Stikeman Elliott on Federal budget fixes for entrepreneurs
Here is the follow-up as promised. The federal Conservative government has made some serious headway on a couple of items that were undermining the ability of private Canadian companies to grow their businesses. Here is Stikeman Elliott’s take on the budget highlights. As you may recall, both of these issues have been highlighted here in the recent past (see prior posts “Deloitte’s study on Canadian VC Crisis is well-timed” December 6-07 and “Solving the Start-up & VC malaise” January 18-08):
“Compliance for Non-Residents Disposing of Taxable Canadian Property
Budget 2008 proposes a number of significant changes to the current compliance regime applicable in respect of non-residents who dispose of certain property (referred to as “taxable Canadian property”) the income or gain from the disposition of which may be taxable in Canada. Most significantly, taxable Canadian property of a nonresident includes unlisted shares of Canadian corporations.
Currently, to ensure that any Canadian tax liability of the non-resident who disposes of such property is collected, section 116 of the Tax Act generally requires the non-resident seller to notify the Canada Revenue Agency (“CRA”) of such disposition and, most importantly, makes the purchaser liable to pay an amount to the CRA on account of the non-resident seller’s possible Canadian tax liability unless the purchaser obtains a clearance certificate from the CRA, the property is “excluded property” (including, generally, listed shares, units of a mutual fund trust, and certain types of indebtedness), or after reasonable inquiry the purchaser had no reason to believe that the seller was a non-resident of Canada. A purchaser that is faced with potential liability under section 116 will normally withhold a portion of the purchase price otherwise payable to the non-resident seller, pending receipt of the appropriate clearance certificate. To obtain a clearance certificate from the CRA, the nonresident seller is generally required to remit the appropriate amount to the CRA, post adequate security for any potential tax liability, or satisfy the CRA that no tax will be owing.
In the case of a non-resident who is resident in a country with which Canada has a tax treaty, most (albeit not all) of Canada’s tax treaties would typically exempt a resident of that country from Canadian taxation on capital gains except for gains on Canadian real and resource properties and shares of companies that derive more than half of their value from such properties. However, any exemption from Canadian taxation afforded by an applicable tax treaty is not currently taken into account under the existing section 116 regime. Therefore, for example, a nonresident who disposes of unlisted shares of a Canadian corporation is likely to face the prospect of a significant portion of the proceeds being withheld (and potentially remitted to the CRA) even if any gain realized on the disposition of those shares is exempt from Canadian taxation under the terms of an applicable tax treaty.
The prospect of this withholding is often a significant concern for non-resident investors in Canadian enterprises, and the section 116 compliance regime has been subject to considerable criticism in recent years as the length of the time period for the review of transactions and the issuance of a clearance certificate by the CRA has increased as a result of a severe administrative backlog in the process.
Effective for dispositions that take place in 2009 and subsequent years, Budget 2008 proposes three significant changes in an attempt to “streamline and simplify” the compliance process that arises in this context. First, the category of “excluded property” will be expanded to exempt from the section 116 compliance process the disposition of a property by a non-resident that is, at the time of its disposition, a “treaty-exempt property” of the non-resident. A property will be considered a “treaty-exempt property” of a non-resident at the time of its disposition if the income or gain from the disposition of that property by the non-resident would be exempt from tax in Canada because of a tax treaty at that time and, in the case of a disposition between related persons, the purchaser sends a notice to the CRA, on or before the day that is 30 days after the acquisition of the property by the purchaser, setting out certain basic information about the non-resident seller and the transaction.
Second, the “reasonable inquiry” defence available under section 116 to purchasers of taxable Canadian property from non-residents will be expanded. As indicated above, currently the defence is only available if the purchaser, after reasonable inquiry, had no reason to believe that the seller was not resident in Canada. Budget 2008 proposes to expand this defence so that the purchaser would also be absolved from liability under section 116 if (i) the purchaser concludes after reasonable inquiry that the non-resident seller is, under a tax treaty that Canada has with a particular country, resident in that country; (ii) the property is a property any income or gain from the disposition of which by the non-resident would be exempt from Canadian tax because of a tax treaty if the nonresident were, because of the tax treaty referred to in (i), resident in the particular country; and (iii) the purchaser sends a notice to the CRA, on or before the date that is 30 days after the acquisition of the property by the
purchaser, setting out certain basic information about the non-resident seller and the transaction. It should be noted that the reasonable inquiry defence only extends to a conclusion reached by a purchaser with respect to the status of the non-resident seller as a resident of a country with which Canada has a tax treaty and does not appear to extend to a conclusion reached by a purchaser with respect to whether the terms of such tax treaty would operate to exempt any income or gain realized by a resident of that country from Canadian taxation. Accordingly, it may well be the case in many instances that a purchaser may simply be unwilling to take any risk that arises with respect to the interpretation or application of a particular relieving provision in a tax treaty that is ostensibly applicable and would, as a result, seek to withhold from the purchase price in order to protect itself. Therefore, as a practical matter, the most significant impact of the proposed changes to the section 116 compliance process may only be to related party transfers. Whether this was intended or not is unclear.
