Select Tax Measures in Canada’s Bill C-59

December 8, 2023

Highlights

On November 28, 2023, the Department of Finance (Finance) tabled a Notice of Ways and Means Motion to implement the Fall Economic Statement Implementation Act, 2023, which subsequently received first reading in Parliament on November 30, 2023 as Bill C-59. Bill C-59 contains proposed legislation regarding numerous measures announced by Parliament and the Minister of Finance which have not yet been enacted into law, including draft legislation released by Finance on April 29, 2022 (April 2022 Proposals), proposals released in the 2023 Federal Budget (Budget 2023), draft legislation released by Finance on August 4, 2023 (August 2023 Proposals) and measures announced in the November 21, 2023, federal Fall Economic Statement (FES 2023). All or a significant portion of Bill C-59 will likely be passed into law before the end of 2023. However, certain portions, including the proposals relating to the Digital Services Tax Act, may be passed into law but may not come into force until a later date.

For more information on the April 2022 Proposals, see our Blakes Bulletin: 2022 Federal Budget: Selected Tax Measures; for Budget 2023, see our Blakes Bulletin: 2023 Federal Budget: Selected Tax Measures; for the August 2023 Proposals, see our Blakes Bulletin: 2023 August 4 Draft Legislation: Selected Tax Measures; and for FES 2023, see our Blakes Bulletin: Key Tax Measures in the 2023 Fall Economic Statement.

Bill C-59 is wide-ranging and divided into five parts. Part 1 includes various Canadian income tax and related measures. Among other things, Part 1 of Bill C-59 further addresses the following:

General anti-avoidance rule (GAAR)
Share buyback tax (SBT)
Excessive interest and financing expenses limitation (EIFEL) rules
Hybrid mismatch arrangements
Dividend received deduction for financial institutions
Substantive Canadian-controlled private corporations (CCPCs)
Clean energy investment tax credits (ITCs)
Intergenerational business transfers
Employee ownership trusts (EOTs)

The majority of this bulletin focuses on the proposed amendments to the Income Tax Act (ITA) set out in Part 1 of Bill C-59, as outlined above.

While there is much to note in Part 1, taxpayers will be pleased to see relieving changes to the previous version of the proposals regarding the SBT and arguably, a form of backtracking on the breadth of the revised GAAR.

Part 2 of Bill C-59 sets out the Digital Services Tax Act (DST Act), which will be enacted at an unspecified future date to be announced by the government, but not earlier than January 1, 2024. Notwithstanding the potential delayed enactment of the DST Act, when it comes into force, the Digital Services Tax (DST) will apply in the year of enactment to taxable revenues from January 1, 2022 to the year of enactment.

Part 3 of Bill C-59 includes various GST/HST measures. Part 4 includes various excise and related measures. Part 5 includes other non-tax related measures.

Notwithstanding the relative breadth and length of Bill C-59, it does not include legislative proposals addressing certain other previously announced tax measures which are of interest to taxpayers, including amendments to the alternative minimum tax regime for high-income individuals (despite the announced intention for such amendments to apply as of January 1, 2024), proposals related to the OECD Pillar II / global minimum tax (or in particular, the proposed Canadian Global Minimum Tax Act), or rules which are intended to prevent CCPCs from deferring tax using foreign resident corporations.

Please see our August 2023 Proposals bulletin for further information on the alternative minimum tax and Pillar II proposals, and our Budget 2022 bulletin for further information on such CCPC proposals.

In addition, the Canada Revenue Agency (CRA) announced on November 28, 2023 that it intends to refresh its guidance on the computation of safe income for purposes of section 55 of the ITA, with its new position on the computation of safe income becoming effective after the same date.

Bill C-59 also does not include revised proposals in respect of proposed amendments subsection 212(13.1) of the ITA (released on August 9, 2022). Such proposed amendments, if enacted in the form proposed, could in certain circumstances subject certain payments made to non-residents of Canada by a limited partnership with Canadian partners to Canadian non-residents withholding tax even where the activities of the partnership (including its general partner/sponsor) and its investments have no nexus to Canada. It is hoped that Finance is reconsidering these proposed amendments as their impact as drafted may be broader than what was intended.

Business Income Tax Measures

General Anti-Avoidance Rule (GAAR)

In Budget 2023, Finance proposed certain amendments to the GAAR. Subsequently, the August 2023 Proposals included certain additional amendments to the GAAR. Bill C-59 continues to reflect the approach set out in Budget 2023 and the August 2023 Proposals but also incorporates a number of significant additional changes, especially to the provisions pertaining to a “significant lack of economic substance.” These revisions are discussed below, along with a brief summary of other key anticipated amendments to the GAAR introduced in the prior proposals.

By way of background, the GAAR applies only when three elements are present: a tax benefit, an avoidance transaction, and a misuse or abuse of provisions of the ITA or other tax enactments. Where the GAAR applies, the tax consequences of an avoidance transaction shall be determined as is reasonable in the circumstances to deny a “tax benefit” that would otherwise be realized.

