targeting Private Corporation Tax Planning” – August 3, 2017.)

On July 18, 2017 (the “Consultation Date”), the Minister of Finance (Canada), the Honourable William Morneau, released the Government’s proposals to address tax planning commonly used by private corporations and their owners in the form of a paper (the “Consultation Paper”) and draft legislation amending the Income Tax Act (Canada) (the “Tax Act”) to implement certain of the proposed measures.

The Government addresses three broad issues in the Consultation Paper:

  • sprinkling income using private corporations;
  • holding a passive investment portfolio inside a private corporation; and
  • converting a private corporation’s regular income into capital gains.

Selected proposals and tax measures are detailed below.

Details of the Proposed Tax Measures

Income Sprinkling

Background

The Consultation Paper notes that the Government has imposed a progressive personal income tax system with five marginal tax rates ranging between 15 percent and 33 percent that apply at different taxable income thresholds. The Government is concerned with arrangements that effectively transfer income that may otherwise be taxable in the hands of a high-income individual to a family member subject to lower tax rates resulting in lower tax receipts for the Government (“income sprinkling”).

The Tax Act currently has a number of provisions that deny or limit the potential benefits of income sprinkling, but the Government believes that additional measures are necessary with a particular focus on investments in private corporations.

Proposed Tax Measures

The measures proposed by the Government fall into three categories:

  1. extension of the tax on split-income (“TOSI”) provisions;
  2. restricting claims under the lifetime capital gains exemption (the “LCGE”); and
  3. new tax reporting obligations applicable to trusts and partnerships.

 

Continue reading to learn how the Canadian Federal Government’s announced target tax planning strategies affect private corporations.

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