2022 Canadian Federal Budget: Business Tax

In her speech for Budget 2022 on April 7 (Budget Day), the minister of finance emphasized that COVID-19 support from the federal government was instrumental in bolstering the Canadian economy throughout the pandemic. The minister asserted that Canadian financial institutions reaped the benefits of that support through de-risking of their balance sheets, leading to higher profits and a strong recovery. As a result, the government is turning to Canadian financial institutions to help fill the hole in the government’s balance sheet.

Budget 2022 proposes two main revenue tools, and two other measures to address perceived aggressive tax planning by FIs.  

Revenue tools

Budget 2022 imposes a one-time 15% tax – the Canada Recovery Dividend (CRD) – on “bank and life insurer groups” and any other entity that is a financial institution for purposes of Part VI of the Income Tax Act (Canada) (ITA) that is related to a bank or life insurer. The term “bank and life insurer groups” is not defined in the ITA or in the Notice of Ways and Means Motion implementing the budget measures. 

The CRD will be based on a corporation’s taxable income for taxation years ending in 2021, which will be pro-rated for short taxation years. Bank and life insurer groups subject to the CRD would be permitted to allocate a $1 billion taxable income exemption by agreement among the group members. The CRD liability will be imposed for the 2022 taxation year and be payable in equal amounts over five years. This measure is expected to generate $4 billion of additional tax revenue.  

Budget 2022 also introduces an additional, permanent tax of 1.5% on the taxable income of members of bank and life insurer groups. A $100 million taxable income exemption can be shared by agreement among the group members. This measure would apply to taxation years ending after Budget Day. If a taxation year includes Budget Day, the tax will be pro-rated based on the number of days in the taxation year after Budget Day.

“Aggressive” tax planning 

Hedging and Short Selling by Canadian Financial Institutions

Budget 2022 contains measures to restrict certain tax benefits where financial institution groups structure transactions to take advantage of both the intercorporate dividend deduction and the deduction for a dividend compensation payment under the securities lending arrangement rules in connection with the same securities. In these structures, a Canadian corporate taxpayer acquires shares of a taxable Canadian corporation, and a related entity that is a registered securities dealer borrows the identical security under a “securities lending arrangement” for the purpose of selling it short. Dividends paid on the acquired shares result in an intercorporate dividend deduction to the shareholder and the securities dealer is entitled to a deduction equal to two-thirds of the amount paid to the lender of the shares.  

The budget proposals provide that, in this case, the intercorporate dividend deduction will be denied in respect of dividends received on shares of a Canadian corporation if a registered securities dealer that is, or that is non-arm’s length to, the shareholder enters into certain hedging transactions to eliminate or substantially reduce the economic exposure to the shares. In this case, the registered securities dealer will be permitted to claim a full (rather than two-thirds) deduction for a dividend compensation payment made under a securities lending arrangement entered into in connection with the hedging transactions. 

To implement this change, the definition of “dividend rental arrangement” has been amended to include a “specified hedging transaction.” A specified hedging transaction in respect of a “DRA share” (that is, a dividend rental arrangement share) of a particular person means a transaction or series of transactions: 

a) that is entered into by 

(i) the particular person, if the particular person is a registered securities dealer, or

(ii) a registered securities dealer (a “connected dealer”), where the connected dealer does not deal at arm’s length with the particular person,

b) that has the effect, or would have the effect if the transaction or series was entered into by the particular person rather than the connected dealer, of eliminating all or substantially all of the particular person’s risk of loss or opportunity for gain or profit in respect of the DRA share, and

c) if the transaction or series is entered into by the connected dealer, it can reasonably be considered to have been entered into with the knowledge, or where there ought to have been the knowledge, that the effect described in paragraph (b) would result.  

By this change to the definition of dividend rental arrangement, subsection 112(2.3) will apply to deny the subsection 112(1) deduction. Similarly, proposed subsection 260(6.2) provides the mechanism for the deduction by the registered securities dealer for the dividend compensation payment in respect of a specified hedging transaction. The deduction is, generally, the lesser of (a) the dividend compensation payment required to be paid and (b) the amount of the dividend in respect of which no amount was deductible under subsection 112(2.3).

This measure is proposed to apply to dividends and related dividend compensation payments that are paid, or become payable, on or after Budget Day, unless the relevant hedging transactions or related securities lending arrangement was in place before Budget Day, in which case the amendment would apply to dividends and related dividend compensation payments that are paid after September 2022.

Use of Tax Havens by Financial Institutions

While few details were provided, Budget 2022 announced a proposal to examine changes to the financial transaction approval process to limit the ability of federally regulated financial institutions to use structures in tax havens to engage in “aggressive tax avoidance.”