Preamble

In Budget 2023, Finance proposed to add a three-pronged preamble describing the scope of the GAAR in general terms, with the stated goal of helping to address interpretive issues and ensuring that the GAAR applies as intended. In the August 2023 Proposals, Finance proposed to delete one prong that expressly provided that the GAAR could apply “regardless of whether a tax strategy is foreseen.” Finance’s reason for doing so was the Supreme Court of Canada’s decision in Deans Knight Income Corp. v. Canada, which had “since clarified and confirmed that the GAAR is not limited to unforeseen situations.”

Bill C-59’s proposed change to the GAAR’s preamble do not depart from the August 2023 Proposals.

Misuse or Abuse: Economic Substance

Budget 2023 proposed to introduce a new economic substance interpretive rule to the “misuse or abuse” test. If an avoidance transaction was “significantly lacking in economic substance,” Budget 2023 provided that this “tends to indicate” there is misuse or abuse that can trigger the GAAR. While the August 2023 Proposals replaced the “tends to indicate” language with a presumption of abuse or misuse, Bill C-59 marks a somewhat unexpected return to Budget 2023’s “tends to indicate” language.

However, Bill C-59 does so by also clarifying that an avoidance transaction significantly lacking in economic substance “is an important consideration” that “tends to indicate” misuse or abuse. This addition to the proposed statutory language emphasizes a concern that economic substance in transactions under audit was not obtaining sufficient consideration by the courts in GAAR analysis. It also suggests that Finance was perhaps more focused on ensuring that a significant lack of economic substance will be an important substantive factor in the misuse or abuse analysis, rather than reversing the Crown’s existing onus at the misuse or abuse stage.

Canadian jurisprudence has consistently held that the Minister of National Revenue (Minister), and not the taxpayer, bears the onus for proving misuse or abuse. Under the proposed amendments to the GAAR, in circumstances where there is a significant lack of economic substance, one might infer that the onus has been shifted to the taxpayer. However, the explanatory notes accompanying Bill C-59 (Explanatory Notes) helpfully state that “it is presumed” has been reverted to Budget 2023’s “tends to indicate” language to prevent the provision from “being interpreted simply as a procedural shifting of the onus to demonstrate misuse or abuse from the Crown to the taxpayer.” Nonetheless, the Explanatory Notes posit that “where there is a lack of economic substance, the starting point would be that there is a misuse or abuse.” The Explanatory Notes go on to observe that, “depending on the relevant facts and law, other considerations may demonstrate that the transaction does not actually frustrate the rationale of the provisions,” without specifically addressing the question of onus. Accordingly, it appears that the Minister continues to bear the traditional burden at the third stage of the GAAR’s application (both with respect to the question of economic substance and the balance of the misuse or abuse test, now aided by the effects of new subsections 245(4.1) and (4.2)), though it is not clear what the practical significance of this will be for transactions held to be significantly lacking in economic substance.

Further, subsection 245(4.1) appears to contemplate that a significant lack of economic substance may yield a “starting point” of a misuse or abuse. Thoughtful practitioners (and the courts) will, practically, in any event, need to properly undertake the standard two-stage misuse or abuse analysis long established by the jurisprudence. In fact, the Explanatory Notes encourage “a more rigorous analysis… to ensure that the transactions are consistent with (or do not frustrate) the object and purpose of the relevant rules, including the relevant scheme of the rules in which the specific rules relied upon are found”. A GAAR consultation paper released by Finance in August 2022 stated that the government was considering shifting the burden to the taxpayer to show that its transaction or series was “consistent” with the object, spirit, and purpose, which some commentators had seen as a potentially high bar, and excluding the possibility of a transaction or series being neither consistent with nor frustrating the object, spirit or purpose. The parenthetical “(or do not frustrate)” in the Explanatory Notes confirms that any such bar is not as high as these commentators had worried.

Budget 2023 also proposed the introduction of subsection 245(4.2) of the ITA which provides factors to consider when analyzing whether a transaction or series of transactions is significantly lacking in economic substance. The August 2023 Proposals identified an additional enumerated factor, pertaining to the use of an accommodation party in achieving neutrality of the opportunity for gain or profit and risk of loss of the taxpayer with respect to the transaction or series under scrutiny. Bill C-59 added a carve-out to the overarching enumerated factor pertaining to the opportunity for gain or profit and the risk of loss, by specifying that the requisite determination would not take into account such opportunity or risk of non-arm’s length taxpayers who have economic interests that are largely adverse to those of the taxpayer in question. The Explanatory Notes clarify that this carve-out is intended to address situations where taxpayers do not deal at arm’s length within the meaning of subsection 251(1) (perhaps because they are statutorily deemed not to deal at arm’s length) but “may nonetheless operate separately from an economic point of view and may have interests or motivations that are largely unaligned” with the taxpayer under scrutiny. This is a welcome change as there are many instances where two taxpayers are deemed to be non-arm’s length under the ITA due to familial relationships and would not be engaged in transactions between themselves that significantly lack economic substance if one properly takes their particular economic circumstances into account.

