UPDATE: The federal budget has been released. Find out all the ways it will affect your pocketbook.
The federal budget to be released this Wednesday by Finance Minister Bill Morneau is likely to introduce several changes for average Canadian families and investors alike. But Morneau himself is aiming to pull off a terrific feat—keeping Canada competitive in trade with world markets while at the same time telling his G20 colleagues this week that “taxing the rich is good economics.”
Of course, the good news is that Morneau is making middle-class Canadians a priority for 2017 and he seems ready to ensure that increases from economic growth won’t only flow to the rich. And while he says the budget will focus on skills training, innovation and promoting long-term growth, he’s also been reluctant to introduce major hikes on investment income. “I don’t foresee any changes to the personal tax rates themselves,” says Greg Bell, tax partner with KPMG in Ottawa. “And I think the Liberals aren’t that opposed to running a deficit for a while. So it will be interesting to see what changes.” Of course, changes can happen in almost any area and rumours have been swirling for weeks. Here are 10 things to watch for in the March 22 budget.
1. Encouraging skills upgrading
Tax credits to help Canadian workers upgrade their skills throughout their lifetime in a global economy that demands it are expected to be generous. “I will also be taking steps to create a culture of lifelong learning, helping people develop the skills they need at every stage of their life to succeed in the new economy,” hinted Morneau this past week.
2. Cracking down on tax evasion
Look for more money to be given to the Canada Revenue Agency to fight offshore tax evasion, an investment that has so far helped the CRA reap millions in extra tax dollars while at the same time achieving the aim of discouraging tax evasion by Canadians. “They’ve made significant investments in the past, so could add to it,” says Bell.
3. Taxing a portion of capital gains on principal residence
A change here could put a cap on the unlimited amount of tax-free capital gains that Canadians have become accustomed to on their principal residence. Tax specialists and policy makers speculate that a possible plan would allow a capped amount to be tax-free on the sale of your principal residence with any proceeds over this amount to be taxed as capital gains in your tax bracket at the time of sale. As an example, a cap of $500,000 in tax-free capital gains on any principal residence means that a home sold for $1 million that was purchased for $100,000 in 1985 say, would have $400,000 taxed at the owner’s tax rate at the time of the sale (about 35% for the average middle class Canadian).
Bell sees a different scenario. “If you claim part of your home as business usage, I can see them perhaps taxing a portion of the principal residence when you sell,” says Bell. “So if you claimed 10% of your home as a business expense, they could tax a 10% portion of your gain when you go sell.”
4. Changes to capital gains inclusion rate
The federal government has never stated it would change the capital gains inclusion rate, currently at 50%. That’s the tax you have to pay when you sell some property, such as stocks, a rental property or a second home, that have increased in value since you bought them. Right now, only 50% of that price difference is subject to tax, with the tax rate depending on your income-tax bracket. But an increase in the rate to 66%, which we had in 1988, or to 75%, which lasted for a decade from 1990 to 2000, is a distinct possibility. “I’ve thought about this change a lot,” says Bell. “And if you increase the capital gain rate to 75%, the taxation level comes closer to that of dividends now. But people are being encouraged to save for retirement and save as well outside of their pensions and RRSPs, so I don’t think it would make sense to change the rates.”
Boosting the inclusion rate to 75% would mean that only 25% of your capital gains from the sale would be tax-free and the remaining percentage would be taxed at your marginal tax rate the year of the sale. The Liberals have long promised to eliminate tax breaks that mostly benefit the wealthy, a change that they promised would boost government revenue by at least $3 billion.
5. Small business deductions may be pared back
Right now, business owners who operate through a Canadian-controlled private corporation (CCPC) are able to claim the small business deduction on the first $500,000 of active business income which allows them to pay extremely low rates of tax when the income is initially earned. The result? A huge tax deferral advantage by leaving the after-tax corporate income inside the corporation as opposed to paying it out immediately.
Business owners are also able to income split after-tax profits from their corporation by issuing shares directly, or through a family trust, to other family members, and paying those family members dividends that are then taxed at lower rates. The fear is that new measures and limits may come out in the upcoming budget to curtail the use of the small business corporation and limit income splitting with family members. “It’s likely there could be some further tightening in partnership structures,” says Bell.
6. Changes to dividend tax credit
It is speculated that the dividend tax credit may be revised and lowered as these tax credits are seen to mainly benefit the wealthy. The reason for these credits initially was to avoid double taxation on earnings that corporations already paid tax on. There’s lots of buzz around this possible change but no mainstream proposal yet. “In Ontario, the top tax rate on dividends is almost 40%, so it’s already quite high,” says Bell. “I’d be surprised if this changes.”
7. “Boutique” tax credits revamp
Sometimes referred to as “tax expenditures,” boutique tax credits refer to government spending that encourage certain programs and behaviours amongst Canadians, such as public transit and post-secondary education. Or, they target certain slices of the population, such as parents, seniors or pensions. These incentives are often given in the form of tax credits. In general, such tax credits are seen today as not being worth the trouble.
In fact, last year the government added one such credit—for teachers’ classroom supplies—while dropping four as of Jan. 1 2017, including the children’s fitness and arts credits, as well as the education and textbook credits for students. This year’s budget may contain the further elimination of a variety of tax credits that are costly, narrowly-targeted, and don’t have a meaningful impact on the taxpayers for whom they were designed. Look for the public transit tax credit, tradespeople tool deduction and volunteer firefighter credit to be on the chopping block.
8. Employee stock option changes
The 2015 Liberal election platform had a proposal to limit the benefits of the 50% employee stock option deduction by placing a cap of $100,000 on annual eligible stock option gains but this was dropped after intense lobbying by startups in the tech and resource industry who rely heavily on non-cash compensation such as stock options to attract much needed, specialized talent to their firms.
“Employee stock options are getting a lot of discussion but it’s a key part of compensation for startups,” says Bell. “But while it’s a hard one to call, they could put an asset test on it—meaning employee stock options would be taxed more heavily for those employees who work for big public companies with a large asset base, like the Big Five banks. I don’t see the taxation of employee stock options for smaller companies and startups changing, though.”
9. Broaden access to the Home Buyers’ Plan (HBP)
Right now, first-time home buyers can withdraw up to $25,000 each from their RRSPs with no tax penalties for the purchase of a new home in Canada for themselves or a relative with a disability. The Liberals could expand the HBP to help Canadians facing a job relocation, the death of a spouse, marital breakdown or who need to accommodate an elderly relative. But while some analysts believe this change is highly expected to come through, Bell isn’t so sure. “I think the housing market is too hot and this would go against trying to cool it,” says Bell.
10. OAS and GIS being tied to a new alternative consumer price index
OAS and GIS payments already rise in tandem with inflation, but the Liberals noted that, according to a Statistics Canada study, the price of most things seniors buy tends to rise faster.
In its 2015 elections platform, the party proposed developing a Seniors Price Index that would supplement the general Consumer Price Index to which OAS and GIS are currently indexed. PwC, the global consultancy firm, noted earlier this year that the House of Commons’ Finance Committee also recently recommended adopting the change. It didn’t make it into the 2016 budget but may make it into the upcoming one.
Overall, it doesn’t look like the federal government is necessarily looking for a lot more tax revenue this year. “Sometime just getting a strong vibrant economy up and running creates more revenue in the long term because more taxpayers in future will be paying tax,” says Bell. “We’re not like the U.S. where they’re forced to balance the budget. I think tightening some of the loopholes in the Canadian budget is the real aim overall this tax year.”
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