This document was prepared by the staff of the Parliamentary Research Branch to provide Canadian Parliamentarians with plain language background and analysis of proposed government legislation. Legislative summaries are not government documents. They have no official legal status and do not constitute legal advice or opinion. Please note, the Legislative Summary describes the bill as of the date shown at the beginning of the document. For the latest published version of the bill, please consult the parliamentary internet site at www.parl.gc.ca.

LS-363E

TABLE OF CONTENTS

BACKGROUND

DESCRIPTION AND ANALYSIS

   A. Tax Credits for Individuals (Clauses 9, 16, 23-26, 32, 68)

   B. Canada Child Tax Benefit (Clauses 33, 73)

   C. Individual Surtax (Clause 52)

   D. Income-Splitting Tax (Clauses 2, 6, 8, 10-11, 16, 27, 29-31, 35, 37, 46, 47)

   E. Lump-Sum Payments (Clauses 17, 30)

   F. Communal Organizations (Clause 41)

   G. Civil Penalties (Clauses 47, 49-50, 66, 70-71)

   H. RRSP/RRIF Proceeds on Death (Clauses 7, 42)

   I. Part VI Capital Tax (Clause 53)

   J. Manufacturing and Processing Tax Rate Reduction (Clause 34)

   K. Offset of Interest (Clauses 48, 51, 67)

   L. Non-Resident Investment Funds that Engage Canadian Service Providers (Clause 21)

   M. Labour-Sponsored Venture Capital Corporation (LSVCCs) Clauses 36, 54-59, 61-63)

   N. Tax Coordination with First Nations (Clauses 27, 35, 44-45, 47)

   O. Demutualization of Insurance Corporations (Clauses 3-5, 13-15, 38-40, 43, 64-65, 67)

   P. Hepatitis C Trust (Clause 12)

   Q. Forward Averaging (Clauses 18-20, 22, 28, 31, 35-36)

   R. Foreign Tax Property (Clauses 60, 69)

BILL C-25: AN ACT TO AMEND THE INCOME TAX ACT,
THE EXCISE TAX ACT AND
THE BUDGET IMPLEMENTATION ACT, 1999

BACKGROUND

Bill C-25 was introduced in the House of Commons on 16 February 2000. It deals with a wide range of matters arising from the 1999 federal budget, as well as government policy announcements made prior to that budget.

Bill C-25 was accompanied by Bill C-24, An Act to amend the Excise Tax Act, a related Act, the Bankruptcy and Insolvency Act, the Budget Implementation Act, 1997, the Budget Implementation Act, 1998, the Budget Implementation Act, 1999, the Canada Pension Plan, the Companies’ Creditors Arrangement Act, the Cultural Property Export and Import Act, the Customs Act, the Customs Tariff, the Employment Insurance Act, the Excise Act, the Income Tax Act, the Tax Court of Canada Act and the Unemployment Insurance Act.

DESCRIPTION AND ANALYSIS

   A. Tax Credits for Individuals (Clauses 9, 16, 23-26, 32, 68)

The basic and spousal amounts for all taxpayers would increase to $6,794 in 1999 and $7,131 in 2000. The existing $500 supplement to the basic amount, with a 4% phase-out rate applied to income over $6,956, would be removed (clause 24). Consequently, the reference to the $500 supplement as an unused credit transferred to a spouse would also be removed (clause 26). Another consequence of the increase in the basic amount would be the upward adjustment of the threshold used for the refundable medical expense supplement (clause 32). The definition of "eligible child" for the purposes of child care expense deduction would be amended to reflect the increase of the basic personal amount (clause 9). The income threshold for children who are dependent on persons deemed to be resident in Canada would also be increased, in accordance with the increase of the basic personal amount (clause 68). The list of eligible medical expenses would be extended to include certain therapies that are not required to be administered by a qualified therapist or medical practitioner (clause 25); however, this measure would be limited to individuals eligible for the disability tax credit (DTC). The definition of "preferred beneficiary," which includes individuals qualified for the DTC, would also be amended to reflect changes in the basic amount (clauses 16, 23).

   B. Canada Child Tax Benefit (Clauses 33, 73)

In the 1999 federal budget, it was announced that the National Child Benefit (NCB) supplement to the Canada Child Tax Benefit (CCTB) will be increased by $350 for each eligible child to reach $955 for the first child, $755 for the second child and $680 for each subsequent child as of July 2000. However, the amendment contained in the Budget Implementation Act, 1999 failed to reflect the two-year phase-in for the supplement. The first step for the increase is $180, effective July 1999, and the second one is $170, effective July 2000. Thus, effective July 1999, the NCB supplement is $785 for the first child, $585 for the second child and $510 for each subsequent child. Clause 73 would contain the correction for this oversight. Clause 33 would also correct an oversight related to the eligibility of an individual entitled to the NCB supplement in respect of a qualified dependant.