Another change introduced by Bill C-59 is that the “significantly lacking in economic substance” analysis for the misuse or abuse test applies to an avoidance transaction or “a series of transactions that includes the avoidance transaction.” While perhaps not entirely clear from the text of the provision, the Explanatory Notes state that assessing the series as a whole would generally provide the best lens for the analysis to avoid an inappropriate determination that a transaction is significantly lacking in economic substance where the transaction is an integral step in a true commercial transaction. However, the Explanatory Notes also provide that in some cases a transaction may be assessed on its own, even when it is part of a series of transactions in which the series has economic substance. For example, the Explanatory Notes state that where an internal reorganization is done to step up the cost base for an asset that will ultimately be sold to an arm’s length party, the reorganization should be assessed independently as it is not integral to the sale that follows. The Explanatory Notes state that the test is intended to “provide flexibility for a holistic and common-sense assessment of the relevant facts and circumstances.” This “holistic approach” may create uncertainty for taxpayers as to whether the provisions require a consideration of individual transactions or a series of transactions as a whole and, if considering individual transactions, which particular transactions in the series are relevant. One expects this uncertainty may be the subject of future litigation. The creation of such uncertainty also arguably goes against one of the purposes of the GAAR as stated in the proposed preamble, which is to strike a balance between taxpayers’ need for certainty in planning their affairs and protecting both the tax base and the fairness of the tax system.

Avoidance Transaction

Bill C-59 does not amend the definition of “avoidance transaction” from the version proposed in Budget 2023 and amended in the August 2023 Proposals.

Penalty

Bill C-59 modifies the penalty introduced in Budget 2023 for transactions not disclosed to the Minister in accordance with the reportable transaction and notifiable transaction rules. For our bulletin discussing these rules, please see our April 2023 Blakes Bulletin: Mandatory Disclosure Update: Department of Finance Introduces Revised Rules in the House of Commons. We have also published bulletins discussing administrative guidance on the application and administration of these rules released by the CRA. See our July 2023 Blakes Bulletin: Canada Revenue Agency Publishes Guidance on Mandatory Disclosure Rules and November 2023 Blakes Bulletin: CRA Designates Notifiable Transactions and Updates Mandatory Disclosure Guidance.

The proposed penalty from Budget 2023 would have been equal to 25% of the tax benefit, other than a tax benefit arising from the creation of unutilized tax attributes. This is modified in Bill C-59 to explicitly include 25% of both the amount by which a person’s tax payable is increased and the amount by which their refundable tax credits are reduced as a result of the application of the GAAR.

Coming Into Force

The amendments to the GAAR for the definition of an “avoidance transaction” and the amendments to the economic substance analysis are proposed to apply to transactions that occur on or after January 1, 2024.

The amendments to the penalty provisions are proposed to apply to transactions that occur on or after the later of January 1, 2024 and the day on which Bill C-59 receives royal assent.

Share Buyback Tax (SBT)

Bill C-59 includes a number of welcome changes to the SBT from the August 2023 Proposals.

As discussed in our Blakes Bulletins regarding Budget 2023 and the August 2023 Proposals, the SBT is a proposed 2% tax on the net value of equity repurchases by public corporations and other “covered entities”, as described below. The net value of equity repurchases is generally calculated as the total fair market value of equity (other than equity that meets the definition of “substantive debt”, as described below) of the covered entity that is redeemed, acquired or cancelled in the applicable taxation year, less the total fair market value of equity (other than substantive debt) of the covered entity that is issued in that year.

In addition to public corporations (other than mutual fund corporations), the definition of a covered entity in the August 2023 Proposals also included a publicly traded trust or partnership that (1) is a real estate investment trust (REIT), (2) is a specified investment flow-through (SIFT) trust or SIFT partnership, or (3) would be a SIFT trust or SIFT partnership if, generally, the references to Canada in the definition of “non-portfolio property” were excluded. The introduction of the third category gave rise to a technical issue whereby a covered entity could include a Canadian exchange traded fund (ETF) that derived more than 50% of its equity value from shares of corporations (other than taxable Canadian corporations) and units of trusts or partnerships (other than Canadian trusts that qualify as REITs or SIFTs, and other than SIFT partnerships) that derived more than 50% of their value from real property located anywhere in the world. This technical issue has now been fixed for most ETFs, as Bill C-59 introduces an exception whereby a mutual fund trust that has issued one or more classes of units in continuous distribution will not be a covered entity unless it is a REIT or a SIFT trust.

Bill C-59 also introduces a number of helpful changes to the calculation of the SBT.

Under the SBT rules, a redemption of equity that occurs as part of a “reorganization or acquisition transaction” (ROAT) is not counted in the calculation of the SBT. Under the August 2023 Proposals, a ROAT was defined to include a redemption as part of an exchange of equity (other than substantive debt) of the covered entity for consideration that consisted solely of other equity (other than substantive debt) of the covered entity (or certain related affiliates that are themselves covered entities). Bill C-59 broadens this prong of the ROAT definition by including a transaction whereby equity of a covered entity is exchanged for a combination of equity of the covered entity (or certain related affiliates) and non-equity consideration (i.e., boot). Consequential with this helpful change, the calculation of the SBT is now increased to take into account the amount of the boot received on such an exchange.

