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Tax Advantage

Canadians still pay too much tax. The Government is taking important steps to reduce personal income taxes to encourage people to work, save and invest. We are helping businesses succeed through lower taxes to spur innovation and growth that will lead to more jobs and higher wages for Canadian workers. Canada’s New Government is also continuing its commitment to restoring tax fairness, making sure that corporations that have been using tax havens are paying their fair share. Budget 2007 takes action on creating a Tax Advantage in Canada through the following measures:

Personal Income Tax

• A new $2,000 child tax credit will provide up to $310 per child of tax relief to more than 3 million Canadian families.


• Ending the marriage penalty by increasing the spousal and other amounts to provide up to $209 of tax relief for a supporting spouse or single taxpayer that is supporting a child or relative.


• Extending the public transit tax credit to innovative fare products like electronic fare cards and weekly passes when used on an ongoing basis.


• Increasing the lifetime capital gains exemption for farmers, fishermen and fisherwomen, and small business owners from $500,000 to $750,000.


• Enacting the Tax Fairness Plan, which delivers over $1 billion in additional tax savings for Canadians including:

• Encouraging older workers to stay in the labour market by permitting phased retirement. This would allow an employer to simultaneously pay a partial pension to an employee and provide further pension benefit accruals to the employee.


• Increasing the age limit from 69 to 71 for converting a registered retirement savings plan (RRSP) to strengthen incentives for older Canadians to work and save.


• Amending the list of qualified investments that can be held by RRSPs and other registered plans to include most investment-grade debt and publicly-listed securities.


• Increasing the share of meal expenses that long-haul truck drivers can deduct for tax purposes from 50 to 80 per cent.

Business Taxes

• Introducing tax reductions which will lower Canada’s tax rate on new business investment. This will encourage investment and job creation, and help Canadian businesses to compete on the world stage.


• Helping manufacturing and processing businesses make the major investments needed to respond to the stronger Canadian dollar and rising global competition by allowing them to write off their capital investments in machinery and equipment acquired on or after March 19, 2007, and before 2009 using a special two-year 50-per-cent straight-line rate.


• Increasing the capital cost allowance rate from 4 to 10 per cent for buildings used in manufacturing and processing, and from 45 to 55 per cent for computers.


• Updating the Canada-U.S. Tax Treaty to facilitate cross-border investment and commerce.


• Cracking down on corporations that use tax havens to avoid paying their fair share of taxes by eliminating the deductibility of interest incurred to invest in business operations abroad, improving information agreements with other countries, and providing more resources to the Canada Revenue Agency to strengthen their audit and enforcement activities.

Other Tax Measures

• Extending the 15-per-cent mineral exploration tax credit by an additional year, until March 31, 2008.


• Establishing a new federal Foreign Convention and Tour Incentive Program to attract foreign conventions and tour groups through a goods and services tax/harmonized sales tax system.


• Doubling the value of goods that may be imported duty- and tax-free by returning Canadian residents after a 48-hour absence from $200 to $400.


• Supporting the Vancouver 2010 Olympic and Paralympic Winter Games by providing a series of tax relief measures in order to facilitate the Games.

Overview

Taxes pay for Canada’s important public services, but high taxes are limiting Canadians’ opportunities and choices. With a more focused government, we can lower taxes to create better incentives for Canadians to succeed.

The Tax Advantage is about reducing taxes in all areas to stimulate investment and economic growth. This includes reducing personal income taxes to improve the rewards from working, saving, and investing in new knowledge and skills. It includes creating a business tax advantage that will encourage businesses to invest in Canada and spur innovation and growth, leading to more jobs and higher wages for Canadian workers. Canada’s New Government also continues its commitment to restoring tax fairness. Canadians deserve to know that everyone will pay their fair share of taxes.

Details on all tax measures are set out in Annex 5.

More Personal Income Tax Relief

Canada’s New Government believes that Canadians still pay too much in taxes. That is why we took action in Budget 2006 and in the Tax Fairness Plan to provide more than $20 billion in tax relief for individuals over two years. That is more than double the previous government’s plan and more than the previous four budgets combined.