   C. Individual Surtax (Clause 52)

Clause 52 would amend the appropriate subsection of the Income Tax Act (ITA) to eliminate the 3% individual surtax, while leaving unchanged the 5% individual surtax applicable on tax payable in excess of $12,500.

   D. Income-Splitting Tax (Clauses 2, 6, 8, 10-11, 16, 27, 29-31, 35, 37, 46, 67)

Clause 30 would amend the ITA to introduce a special tax to be imposed on certain income of individuals aged 17 or under. The types of income subject to this new tax would include dividend income, other shareholder benefits, partnership income and trust income from the business of providing goods or services to a business carried on by a relative of the minor individual. The tax rate would be the top marginal rate (29%). Income taxed as split income would not be taxed as regular income (clause 2). In addition, the amount taxed as split income in the hands of a minor child would not be attributed to another person (clause 6), particularly a parent or any other transferor (clause 11). Where the child was liable to pay the tax on split income, a new provision in the ITA would impose a joint and several liability for the tax on a parent of the child (clause 46). Income subject to the special tax on split income would not be eligible for any deductions or credits other than the dividend tax credit and foreign tax credit (clauses 30-35). The special tax would also be excluded from the "tax otherwise payable" for the purpose of the overseas employment tax credit (clause 31). Also modified would be the rule for retaining the nature of income when it goes from a trust to a beneficiary (clause 16), the rules for reserve for debt forgiveness for resident individuals (clause 8), and rules for transfers and loans to corporations (clause 10). The amendment would affect the section related to income not earned in a province and the Quebec abatement (clause 27). The minimum tax in respect of a taxpayer for a taxation year would not be less than the new tax on split income (clause 37) and that tax would be excluded from the calculation of tax payable from which minimum tax carryover could be claimed (clause 29). "Split income" would be added as a new definition for the purpose of the ITA (clause 67). All these amendments would be effective in the 2000 and subsequent taxation years.

   E. Lump-Sum Payments (Clauses 17, 30)

The proposed changes would be applied to qualifying lump-sum payments received after 1994. Individual taxpayers receiving retroactive lump-sum payments over $3,000 in a particular taxation year would be allowed to use a special mechanism to compute the tax payable on this amount, thereby reducing the tax liability of the year of receipt (clause 17). This clause was amended to specify some deductions that could not be used in the calculation. A notional amount of interest would be added to reflect the delay in payment of tax on the retroactive lump-sum payment (clause 30).

   F. Communal Organizations (Clause 41)

Clause 41 would amend the ITA to allow the income of certain religious communities to be allocated differently for income tax purposes among all the adult members.

   G. Civil Penalties (Clauses 47, 49-50, 66, 70-72)

As a result of these changes to the ITA, civil penalties would apply to third parties who made false statements or omissions in relation to the tax matters of others (clause 47, 49, 50). Clause 50 was amended subsequently so that the penalty that could apply for making or participating in the making of a false statement would be capped at the lesser of 50% of tax sought to be avoided or $100,000. In particular, clause 50 specifies penalties for tax shelter and other tax planning arrangements, as well as advising or participating in a false filing. The amount of penalty would be the greater of $1,000 and 100% of the gross revenue derived by the person in respect of the arrangement, or the amount of tax sought to be avoided or refunded, accordingly. Similar penalty provisions would modify the Excise Tax Act (ETA) (clauses 70-72). Clause 70 was amended to make it consistent with changes made to clause 50 and to other provisions in the ITA. The introduction of third party penalty rules would extend the protection of a person already convicted of an offence (clause 66).

   H. RRSP/RRIF Proceeds on Death (Clauses 7, 42)

A restriction in the ITA limits the tax relief on the deceased’s estate resulting from registered retirement savings plan (RRSP) and registered retirement income fund (RRIF) distributions to financially dependent children and grandchildren only where there is no surviving spouse. Clauses 7 and 42 would amend the ITA to remove this restriction to allow tax relief on distributions to dependent children and grandchildren even where there was a surviving spouse.

   I. Part VI Capital Tax (Clause 53)

Clause 53 would amend Part VI of the ITA to extend by one year the application of the additional Part VI capital tax on banks and other large deposit-taking institutions. This surcharge would continue to apply at a rate of 12% of the capital tax imposed under Part VI of the ITA.

   J. Manufacturing and Processing Tax Rate Reduction (Clause 34)

The Manufacturing and Processing (M&P) tax credit, 7 percentage points, would be extended to corporations that produce electrical energy or steam for sale. This extension would start 1 January 1999 with a one percentage point tax rate reduction, and would be followed by a reduction of two percentage points in each of the three subsequent years.

   K. Offset of Interest (Clauses 48, 51, 67)

When a taxpayer is a corporation, interest on tax arrears is non-deductible while interest on refunds is taxable. New rules would create a mechanism whereby a corporation could offset income tax refund amounts against income tax arrears amounts (clause 48). The computation of interest would also be modified (clause 67). The new interest offset provisions would limit the right to object to an assessment or determination (clause 51).