Further, under the SBT rules, equity of a covered entity that is acquired by a “specified affiliate” will be deemed to be acquired by the covered entity for purposes of the calculation of the SBT, subject to certain narrow exceptions. However, under the August 2023 Proposals, a disposition of such equity by a specified affiliate did not reduce the SBT, which appeared inappropriate from a policy perspective. Bill C-59 fixes this issue by proposing to reduce the SBT to take into account a disposition of equity of a covered entity by a specified affiliate of the covered entity (other than a disposition to the covered entity or a specified affiliate of the covered entity) to the extent that the acquisition of the equity was previously included in the calculation of the amount of SBT paid by the covered entity.

The August 2023 Proposals provided that only certain issuances of equity by a covered entity were taken into account to reduce the calculation of the SBT (generally, issuances (i) solely for cash, (ii) made to an employee in the course of employment, or (iii) on the conversion of a convertible debt that was issued solely for cash). Bill C-59 proposes to broaden the concept of a “good” issuance to include an issuance of equity in exchange for property if the property is used in the applicable covered entity’s active business.

Bill C-59 also broadens the definition of a ROAT, being redemptions that do not increase the amount of SBT payable by a covered entity, to include (i) a redemption of units of a unit trust made by the holder of the unit provided that the redemption price does not exceed the fair market value of the redeemed unit, and (ii) a redemption of equity pursuant to the statutory right of dissent. The first exception should be particularly helpful in the context of REIT reorganizations.

Redemptions and issuances of “substantive debt” are not taken into account in the calculation of the SBT. Under the August 2023 Proposals, in order to qualify as substantive debt, equity was required to meet four tests, the description of which can be found in our August 2023 Proposals bulletin.

Bill C-59 broadens the test that the equity be non-voting by providing that the equity need only be non-voting in respect of the election of the board of directors, the trustees, or the general partner, as applicable, except in the event of a failure or default under the terms or conditions of the equity. This change clarifies in particular that preferred shares that provide holders with the right to vote upon a failure of the issuer to pay dividends for a certain period of time are not precluded from qualifying as substantive debt.

Bill C-59 also introduces a helpful change to the test in respect of the coupon on the equity, by removing the requirement that the dividends or other distributions must be “expressed as a percentage,” which clarifies that preferred shares that pay a dividend, the amount of which is drafted in the share terms as a particular dollar number (rather than as a percentage of the issue price), are not precluded from qualifying as substantive debt.

Lastly, Bill C-59 proposes to add a new prong to the test in respect of a fixed redemption price, to provide that equity is not precluded from meeting the test because of changes in the value of a currency other than Canadian dollars relative to the Canadian dollar. This change clarifies that preferred shares that are denominated in non-Canadian currency are not precluded from qualifying as substantive debt simply because all amounts are required to be computed for purposes of the ITA in Canadian dollars (in the absence of a functional currency election), which could result in the equity being redeemed for an amount that exceeds its issue price (as translated into Canadian currency).

Excessive Interest and Financing Expense Limitation (EIFEL) Rules

Bill C-59 includes revised proposals for the EIFEL rules (revised EIFEL proposals) that were first announced in the 2021 budget. See our Budget 2022 bulletin. The EIFEL rules will generally limit taxpayers’ deductions for “interest and financing expenses” (IFEs) to 30% of “adjusted taxable income” for taxation years beginning on or after January 1, 2024 (40% for taxation years beginning on or after October 1, 2023 and before 2024).

The revised EIFEL proposals constitute the fourth iteration of the EIFEL rules, following previous releases of draft legislation on February 4, 2022, November 3, 2022 and August 4, 2023 (previous EIFEL proposals). For our commentary on the previous EIFEL proposals, please refer to our February 2022 Blakes Bulletin: Department of Finance (Canada) Releases Significant Draft Tax Legislation and August 2023 Proposals.

The revised EIFEL proposals introduce various minor technical changes to the rules. The key changes are described below.

Filing Requirement

As announced in the previous EIFEL proposals, taxpayers will be required to file a prescribed form with their income tax returns to compute the portion of IFEs, if any, made non-deductible pursuant to the EIFEL rules. The revised EIFEL proposals now state that the prescribed information on the form is “for the purpose of determining the deductibility of its [IFEs] and determining its exempt [IFEs].”

This may suggest that the failure to file such a form would cause IFEs not to be deductible and amounts not to be recognized as exempt IFEs. The CRA is granted the power to assess taxpayers beyond the normal reassessment period where this form is not filed or is filed with (presumably material) omissions.

Excluded Entities

A taxpayer that is an “excluded entity” is not subject to the EIFEL rules. Excluded entities include corporations and trusts or groups of corporations and trusts which, among other requirements, carry on substantially all of their business in Canada and do not have foreign affiliate holdings that exceed a de minimis threshold of C$5-million (computed both on a book value and a fair market value basis). The revised EIFEL proposals have altered the book value calculation of foreign affiliate holdings to include all foreign affiliates of the taxpayer’s corporate group, not just foreign affiliates of the taxpayer. They have also altered the fair market value calculation of foreign affiliate holdings to include the group’s proportionate share of the fair market value of property held by foreign affiliates of the group, as opposed to 100% of the fair market value of property held by the taxpayer’s foreign affiliates.