Budget 2006 included:

• A goods and services tax (GST) reduction from 7 to 6 per cent.


• A doubling of the pension income credit, the first increase in 20 years.


• A $500 children’s fitness tax credit amount.


• Support for apprenticeships and students.


• A $1,000 Canada Employment Credit amount.

The Tax Fairness Plan has also significantly enhanced the incentives to save and invest for family retirement security.

• The $1,000 increase in the age amount, from $4,066 to $5,066, benefits low- and middle-income seniors, who will receive up to about $155 of additional income tax relief for 2007.


• Pension income splitting represents a major positive change in tax policy for pensioners. It recognizes the special challenges of planning and managing retirement income by providing targeted assistance to pensioners.


• This plan is providing more than $1 billion in tax relief annually to seniors and pensioners.

Canadians still pay too much tax. This not only makes it harder for families to make ends meet, but it also prevents our economy from growing as much as it could. Lower taxes mean a higher quality of life for Canadians. That’s why Advantage Canada includes a Tax Advantage for our country.

In Budget 2007, Canada’s New Government is creating a Working Families Tax Plan. This plan, effective January 1, 2007, will deliver a new $2,000 tax credit amount for each child under 18 years of age, and increase the credits for low-income spouses and others to the same level as the basic personal amount. In total, it will remove 230,000 low-income Canadians from the tax rolls. Proposed measures will also help older workers keep a foot in the labour market, encourage investment, enhance support for public transit use and promote tax fairness. Budget 2007 will provide an additional $5.7 billion in tax relief for individuals over three years.

Budget 2007 also delivers on the Tax Back Guarantee—the Government’s commitment to use the interest savings from national debt reduction to reduce personal income taxes for Canadian families.

New $2,000 Child Tax Credit

Canada’s New Government is committed to helping families. The most important investment we can make as a country is to help families raise their children.

This Government understands that no two Canadian families are exactly alike. Each has its own circumstances and needs. That is why Budget 2006 introduced the Universal Child Care Benefit (UCCB), which provides $100 per month for each child under age 6 to help parents choose the child care option that best suits their families’ needs—whether that means formal child care, informal care through neighbours or relatives, or a parent staying at home. The UCCB provides more than $2.4 billion each year to 1.5 million families and over 2 million children.

Budget 2007 provides more support for families to recognize that raising children involves additional expenses. Effective January 1, 2007, families will be able to claim a new tax credit for each child under age 18. The tax credit will be calculated as $2,000 per child multiplied by the lowest personal income tax rate (15.5 per cent).

The new child tax credit will benefit about 3 million taxpayers, taking up to 180,000 low-income Canadians off the tax rolls and providing more than 90 per cent of taxpaying families with the maximum benefit of $310 per child. Given the average number of children per family, the measure will provide tax relief of about $430 on average for those with incomes less than $37,000 and about $505 on average for those with incomes between $37,000 and $74,000. It is estimated that this measure will provide $355 million in additional tax relief in 2006–07, and about $1.5 billion in additional tax relief in both 2007–08 and 2008–09.

Fairness for Single-Earner Families

Currently, taxpayers who have low-income spouses, or single taxpayers who support dependants such as a child or elderly parent, receive a tax-free amount of up to $7,581 in 2007. The tax relief for the supporting person is reduced as the spouse’s or dependant’s net income increases, and is fully phased out once it reaches $8,340.

Budget 2007 proposes to increase the credits for low-income spouses and dependants of single individuals by raising the amounts to the same level as the basic personal amount ($8,929) from their current level ($7,581), effective January 1, 2007. These amounts will grow with currently legislated future increases in the basic personal amount, meaning that they will reach at least $10,000 by 2009, $1,500 higher than previously legislated.

This measure will provide up to $209 in additional tax relief, so that single-earner families will receive the same tax relief as that already provided through the basic personal amount to two-earner families.

• Primary earners where the family has a spouse with income less than $8,929.


