On August 4th, 2023, the Department of Finance Canada (“Finance”) released draft legislative proposals which included revised proposals to amend the general anti-avoidance rule (the “GAAR”) in section 245 of the Income Tax Act (Canada) (the “ITA”) (the “Revised GAAR Proposals”). The revised proposals follow several GAAR proposed amendments initially introduced in the 2023 Federal Budget (“Budget 2023”) tabled on March 28th, 2023.
The proposals to amend the GAAR will apply to transactions that occur on or after January 1st, 2024, except for the amendments to the preamble to the GAAR and related provisions which will come into force on Royal Assent.
With the increase in working at home arrangements due to
current events, employers and their employees may have questions about the tax
treatment of home office expenses for these employees.
Generally, an employer can compensate an employee for home
office expenses by way of an allowance or a reimbursement. An employee can also
be given an “accountable” advance which is treated as a reimbursement assuming
that the employee can provide itemized receipts and the balance is returned to
the employer.
If an employee receives an allowance or if he or she pays
for the expenses out-of-pocket, then the expenses may be deductible subject to
certain requirements discussed below. If an allowance or reimbursement is
considered a taxable benefit and not deductible to the employee, the employer
can mitigate the cost to the employee by compensating the employee for the
additional tax but will have to do so on a “gross up” basis as paying an
employee’s tax is also itself a taxable benefit.
In the 2019 Federal Budget, the Canadian
government outlined its proposal to introduce a $200,000 annual limit on
employee stock option grants for employees of “large, long-established,
mature firms”. The government takes the view that the current regime of
preferential tax treatment for employee stock options does not help to achieve
the policy objective of supporting younger and growing Canadian businesses, but
instead, disproportionally benefits executives of large, mature companies who
take advantage of the rules as a preferred form of compensation.
In an effort to provide further
clarifications to the proposed new stock options rules, the Department of
Finance released a Notice of Ways and Means Motionon June 17, 2019.
Current
Regime
Under the current stock option rules,
pursuant to subsection 7(1) of the Income
Tax Act (Canada) (the “Act”), at
the time when employee stock options are exercised by an employee, a taxable
benefit is added to the employee’s taxable income to the extent the fair market
value (“FMV”) of the underlying
shares exceeds the exercise price specified in the option agreement. However,
provided that at the time of the grant, the options are not in-the-money (i.e.
exercise price is not less than FMV) and, generally, common shares are issued
upon the exercise of the options, the employee is entitled to claim a deduction
under paragraph 110(1)(d) in the amount of 50% of the taxable benefit
determined under subsection 7(1).
New
Proposed Amendments
The new draft legislative proposals, if
enacted as proposed, would impose a $200,000 annual vesting limit on employee
stock option grants (based on the fair market value of the underlying shares at
the time the options are granted) that could be entitled to receive the 50%
deduction allowed under paragraph 110(1)(d).
Under the new regime, a vesting year in
respect of an option agreement is determined by either: (i) the calendar year
in which the employee is first able to exercise his or her option as specified
in the option agreement; or (ii) if the option agreement does not specify a
vesting time, the first calendar year in which the option can reasonably be
expected to be exercised.
The new annual vesting limit would not
apply to employee stock options granted by “specified persons” as defined in
the Act to mean: (i) Canadian-controlled private corporations (“CCPCs”); and (ii) non-CCPCs that meet
certain prescribed conditions (yet to be released).
In addition, the new draft legislative
proposals introduce a tax deduction for an employer who enters into an option
agreement with its employee to grant non-qualified securities. The amount of
deductions the employer is entitled to claim against its taxable income for a
taxation year would be equal to the amount of taxable benefit its employees realize
under subsection 7(1) in respect of non-qualified securities.
An employer would be entitled to claim
such deductions under circumstances where the following conditions are met: (i)
at the time of entering into the agreement, the employer notifies the employee
in writing that the security is a non-qualified security; (ii) the employer
notifies the Minister of National Revenue that the security is a non-qualified
security in prescribed form filed with the employer’s income tax return in the
year the agreement is entered into; and (iii) the employer is a specified
person and the employees would have otherwise been entitled to claim the
deduction under paragraph 110(1)(d).