Transitional Rules

The EIFEL rules include transitional rules that allow a taxpayer, jointly with group members, to elect to have special rules apply for the purposes of determining the excess capacity of the taxpayer (and each group member) for each of the three years immediately preceding the first taxation year in which the EIFEL rules apply. These rules provide electing taxpayers with a three-year carryforward of excess capacity for such pre-regime years (absent such an election, no such carryforward is permitted). Generally, these rules seek to approximate what would have been the unused portion of a taxpayer’s excess capacity had the EIFEL rules applied in those earlier years.

The revised EIFEL proposals provide for the making of amended elections with respect to the transitional rules either as of right where a subsequent reassessment could otherwise invalidate the election or with the discretionary permission of the CRA. This change recognizes that subsequent events, such as loss carrybacks or other reassessments, may change amounts that are relevant in determining excess capacity carried forward under the transitional rules. These rules allowing for late or amended elections parallel the ones applicable in respect of elections to transfer capacity to other group members.

Interest and Financing Expenses

Under the previous EIFEL proposals, a taxpayer’s IFEs were generally reduced by amounts received (or gains realized) by the taxpayer under an agreement to hedge the cost of funding a borrowing/other financing or to hedge the borrowing/other financing. The revised EIFEL proposals have expanded the scope of this reduction to IFEs so that amounts received (or gains realized) by a taxpayer under a borrowing/other financing, not just an agreement ancillary to the borrowing/other financing, will also reduce the taxpayer’s IFEs. The amounts must be included in income and must reasonably be considered to reduce the cost of funding with respect to the borrowing/other financing. The Explanatory Notes suggest that this is intended to allow taxable gains on the repayment of a borrowing/other financing (such as foreign currency gains) to reduce IFEs. However, the scope of the legislation could be interpreted more broadly to cover other categories of income such as refunds of interest under such agreements or fees. A corresponding change has been made to increase a taxpayer’s “interest and financing revenues” by such amounts.

Financial Institution Group Entities

The EIFEL regime contains rules generally permitting the transfer of capacity to deduct IFEs between members of a group. However, a “financial institution group entity” is generally not permitted to transfer capacity to other group members other than another financial institution group entity. The Explanatory Notes state that the rationale for this restriction is that financial institution group entities are expected to often generate net interest income as part of their regular business operations. The restriction on transfers of capacity ensures that financial institution group entities’ interest income does not inappropriately shelter IFEs of entities that do not carry on financial businesses or ancillary activities. The revised EIFEL proposals have expanded the definition of “financial institution group entity” to include an entity that is in the same corporate group as a financial institution and whose primary business is the provision of portfolio/fund management or investment advice with respect to real estate.

Interaction with other Regimes

Bill C-59 also addresses the interaction of the various proposals that may limit the deductibility of a payment. Limitations on deductibility of a payment are to be determined first by reference to the hybrid mismatch rules, then the thin capitalization rules, and finally the EIFEL rules.

Hybrid Mismatch Arrangements

Bill C-59 includes revised versions of the April 2022 Proposals which introduced new rules targeting “hybrid mismatch arrangements.” The April 2022 Proposals were proposed to be effective as of July 1, 2022. Bill C-59 does not change that effective date, nor does it make significant changes to the framework of the rules, though the revised version of the rules does include more targeted changes responding to comments received on the consultation draft. In addition, Bill C-59 includes new provisions to address the application of the hybrid mismatch rules to the foreign affiliate regime in the ITA.

The hybrid mismatch rules implement the OECD’s Action 2: Report on Neutralizing the Effects of Hybrid Mismatch Arrangements (Action 2 Report). These rules target structures that give rise to a cross-border “deduction/non-inclusion mismatch,” i.e., a situation where either (a) a Canadian payor makes a deductible payment that is not fully taxed as ordinary income under the taxation laws of the jurisdiction of the recipient, or (b) a foreign payor makes a deductible payment that is not fully taxed as ordinary income under the ITA in the hands of a Canadian recipient. Where the rules apply in respect of a particular payment, if the payor is a Canadian resident the deduction for the payment will be denied (Primary Rule) whereas if the payor is a non-resident, the Canadian recipient will be subject to an income inclusion (Secondary Rule), in each case to the extent of the mismatch that would otherwise arise. In circumstances where the Primary Rule denies a deduction in respect of interest paid by a Canadian corporation, the amount of the payment for which the deduction is denied is deemed to be a dividend for Canadian withholding tax purposes.

The rules apply where a payment arises under one of three types of arrangements: a “hybrid financial instrument arrangement,” a “hybrid transfer arrangement” or a “substitute payment arrangement.” Bill C-59 does not change the definitions of the first two categories, but it does amend the definition of a substitute payment arrangement to require that there be a cross-border element to the arrangement. This change aligns the definition of a substitute payment with the requirements of the other two categories, which are also only applicable to cross-border arrangements, and is consistent with the broader policy intention of the rules as described in the Action 2 Report and Explanatory Notes.

One of the conditions for the hybrid mismatch rules to apply to a particular arrangement is that either (a) the parties to the arrangement do not deal with each other at arm’s length or are “specified entities” in respect of each other, or (b) the arrangement is a “structured arrangement.” A “specified entity” relationship is generally defined as a situation where one party owns a greater than 25% equity interest in the other party, or a third party owns a greater than 25% equity interest in both parties to the arrangement. For these purposes, an entity is generally deemed to own equity in another entity if it has certain rights to acquire or control that equity. Helpfully, Bill C-59 adds a carve-out, similar to the carve-out from the same deeming rule as it applies in the thin capitalization rules, for such rights that exist to secure repayment of indebtedness.