• Single parents working hard to make ends meet, and single individuals who have accepted the valuable role of caring for a dependent relative such as an elderly parent. Increasing the credit amount for these individuals helps preserve tax fairness between different family circumstances.

This measure will benefit about 1.8 million taxpayers, with almost 75 per cent of tax relief going to individuals earning less than $75,000, and will remove 50,000 Canadians from the tax rolls. It is estimated that this measure will provide $70 million in tax relief in 2006–07, $270 million in 2007–08 and $280 million in 2008–09.

 

Table 5.7 shows the distribution of personal income tax measures introduced by Canada’s New Government in Budget 2007, the Tax Fairness Plan, and Budget 2006. Taken together, they provide tax relief to all taxpayers, with about 75 per cent of the relief going to taxpayers with less than $75,000 in income.

Table 5.7
Distribution of Tax Relief for Canadians: Budget 2007, the Tax Fairness Plan and Budget 2006 (per cent)

Individual Income	Budget 20071	Budget 2007,1 Tax Fairness Plan  and Budget 20062
Under $37,178	50.1	29.7
$37,178–$74,357	33.1	44.7
$74,358–$120,887	12.6	17.3
$120,888+	4.2	8.3
Total	100.0	100.0
1 Includes increase in spousal and equivalent amount, new child tax credit and Working Income Tax Benefit. 2 Broad-based personal income tax reductions from Budget 2006 and the 2006 Tax Fairness Plan (does not include the 2006 GST reduction).

Strengthening Our Commitment to Promoting Public Transit

Canada’s New Government is acting to deliver real reductions in air pollutants, greenhouse gas emissions and harmful substances in our communities.

Budget 2006 introduced the public transit tax credit to encourage individuals to make a sustained commitment to public transit use by providing a credit for the purchase cost of monthly public transit passes, or passes of a longer duration. This measure, widely welcomed by Canadians, will be strengthened under Budget 2007 as a means to continue to reward those who make a sustained commitment to public transit.

Some transit authorities are planning to replace their monthly passes with user-friendly and innovative cost-per-trip fare products that will help improve accessibility to transit. To ensure that individuals continue to be encouraged to use public transit, Budget 2007 proposes to extend the public transit tax credit to include electronic fare cards that are used for at least 32 one-way trips in a monthly period. Transit authorities will need to track and certify usage and cost.

Further, the public transit tax credit will be provided where four weekly passes are purchased consecutively. This change will also help low-income individuals who may not be able to afford the financial commitment of a monthly pass to take advantage of the credit.

These changes will be effective for the 2007 tax year. It is estimated that these measures will reduce federal revenues by $10 million in 2007–08 and $20 million in 2008–09.

Increasing the Lifetime Capital Gains Exemption

Small business owners, farmers, fishermen and fisherwomen are key contributors to Canada’s economic success. Among the ways that Canada’s federal income tax system supports these entrepreneurs is the lifetime capital gains exemption (LCGE). By providing a tax exemption on up to $500,000 of capital gains realized on the disposition of qualified farm and fishing property or qualified small business corporation shares, the LCGE increases the rewards of investing in small business, farming and fishing. The exemption also helps these entrepreneurs better ensure their financial security for retirement.

In recognition of the importance of small business owners, farmers, fishermen and fisherwomen to the Canadian economy, Budget 2007 proposes to increase the LCGE to $750,000 from $500,000. This is the first time it has been increased since 1988. This new limit will apply to dispositions on or after March 19, 2007, of qualified farm and fishing property and qualified small business corporation shares.

It is estimated that this measure will reduce federal revenues by $5 million in 2006–07, $85 million in 2007–08 and $90 million in 2008–09.

Meal Expense Relief for Truck Drivers

Canada’s economy depends on the trucking sector to function effectively. Increasing demand for highly skilled truck drivers and a rapidly aging workforce are raising concerns that Canada may be facing a shortage of qualified truck drivers. According to a study conducted by the Canadian Trucking Human Resources Council, the trucking industry currently needs some 38,000 new drivers annually.