Finally, a related change proposed by Budget 2008 is to exempt certain non-residents from filing a Canadian income tax return in respect of a disposition of taxable Canadian property. Currently, a non-resident is required to file a Canadian income tax return for any taxation year in which the non-resident (or a partnership of which the non-resident is a member) disposes of taxable Canadian property. This requirement is typically viewed by nonresident investors as an onerous feature of the Canadian tax compliance landscape, particularly in circumstances where no Canadian income tax would be payable because of, for example, the application of a tax treaty. Budget 2008 proposes to ease this burden by exempting non-residents from filing Canadian income tax returns for any taxation year in which the non-resident satisfies all of the following criteria: (i) no mainstream Canadian tax is
payable by the non-resident for the taxation year (including, it would seem, tax on the disposition of the taxable Canadian property); (ii) the non-resident is not currently liable to pay any amount under the Tax Act in respect of any previous taxation year (other than, generally, in respect of certain stipulated amounts for which the CRA has been provided with adequate security); and (iii) each taxable Canadian property disposed of by the non-resident in the year is either “excluded property” (which as described above, will now include “treaty-exempt property”) or a property in respect of the disposition of which the CRA has issued to the non-resident a clearance certificate under section 116 of the Tax Act.
Enhancements to the SR&ED Program
Budget 2008 proposes certain improvements to the scientific research and experimental development (“SR&ED”) tax incentive program for qualifying Canadian-controlled private corporations (“CCPCs”). The Tax Act currently provides qualifying CCPCs with an enhanced SR&ED investment tax credit (“ITC”) of 35 percent on their first $2 million of qualified expenditures (qualifying CCPCs are those with taxable income (on an associated group basis) for the preceding taxation year of not more than the federal small business income threshold (i.e., $400,000 in 2008)). For qualifying CCPCs with taxable income over the small business income threshold, the $2 million expenditure limit is reduced by $10 for every $1 of taxable income over the threshold. The $2 million expenditure limit is also phased out for qualifying CCPCs having taxable capital (for Large Corporations Tax purposes) of between
$10 and $15 million in the prior year. The expenditure limit is reduced by $4 for every $10 by which taxable capital exceeds $10 million. The ability to claim the 35 per cent investment tax credit rate and related 100 per cent refund is, therefore, eliminated once taxable capital exceeds $15 million or once taxable income reaches a maximum of $600,000 for 2007 and subsequent years.
Budget 2008 proposes to enhance the SR&ED tax incentive program by increasing the expenditure limit from $2 million to $3 million. The upper limit for the taxable capital phase-out range will be increased from $15 million to $50 million and the upper limit of the taxable income phase-out range will also be increased from $600,000 to $700,000.
In order for expenditures to be deductible, qualifying SR&ED activities must generally be carried on in Canada. Budget 2008 proposes to further extend the SR&ED ITC by recognizing certain salary or wages incurred by a taxpayer in respect of SR&ED activities carried on outside Canada. The activities must be directly undertaken by the taxpayer and must be done solely in support of SR&ED carried on by the taxpayer in Canada. Permissible salary or wages incurred by a taxpayer in a taxation year will be limited to 10 per cent of the total salary and wages directly attributable to SR&ED carried on in Canada by the taxpayer during the year. These proposed changes will generally be applicable for taxation years that end on or after February 26, 2008.”
Here is the CVCA’s take on it. We’ve been pushing for these items, among others, so these budget measures are a great victory for the Canadian Venture Capital & Private Equity Association (congrats Rick, Richard, Howard, Robin, et al).