A structured arrangement arises where it can reasonably be considered that the economic benefits of a mismatch are priced into the arrangement, or that the arrangement is otherwise intentionally designed to produce a mismatch. Bill C-59 does not propose any material changes to the definition of a structured arrangement itself. However, the Explanatory Notes provide helpful clarification that the list of factors in the Action 2 Report for determining whether an arrangement is a structured arrangement are neither exhaustive nor determinative, and the presence or absence of any one of those listed factors is not dispositive. In particular, the notes indicate that the presence of foreign tax disclosure in an offering document that describe beneficial tax treatment to investors in the jurisdiction where a financial instrument is marketed may not suggest the presence of a structured arrangement where, for example, the terms and conditions of the instrument are the same or similar to other instruments in the market and are designed to achieve commercial or regulatory objectives. This is a welcome clarification for Canadian issuers who issue securities in foreign jurisdictions where the local tax treatment of the issued securities may be different from the Canadian tax treatment.

The April 2022 Proposals allowed for an offsetting deduction where a Canadian taxpayer who was subject to the Primary Rule in respect of a payment demonstrates that the mismatch was only temporary (e.g., where the foreign jurisdiction defers recognition of an amount in income, or subsequently disagrees with the taxpayer’s filing position that an amount is not to be included in income). The April 2022 Proposals did not include similar relief for a non-resident recipient who was subject to Canadian withholding tax as a result of the application of these rules to interest paid by a Canadian corporation. Bill C-59 provides a new mechanism for a non-resident to obtain a refund of such withholding tax.

The April 2022 Proposals included a rule (foreign affiliate DRD denial rule) that denies a dividends received deduction under section 113 of the ITA in respect of a dividend received by a Canadian corporation on the share of a foreign affiliate where the dividend was deductible in computing the income of the foreign affiliate under applicable foreign law. Bill C-59 does not change this rule, but adds a grossed-up deduction for foreign withholding tax applicable to the portion of the dividend for which the dividends received deduction was denied. This change responds to concerns that the rule would otherwise result in double taxation where the foreign affiliate dividend is subject to local withholding tax.

Bill C-59 also includes the following new provisions with respect to the intersection of the hybrid mismatch rules with the foreign affiliate regime in the ITA.

Bill C-59 introduces a previously unannounced rule pursuant to which a dividend received by a foreign affiliate of a taxpayer from another foreign affiliate will be included in calculating foreign accrual property income (FAPI) to the extent that an amount in respect of the dividend is deductible by the payor affiliate. The Explanatory Notes indicate that this rule is intended to align with the policy underlying the foreign affiliate DRD denial rule. Notably, the rule as currently drafted would apply regardless of whether the dividend is included in income under the local tax laws of the recipient affiliate (which may be the same jurisdiction as the payor affiliate). It is questionable whether this is an appropriate result from a policy perspective, particularly in situations where the payor and recipient affiliates are residents in the same foreign jurisdiction and the payment is fully included in the recipient’s income under local law. This rule is proposed to apply prospectively to dividends received on or after July 1, 2024.
Bill C-59 responds to concerns raised by the community that the hybrid mismatch rules could have inappropriate results in the foreign affiliate context under the rules which require a foreign affiliate of a taxpayer to compute FAPI as if it were a taxpayer resident in Canada. Under Bill C-59, the Primary Rule will not apply for purposes of computing FAPI. However, the Secondary Rule will apply for FAPI purposes in respect of payments arising on or after July 1, 2024, subject to certain modifications.

One of the concerns raised by stakeholders in respect of the initial draft of the hybrid mismatch rules was that compensation payments made under ordinary course client-driven securities loans between non-arm’s length parties such as Canadian securities dealers and their related non-Canadian counterparts could be caught by the regime. Bill C-59 responds to these concerns by adding a very narrow exception.

Specifically, Bill C-59 provides that an “exempt dealer compensation payment” will not be considered to arise under a “hybrid transfer arrangement” under certain circumstances. This change applies quite narrowly, primarily to Canadian securities dealers who receive dividend compensation payments from their related non-resident counterparts. Given the narrow scope of the exception and the new restrictions on the dividends received deduction (discussed below under “Dividend Received Deduction by Financial Institutions”), this exception is unlikely to have any significant impact.

Finally, Bill C-59 includes new reporting rules that will require taxpayers that are subject to the hybrid mismatch rules to include certain prescribed information in their Canadian income tax returns. These new reporting requirements will apply in respect of payments that arise on or after July 1, 2023.