In order to provide better recognition of the significant meal expenses incurred by long-haul truck drivers while on the road, Budget 2007 proposes to increase to 80 per cent from 50 per cent the share of meal expenses that long-haul truck drivers can deduct for tax purposes.

This increase will be phased in over a five-year period, beginning with an increase to 60 per cent from 50 per cent for meal expenses incurred on or after March 19, 2007. This measure will apply to both long-haul truck drivers who are employees and long-haul truck drivers who are self-employed.

It is estimated that this measure will reduce federal revenues by $15 million in 2007–08 and $25 million in 2008–09.

Phased Retirement—Pension Payments and Accruals for Older Workers

As the Canadian workforce ages, it will become more important for older, more experienced workers to keep a foot in the labour market.

The Income Tax Regulations currently prohibit phased retirement arrangements by preventing employees from accruing pension benefits under a defined benefit registered pension plan if they receive a pension from the plan of the same or a related employer. This reduces incentives for older workers to remain in the labour force. The Government of Quebec has proposed changes to accommodate phased retirement arrangements under its provincial pension rules.

Canada’s New Government wants to help employers to retain older workers. To do this, Budget 2007 proposes to permit an employer to simultaneously pay a partial pension to an employee and provide further pension benefit accruals to the employee. The measure will apply only to employees aged 55 years and over who are entitled to an unreduced pension. These changes will come into effect beginning in 2008.

It is estimated that this change will have a small fiscal impact.

Increasing the Age Limit for Maturing RPPs and RRSPs

The Income Tax Act currently requires that an individual’s registered retirement savings plan (RRSP) be converted to a registered retirement income fund (RRIF), or be used to acquire a qualifying annuity, by the end of the year in which the individual turns 69 years of age. Similarly, registered pension plan (RPP) payments must generally begin by the end of the year in which the pension plan member turns 69 years of age. These rules help ensure an orderly recognition of tax-deferred retirement savings in income.

Many older Canadians want to continue working and saving. As Canada’s population ages, it will be important to allow them to do so. Budget 2007 proposes to increase the RRSP/RPP maturation age limit to 71 years of age, effective for the 2007 and subsequent taxation years.

RRIF owners must withdraw a specified minimum amount each year following the year in which the RRIF is established. This requirement will be waived for 2007, for those RRIF owners who turn 71 years of age in 2007, and for 2007 and 2008, for those RRIF owners who turn 70 years of age in 2007.

It is estimated that this measure will reduce federal revenues by $10 million in 2006–07, $130 million in 2007–08 and $135 million in 2008–09.

RRSP Qualified Investments

The list of qualified investments that can be held by RRSPs and other registered plans will be expanded to include most investment-grade debt and publicly-listed securities. These changes will apply on or after March 19, 2007, and will provide registered plan investors with greater investment choice and diversification opportunities.

This measure will have no impact on federal revenues.

Northern Residents Deduction

Two income tax deductions are available to residents of the north in prescribed areas to assist in drawing skilled labour to northern and isolated communities by providing recognition for the additional costs faced by residents of these areas: a residency deduction of up to $15 a day, and a deduction for two employer-provided vacation trips per year and unlimited employer-provided medical travel. Residents of the Northern Zone are eligible for full benefits, while residents of the Intermediate Zone are eligible for 50 per cent of the benefits.

Budget 2007 proposes to include the District Municipality of Mackenzie, in British Columbia, in the Intermediate Zone for the purpose of the northern residents deduction. This technical change is in line with the original intent of the 1988 Task Force on Tax Benefits for Northern and Isolated Areas.

This measure will be effective for the 2007 tax year. It is estimated that this change will have a small fiscal impact in 2006–07 and subsequent years.

Building a Business Tax Advantage

Creating a Canadian Tax Advantage will allow us to attract and retain business investment. This is more important than ever because world economies have become increasingly integrated. Countries with high taxes discourage investment and those with competitive tax rates reap the benefits of more investment. Canada must work to increase the competitiveness of its business taxes and be more responsive to the actions of other countries.