In order to be entitled to claim the tax
deduction, it is critical that the employer designates the options that would
have otherwise qualified for a deduction under paragraph 110(1)(d) as
non-qualified securities by specifying this in the option agreement.
The new draft legislative proposals will
apply to employee stock options granted on or after January 1, 2020.
The federal government is currently
seeking input on the characteristics of companies that should be considered
“start-up, emerging, and scale-up companies” for purposes of the prescribed
conditions as well as views on the administrative and compliance implications
associated with putting such characteristics into legislation. Submissions of
any comments with respect to the prescribed conditions for the consideration by
the Department of Finance are due on September 16, 2019.
Tax Court confirms that arrears interest on taxes resulting from GAAR assessment accrue from the taxpayer’s balance-due day
In Quinco Financial Inc. v. R. (2016 TCC 190), the Minister of National Revenue had assessed Quinco under section 245 (the “GAAR”) of the Income Tax Act (Canada) (“ITA”) to deny certain claimed capital losses. Arrears interest on the resulting tax due was also assessed, which the Minister computed from Quinco’s “balance-due day”. The “balance-due day” is the deadline by which a taxpayer is required to pay to the Receiver General certain amounts payable under the ITA for a particular taxation year. For a corporate taxpayer, it is either two or three months after the end of the particular taxation year, depending on the circumstances.
Quinco took the position that it should not be liable for arrears interest on the assessed tax debt for the period prior to the assessment date. It proffered numerous arguments to support its position. The most interesting argument was that, although a GAAR assessment requires a determination of the tax consequences reasonably necessary to deny the tax benefit, it does not permit or extend to the recharacterization of the transaction for any other tax purposes; therefore, a taxpayer’s liability for interest does not arise until the date of the reassessment.
Justice Bocock rejected this argument and explained that an assessment under the GAAR,
“whether alone or in conjunction with another technical omission or non-compliant act, is not an assessment divorced from the other provisions of the Act.”
Here, the assessment was raised utilizing the GAAR, but the assessment “insinuated itself into Part I of the Act to reassess the taxpayer otherwise in the normal course.” Justice Bocock held that subsection 161(1) arrears interest accrues on any tax payable determined under the GAAR from the balance-due day until the GAAR assessment issuance date (and onwards until payment of the tax payable).
Canadian and provincial income taxes are assessed on worldwide income on the basis of a taxpayer’s residence. Subsection 104(2) of the Income Tax Act (the “Tax Act”) provides that a trust is deemed to be an “individual” for purposes of the Tax Act. Consequently, trusts that are resident in Canada or deemed to be resident in Canada will be taxed on their worldwide income as opposed to only their Canadian source income. Despite the tax implications accompanying a taxpayer’s residency status, the Tax Act provides little in the way of guidance for determining the residency of a trust. As a result, Canadian courts have been tasked with making this determination.
Central Management and Control
In 2009, Garron Family Trust (Trustee of) v. R.[1] changed the long-standing approach to determining the residency of trusts in Canada.[2] The test set out in Garron provides that the residency of a trust is where the central management and control of the trust actually takes place.[3] The court clarified that the assessment into who has central management and control is a question of fact to be examined on a case by case basis. In concluding that the central management and control of the Summersby and Fundy trusts (the “S&F Trusts”) resided with the beneficiaries, the court considered several factors, including:
Whether the evidence or lack of evidence demonstrated an active or passive role taken by the trustee in its management of the trust;
The true controlling minds behind investment decisions and management of the S&F Trusts’ assets;
The use of a protector mechanism to exert control over the trustee;
The beneficiaries’ demonstrated interest in the trustee’s management of the S&F Trusts;
The trustee’s expertise in managing trusts; and
The trustee’s knowledge of the transactions it had been asked to approve.