Dividends Received Deduction by Financial Institutions

Budget 2023 proposed to deny the inter-corporate dividend deduction on shares of Canadian companies held by financial institutions as mark-to-market property. FES 2023 proposed excluding “taxable preferred shares” from the Budget 2023 measure. The Budget 2023 measure, as amended by FES 2023, has been included in Bill C-59. However, Bill C-59 makes one substantive change to the previous iterations of the measure, namely by providing that the dividends received deduction will be denied for dividends on taxable preferred shares issued by any corporation (including a financial institution) that are or would be tracking property of the shareholder at any time in the year. The Explanatory Notes indicate that this addition was made to prevent the issuance of taxable preferred shares that provide financial institutions with exposure to underlying Canadian equities that would have been subject to the new measure had those underlying equities been held directly by the financial institution. The Explanatory Notes also note that tax under Part IV.1 and Part VI.1 of the ITA may also be applicable to taxable preferred shares, although the policy linkage between the concerns identified in the Explanatory Notes and the Part IV.1/Part VI.1 regime was not identified.

The Explanatory Notes released in connection with Bill C-59 also provide additional colour to the new regime in several respects. Budget 2023 had expressed the view that the policy behind the dividends received deduction conflicts with the policy behind the mark-to-market regime. The Explanatory Notes do not make this statement, but rather point out that the dividends received deduction can be denied in other circumstances (such as with respect to term preferred shares) and that the new rule is intended to align the treatment of dividends on shares that are mark-to-market property with realized or unrealized gains on such shares, namely as being ordinary income. The Explanatory Notes do not indicate why the policy concerns underlying dividends received deduction — namely the desirability of corporate integration and the minimization of double taxation — were thought not to be applicable to mark-to-market property (other than taxable preferred shares). The Explanatory Notes also provide more colour as to the application of the new rule to dividends on shares that would be mark-to-market property if the shares were held by the financial institution, explaining that the provision would apply in circumstances where the dividend was received in respect of shares that are not held directly by the financial institution, such as shares held through a trust that makes a taxable dividend designation under subsection 104(19) of the ITA, or shares that have been loaned out under a securities lending arrangement under which dividend compensation payments are made. As well, the Explanatory Notes address the application of the new measure to shares that are tracking property. The Explanatory Notes state that the rationale for the tracking property provision is to ensure that financial institutions cannot avoid the new measure by holding shares that are mark-to-market property indirectly through another corporation (other than another financial institution) in which the financial institution has a significant interest on the basis that the dividend payer itself is a corporation in which the financial institution has a significant interest, and therefore is outside the mark-to-market regime.

Substantive Canadian-Controlled Private Corporations

Bill C-59 contains previously announced rules for “substantive CCPCs” first introduced in Budget 2022. Those rules are described in our Budget 2022 bulletin. The substantive CCPC rules in Bill C-59 are substantially identical to previously released draft legislation.

Clean Energy

Following the August 2023 Proposals and the announcements made in FES 2023, Bill C-59 provides further modifications and clarifications to the Carbon Capture, Utilization and Storage (CCUS) ITC and the Clean Technology ITC.

With respect to the CCUS ITC, an expanded definition of “dual-use equipment” is proposed to include equipment that is part of a CCUS project that is not used for natural gas processing or acid gas injection and that generates certain electrical energy, heat energy, or a combination thereto (including certain equipment that is physically and functionally integrated with such equipment), and that is used as part of a control, monitoring or safety system (including certain buildings or other structures). The proposed legislation also provides for a taxpayer filing a revised project plan.

With respect to the Clean Technology ITC, the recapture rules have been expanded to provide clarification in application to partnerships, including the applicable mechanic, additions to tax and changes to any information return.

Labour requirement updates applicable to both the CCUS ITC and Clean Technology ITC contain interpretive clarifications in respect of the eligible collective agreement under the prevailing wage requirements. With respect to the apprenticeship requirements, a reasonable effort standard has been implemented wherein if certain actions have been taken, the requirement is deemed to be satisfied. This includes posting bona fide job advertisements and taking certain actions with a trade union.

The legislation also proposes a set of rules regarding the application of the “clean economy” ITCs to partnerships, including:

Unreasonable allocations of ITCs amongst partners;
Clarification that an ITC allocated to a limited partner cannot exceed that limited partner’s at-risk amount (with the prior draft rule embedded in the applicable ITC provisions being removed);
An apportionment rule between the various ITCs;
A rule that deems government assistance or non-government assistance received by a partner to be received by the partnership;
A rule that deems an allocated credit to have been received by the partnership at the end of its fiscal period for purposes of reducing capital cost of the related depreciable property; and
A rule in respect of tiered partnerships to provide a look-through and deem a partner of an upper-tier partnership to be a member of the lower-tier partnership.

Lastly, the legislation contains rules regarding (1) the extension of the normal reassessment period to either three or four years after the day the form is filed, (2) extension of penalties to false statements made on an ITC form, and (3) the provision of information by a government official in the ITC context.

Personal Income Tax Measures

Intergenerational Business Transfers

In Budget 2023, Finance released proposals to address their concerns with the intergenerational business transfer provisions created by Bill C-208. The version of these rules contained in Bill C-59 keeps substantially the same rules as those published with Budget 2023 but with some adjustments.

Bill C-59 includes several relieving rules. The first proposes to allow an initial transferee child to transfer an interest in the transferred business to another child without causing negative tax consequences to the original transferor. Similar relieving rules now apply in situations where a business disposes of assets used to carry on the business to satisfy debts owed to creditors — such action should not change the tax consequences of the initial transfer.