Lowering taxes is not enough: the tax system must also be fair and it must leave investment decisions in the hands of Canadians. Business taxes must be competitive for all sectors, industries and business structures, and the tax system should be neutral to ensure that tax considerations do not unduly influence business and investment decisions.

The Government is committed to building a business tax advantage—grounded in a tax system that is internationally competitive. This commitment is evident in Budget 2006 and the Tax Fairness Plan, which move Canada in the right direction by:

• Reducing the general corporate income tax rate to 18.5 per cent from 21 per cent by 2011.


• Accelerating the elimination of the federal capital tax by two years to January 2006.


• Eliminating the corporate surtax for all corporations in 2008.


• Levelling the playing field in the taxation of publicly-traded income trusts, partnerships and corporations.

As a result of these tax reductions, Canada will re-establish a solid corporate statutory income tax rate advantage over the U.S., reaching 5.8 percentage points for manufacturing income by 2011. Canada will also achieve a meaningful overall tax advantage over the U.S., reaching 3.3 percentage points by 2011, as measured by the METR on new business investment.

Canada needs to broaden its Tax Advantage beyond the U.S. As Chart 5.3 shows, when already legislated tax reductions are fully implemented in 2011, Canada’s METR will be 31.1 per cent, the third-highest METR in the Group of Seven (G7). Other G7 countries are taking action to reduce taxes. For example, Germany recently announced business tax reductions that will reduce its METR. To move Canada toward a position of strength, Canada’s New Government set the course in Advantage Canada to further improve Canada’s tax competitiveness by establishing the lowest METR in the G7.

Changes to provincial tax structures will also be required to achieve the optimal tax environment for Canadian businesses to grow and prosper. Many provinces continue to impose capital taxes and retail sales taxes on business investment, which significantly dampens investment activity. Accordingly, the Government encourages provinces to implement decisive measures to help broaden the Tax Advantage for Canadian businesses.

Budget 2007 proposes measures that would allow Canada to become one of the most investment-friendly countries in the G7 by:

• Providing assistance for Canada’s manufacturing sector.


• Aligning capital cost allowances with useful life for manufacturing buildings and other assets.


• Providing a financial incentive to the provinces to facilitate the elimination of provincial capital taxes.

With the changes proposed in this budget, the METR on investment in Canada in 2011 would drop to 28.6 per cent from 31.1 per cent, which would give Canada the third-lowest METR in the G7. Actions by provincial governments to eliminate capital taxes and harmonize retail sales taxes with the GST would lower Canada’s METR to 21.1 per cent, giving Canada the lowest METR in the G7 by a significant margin.

Assistance for Canada’s Manufacturing Sector

Canada’s manufacturing and processing (M&P) sector is a significant contributor to our economy. As discussed in Chapter 2, the manufacturing sector has had a particularly challenging year.

In recognition of the economic challenges facing the sector, Budget 2007 proposes a new investment incentive for M&P businesses. For investment in eligible machinery and equipment from now until the end of 2008, businesses engaging in manufacturing or processing will be eligible to claim accelerated capital cost allowance at a rate of 50 per cent on a straight-line basis. The proposed rate will allow these investments to be written off over a two-year period on average, after taking into account the half-year rule, which treats assets as if they had been purchased in the middle of the year. This measure will apply to investments in eligible machinery and equipment on or after March 19, 2007, and before 2009 by businesses engaged in manufacturing or processing in Canada of goods for sale or lease.

This measure is expected to reduce federal revenues by $170 million in 2007–08 and $565 million in 2008–09, totalling about $1.3 billion over the period 2007–08 to 2009–10.

In addition, Budget 2007 proposes to increase the capital cost allowance rate for buildings used for manufacturing or processing in Canada of goods for sale or lease to 10 per cent from 4 per cent. This change will better reflect the useful life of buildings in this sector. Further details on this measure are provided in the following section.

Together, these measures will provide a more favourable climate for M&P businesses to accelerate or increase their investment in buildings, machinery and equipment, and will assist the sector in restructuring to meet the challenges that it is currently facing.