   L. Non-Resident Investment Funds That Engage Canadian Service Providers (Clause 21)

Under clause 21, a non-resident investment fund would not be considered to be carrying on business in Canada solely by reason of engaging a Canadian firm to provide financial management-related services. Some conditions would have to be met, however. First, the non-resident fund could not sell units to investors resident in Canada, issue a prospectus or advertise. Second, the fund would have to meet one of the two following tests: the Canadian resident firms would have to deal at arm’s length with the service fund (to ensure that the fund was not carrying on business through its own operations in Canada), or the fund’s annual rate of investment turnover would originally have had to be low (to ensure a primarily passive nature in the fund’s investment activities). Clause 21 was amended in committee to remove the turnover test for verifying that the Canadian service provider was dealing at arm’s length. This clause was also amended to raise the proposed ownership restriction for the fund from 20% to 25% for any one investor and affiliates.

   M. Labour-Sponsored Venture Capital Corporations (LSVCCs) (Clauses 36, 54-59, 61-63)

Proposed measures would combine initiatives to encourage investment in small business, align federally incorporated LSVCC rules with those that are provincially incorporated, and make other clarifications. In particular, Community Small Business Investment Funds (CSBIF) in Ontario are required to invest in businesses with no more than $1 million in assets. The investments in CSBIFs of an LSVCC registered in Ontario count towards that province’s business investment requirement. The proposed change states that 150% of the cost of such LSVCC investment funds would count towards the federal business investment requirement (clauses 56-57). The period in which at least 80% of the first issuance of Class A shares should be invested in any combination of liquid reserves and eligible businesses would be shortened from five to two years (clause 54(3)). In this way, the tax credit recovery rules that apply when requirements are not met, or where there is a change of share attribution that does not meet the requirements, would be modified (clauses 56-57, 61-63). Additional changes would be proposed in cases of share attribution, amalgamation, mergers or winding-up (clauses 36, 59). Clause 59 was amended to ensure that the resulting corporation would not be prevented from qualifying as a LSVCC on the ground that it issued shares to a person not ordinarily permitted to receive shares from an LSVCC. A corporation’s decision on whether to continue or not in the LSVCC regime after an amalgamation or merger would be clarified (clause 54 (4)). New penalties would apply in the event of an LSVCC discontinuing its venture capital business (clause 58).

   N. Tax Coordination with First Nations (Clauses 27, 35, 44-45, 47)

The clauses listed above are related to measures that would facilitate the integration of the federal income tax system with personal income tax imposed by an Aboriginal government in Canada by allowing a federal tax reduction. This reduction would be equal to the amount of the individual’s tax payable to an Aboriginal government.

   O. Demutualization of Insurance Corporations (Clauses 3-5, 13-15, 38-40, 43, 64-65, 67)

Amendments to the ITA would provide new rules to apply to the process of converting a mutual insurance corporation into a corporation with share capital (clauses 13-15, 38, 40). To ensure that the process would not create more tax liabilities, further amendments are proposed. Clause 3 specifies that an issuance of shares directly resulting from demutualization would have no immediate tax consequences. For income tax purposes, benefits under an annuity contract in connection with the demutualization of an insurance corporation would not be included in income (clause 43). Clause 39 clarifies that dividends paid by an insurance corporation would not be included in taxable income if they were part of the process of demutualization (clause 39). A small change is proposed that would allow a new insurance corporation to release social insurance numbers to its holding corporation in order to satisfy its own tax reporting obligations (clause 65). Non-resident policy holders would be subject to the Part XIII withholding tax ("Tax on income from Canada of non-resident persons") in connection with the demutualization benefits (clause 64).

   P. Hepatitis C Trust (Clause 12)

Clause 12 would amend the appropriate section of the ITA by excluding for tax purposes the income earned by the trust established to provide compensation to a number of Canadians infected with the hepatitis C virus through the blood distribution system.

   Q. Forward Averaging (Clauses 18-20, 22, 28, 31, 35-36)

Section 120.1 of the ITA allows a deduction in computing tax payable where the amount was forward averaged. The mechanism for forward averaging lapsed at the end of 1997; therefore, all related sections, subsections and references in other sections would be repealed.

   R. Foreign Tax Property (Clauses 60, 69)

The foreign property limit for persons with respect to a trust governed by a registered pension plan (RPP), RRSP or RRIF is 20%. Part XI of the ITA imposes a tax if persons invest too heavily in foreign property under such plans. However, additional foreign property is allowed in qualifying small businesses; the limit is the lesser of three times the additional small business investment amount ("3 for 1" rule) and the 20% restriction on all assets. Proposed changes would amend the definitions of "small business property" and "small business investment amount" (clause 60). The amendment to the definition of small business property would have consequences for the meaning of "spouse" and "former spouse" (clause 69).