The intergenerational transfer provisions require management of the relevant business to be transitioned from the transferor to the transferee. Bill C-59 clarifies that “management” refers to the direction or supervision of business activities but does not include the provision of advice. This clarification appears to be aimed at ensuring only genuine transfers take place but also gives additional comfort to transferors who continue to serve in an advisory role post-transaction by ensuring that giving advice alone will not constitute “management” of the business and should not create a risk of recharacterizing the transaction to result in a deemed dividend.

Bill C-59 also adds rules prohibiting the intergenerational transfer exception from applying to successive transfers of the same business — an important consideration for taxpayers who want to transfer their business in tranches.

It should also be noted that a previous version of the rules included in the August 2023 Proposals had a provision requiring the corporation, the shares of which were being sold, to be controlled by the transferor or their spouse. This is no longer a requirement under Bill C-59, which expands the availability of the intergenerational transfer provisions to circumstances where the transferor is not the controlling shareholder of the business.

These amendments are proposed to apply to share transfers that occur on or after January 1, 2024.

Employee Ownership Trusts (EOTs)

Budget 2023 provided for the creation of EOTs, which are trusts that directly, or indirectly through another corporation, hold shares of a corporation for the benefit of the corporation’s employees. The EOT provisions are intended to encourage business owners to sell their shares to an EOT or a corporation owned by an EOT for the benefit of the employees of the business. The August 2023 Proposals contained EOT provisions that were substantially similar to the draft legislation released with Budget 2023. Bill C-59 makes only relatively minor technical changes to the EOT rules set out in the August 2023 Proposals.

A significant criticism of the EOT rules is that they do not provide owners who sell to an EOT with meaningful tax benefits. The primary benefit is the extension of the existing five-year capital gains reserve to 10 years (with a minimum of 10% of the gain being required to be included in income each year). This is not a substantial incentive when weighed against the potential complexities of compliance with the EOT requirements. FES 2023 proposed some substantive, albeit temporary, enhancements to the tax benefits available to owners who sell their qualifying businesses to an EOT. Specifically, FES 2023 proposed that, for the 2024, 2025 and 2026 taxation years the first C$10-million in capital gains realized on the sale of a business to an EOT be exempt from taxation, subject to certain conditions. FES 2023 indicated that further details would be forthcoming “in the coming months”. None of these details were included in Bill C-59, so it remains to be seen what requirements will need to be met in order for an owner to qualify for this capital gains exemption.

International Tax Measures

Digital Services Tax (DST)

As a next step towards implementing a digital services tax, Bill C-59 includes the enactment of the Digital Services Tax Act, which will apply in the first year of application to taxable revenues from January 1, 2022 to the current year. Bill C-59 enacts the legislation at an unspecified future date to be announced by the government, but not earlier than January 1, 2024.

Other Tax Measures

First Home Savings Accounts (FHSAs)

Bill C-59 contains various changes relating to FHSAs.

Two such changes relate to the common reporting standards regime. Under that regime, a reporting financial institution is required to report certain information to the Minister with respect to each of its reportable accounts.

A “non-reporting financial institution” is not required to report such information. Bill C-59 amends an applicable regulation to include an FHSA, thereby ensuring an FHSA is a “non-reporting financial institution” and is thus not required to report pursuant to the common reporting standards. This is consistent with the treatment of other tax advantaged accounts, including RRSPs and TFSAs.

In addition, Bill C-59 amends another applicable regulation to ensure that FHSAs are considered “excluded accounts,” and therefore not reportable, for purposes of the common reporting standards rules. Again, this is consistent with the treatment of other tax advantaged accounts, including RRSPs and TFSAs.

These changes were previously announced and are effective as of April 1, 2023.

GST/HST and Underused Housing Tax

Bill C-59 also implements various previously-announced changes to the Excise Tax Act and GST/HST, including raising the input tax credit documentation thresholds and amending the definition of an intermediary to include a billing agent for purposes of the input tax credit information rules.

The changes relating to the GST/HST joint venture election rules and the Underused Housing Tax Act released as part of FES 2023 are not included in Bill C-59 as the consultation periods in respect of the draft legislation remain open until the new year.

Tax Developments Outside Bill C-59 — Capital Gains Stripping (Section 55 of the ITA)

Unrelated to Bill C-59, the CRA on November 28 announced it would release a paper with refreshed guidance on the computation of safe income and gave a presentation previewing that guidance.

Dividends paid out of the safe income of a Canadian corporation can be received by another Canadian corporation without the risk of subsection 55(2) applying to deem such dividends to be proceeds of disposition or a gain.

Paying safe income dividends to reduce a capital gain prior to the sale of shares of a corporation is a common and longstanding tax planning strategy. In addition, since the amendments to subsection 55(2) enacted in 2016, which broadened the circumstances to which subsection 55(2) applies, taxpayers have increasingly relied on safe income to ensure subsection 55(2) does not apply to ordinary course inter-corporate dividends.

The refreshed CRA guidance will be relevant to all taxpayers who rely on safe income to pay inter-corporate dividends or to reduce capital gains on a disposition of shares of a corporation. The CRA has announced that its new position on the computation of safe income is effective after November 28, 2023.

For further information, please contact any member of our Tax group.