Aligning Capital Cost Allowance Rates With Useful Life

The capital cost allowance (CCA) system determines how much of the capital cost of an asset a firm may deduct each year. CCA rates are generally set so that the deduction for capital costs is spread over the useful life of the asset. This ensures the accurate measurement of income for tax purposes and promotes neutrality with respect to investment decisions. Where a CCA rate is too low to reflect an asset’s useful life, an increase to that CCA rate can reduce the tax burden on investment and increase the efficiency of the tax system.

As part of the Government’s continuing review of CCA rates, and to further the Canadian Tax Advantage, a number of changes to CCA rates are proposed to better reflect the useful life of assets. As discussed above, Budget 2007 proposes to increase the CCA rate for buildings used in manufacturing and processing to 10 per cent from 4 per cent. In addition, Budget 2007 proposes to:

• Increase the CCA rate for other non-residential buildings to 6 per cent from 4 per cent.


• Increase the CCA rate for computers to 55 per cent from 45 per cent.


• Increase the CCA rate for natural gas distribution pipelines to 6 per cent from 4 per cent.


• Increase the CCA rate for liquefied natural gas facilities to 8 per cent from 4 per cent.

The CCA changes are effective for eligible property acquired on or after March 19, 2007. Together, they will reduce Canada’s METR as of 2011 by 2.5 percentage points, from 31.1 per cent to 28.6 per cent. These changes are expected to reduce federal revenues by $60 million in 2007–08 and $145 million in 2008–09.

Facilitating the Elimination of Provincial Capital Taxes

Capital taxes must be paid regardless of whether a corporation is profitable. This adds directly to the cost of doing business in Canada and is why Canada’s New Government acted in 2006 to accelerate the elimination of its general capital tax.

While many provinces have made progress in reducing their capital tax burden, further action would have substantial economic benefits (Table 5.8). To this end, Budget 2007 proposes to provide a financial incentive in respect of the period March 19, 2007 to January 1, 2011 to provinces to support and encourage them to eliminate or accelerate the elimination of their capital taxes by 2011. The incentive would be available to provinces that, on or after March 19, 2007, enact legislation to eliminate their capital taxes before January 1, 2011.

The amount of the federal incentive will equal the average expected federal corporate income tax gain from the elimination of provincial capital taxes. Provincial capital taxes are deductible for federal income tax purposes. As a result, the elimination of provincial capital taxes increases federal corporate income tax revenues. The incentive would also be available to provinces that restructure their capital tax on financial institutions into a minimum tax, similar to the federal minimum tax on financial institutions.

The elimination of provincial capital taxes would further strengthen Canada’s business tax advantage, reducing the overall tax burden on new business investment (METR) by 1.3 percentage points.

Table 5.8
Provincial Capital Taxes

	General Capital Tax	Capital Tax on Financial Institutions
British Columbia	No	Yes
Alberta	No	No
Saskatchewan	Eliminating (2008)	Yes
Manitoba1	Reducing	Yes
Ontario2	Eliminating (2012)	Eliminating (2012)
Quebec3	Reducing	Reducing
New Brunswick	Eliminating (2009)	Yes
Nova Scotia	Eliminating (2012)	Yes
Prince Edward Island	No	Yes
Newfoundland and Labrador	No	Yes
1 Manitoba recently announced its intention to eliminate its general capital tax should the fiscal situation of the province permit. 2 Ontario announced its intention to accelerate the elimination of its capital taxes should the fiscal position of the province permit. 3 Quebec announced the gradual reduction of its general capital tax rate, to 0.29 per cent in 2009 from 0.60 per cent in 2005, and its capital tax on financial institutions, to 0.58 per cent in 2009 from 1.20 per cent in 2005.

Furthering Provincial Sales Tax Harmonization

Provincial retail sales taxes contribute to making Canadian businesses less competitive because they generally apply to business inputs, resulting in higher production costs. Provincial governments have an important role to play in making Canada’s economy more competitive through the elimination of these taxes.

Restructuring provincial retail sales taxes would make a significant contribution to Canada’s Tax Advantage. If the five remaining provinces with retail sales taxes moved to a value-added tax (VAT) harmonized with the GST, Canada’s overall METR would decline by 6.2 percentage points. Harmonization by Ontario alone would lower the Canadian METR by 4.5 percentage points. A reduction of this magnitude would have a significant impact on the competitiveness of Canadian businesses and the standard of living of Canadians.

The Government is committed to establishing the conditions that will encourage new capital investment in Canada and is ready to work with the provinces that would like to eliminate their retail sales taxes and move to a harmonized VAT system. Moving forward with provinces to complete the sales tax harmonization initiative, coupled with the full elimination of provincial capital taxes, would give Canada the lowest tax rate on new investment among the G7 countries by 2011.

International Tax Fairness

Canadian businesses compete successfully around the world, and Canada’s system of international taxation is important to ensure our companies remain competitive. For example, Canada maintains one of the world’s largest networks of bilateral tax treaties to protect Canadian companies and investors against international double taxation. As well, Canada’s generous tax credits for research and development keep this country at the leading edge of innovation.

At the same time, the system must ensure that appropriate taxes are paid so that everyone pays their fair share. Some corporations, both foreign-owned and Canadian, have taken advantage of Canada’s tax rules to avoid tax. Others, especially wealthy individuals, use tax havens to help them hide income and evade tax. In all of these cases, working Canadians and small businesses, among others, are left having to pay more tax than they otherwise should. This is simply not fair.

Budget 2007 proposes to make Canada’s international tax system fairer and more competitive.

• Canada and the United States have agreed in principle to update the Canada-U.S. Tax Treaty to facilitate cross-border investment and commerce—notably with the elimination of non-resident withholding tax on interest payments. Canada also plans to unilaterally remove the withholding tax from arm’s length interest payments to other countries.


• An International Tax Fairness Initiative will be implemented both to fix long-standing problems in Canada’s international tax rules, and to improve the ability of the Canada Revenue Agency to enforce them.

Together with the lower tax rates Canada is committed to maintaining, the proposals in Budget 2007 mean that the tax system will continue to help Canadian businesses in their drive to be world leaders, while at the same time making sure that everyone pays the taxes that they owe.

These actions represent important steps to improve Canada’s system of international taxation—but we need to continue to look for further improvements. The Minister of Finance will set up an advisory panel to examine the system over the next year to identify further improvements for consideration in Budget 2008.

Canada-U.S. Tax Treaty

Canada’s income tax treaty with the United States is a vital part of the international tax environment. Budget 2007 announces that the two countries’ representatives have agreed in principle on the major elements of an updated Canada-U.S. Tax Treaty, with formal negotiations expected to conclude in the very near future.

Canadians and Canadian businesses will get a number of specific benefits from this treaty update, including:

• Lower borrowing costs and a more competitive lending market, with the elimination of withholding tax on interest paid on all arm’s length debt.


• Easier cross-border investment as the withholding tax is removed from interest paid between non-arm’s length persons between Canada and the U.S.


• Better access to U.S. capital, since treaty benefits will be extended to limited liability companies, commonly used by U.S. venture capital firms and others.


• More mobility for Canadians working in the U.S., with further harmonization of the tax treatment of pension contributions in the two countries and new rules to clarify the treatment of stock options.

Withholding Tax on Interest Payments

Assuming an exemption from withholding tax on both arm’s length and non-arm’s length interest is implemented in the Canada-U.S. Tax Treaty as expected, Budget 2007 will further simplify the Canadian international tax system by eliminating Canadian withholding tax on interest paid to all arm’s length non-residents regardless of their country of residence. This will maximize the impact of this measure on increasing the availability of capital and lowering cost to Canadian business.

This legislated exemption from withholding tax would apply to interest paid after the date on which the withholding tax exemption in the proposed Canada-U.S. Tax Treaty comes into effect.

The withholding tax on non-arm’s length interest payments between Canada and the U.S. will be phased out over a three-year period.

The exemption from withholding tax in respect of both arm’s-length interest and non-arm’s length interest with the U.S., and with respect to arm’s length interest paid to lenders resident in other countries, is expected to cost $70 million in 2007–08 and $180 million in 2008–09.

International Tax Fairness Initiative

Budget 2007’s International Tax Fairness Initiative builds on the Tax Fairness Plan and proposes a significant and long-overdue improvement to how Canada taxes foreign-source business income. It also enhances the ability of the Canada Revenue Agency, working with its partners in other countries, to track down and deal with those who try to use aggressive international tax planning to shirk their tax obligations and increase the burden on other Canadian taxpayers. This will make Canada’s tax system much fairer.

Budget 2007 proposes to:

• Eliminate the deductibility of interest incurred to invest in business operations abroad.


• Improve our information exchange agreements with other countries.


• Provide more resources to the Canada Revenue Agency to strengthen their audit and enforcement activities.

Interest Deductibility and Foreign Affiliates

When a company (or other taxpayer) borrows money for an income-earning purpose, the interest it pays on the borrowed money is generally tax-deductible. This ensures that the income is correctly measured: the interest is a cost of earning it, and like other costs it should be deductible.

Owning shares in a company is usually considered an income-earning purpose, since most dividends are taxable. If the shares are bought using borrowed money, the tax system ordinarily allows the interest expense to be deducted.

There is, though, one important kind of dividend income that does not get taxed in Canada. This is dividend income that a foreign subsidiary corporation, known as a foreign affiliate, pays to its Canadian parent company out of the foreign affiliate’s "exempt surplus"—its foreign business income. Despite the fact that these exempt surplus dividends are not taxed in Canada (and neither is the underlying foreign income), the parent company in Canada can deduct the interest it pays on borrowed money used to acquire the shares of the foreign affiliate. In other words, the Canadian tax system recognizes the expense but not the corresponding revenue.

Canada’s existing tax rules permit this mismatch, and multinational corporations have used it to their advantage. The corporations borrow in Canada to fund business operations abroad, then use the resulting interest deductions to offset Canadian-source income. By giving this tax saving to the corporations, Canadian taxpayers are indirectly subsidizing their international operations. That subsidy makes it more attractive for even a Canadian-owned company to locate new income-earning operations in a foreign country rather than in Canada, other things being equal.

These problems are not new. For example, the 1997 Report of the Technical Committee on Business Taxation recommended disallowing the deduction of interest expense on borrowed money used to invest in foreign affiliates. The Auditor General of Canada also highlighted this issue as a concern in both 1992 and 2002.

Canada’s New Government has chosen to act, to ensure that everyone pays their fair share of tax. Budget 2007 proposes that interest expense on indebtedness incurred to acquire the shares of a foreign affiliate no longer be deductible, unless and until the shares generate income that Canada actually taxes. The restriction on interest deductibility will apply to interest payable after 2007 on new debt incurred on or after March 19, 2007. The restriction will apply to existing non-arm’s length debt for interest payable after 2008 and, to moderate the immediate impact of these changes on firms in relation to their arrangements with arm’s length lenders, will apply to arm’s length debt for interest payable after 2009.

This measure is expected to generate $10 million in federal revenue in 2007–08 and $40 million in 2009–10.

Improving the Exchange of Tax Information

In order for all Canadians to enjoy lower taxes, those who owe tax have to pay it. Budget 2007 proposes concrete steps to reinforce the ability of the Canada Revenue Agency (CRA) to collect tax by building on our existing tax treaty network to update our exchange of information standards. No new or revised tax treaties will be signed that do not include comprehensive exchange of information provisions.

In addition, because the greatest challenges the CRA faces in enforcing Canada’s tax laws are in respect of income earned in countries with which Canada does not have a tax treaty, Budget 2007 will provide incentives for non-treaty countries to enter into comprehensive tax information exchange agreements (TIEAs) with Canada. Non-treaty countries will be asked to agree to a TIEA within five years of being approached by Canada to do so. If a jurisdiction does agree to a TIEA, business income earned in that jurisdiction by foreign affiliates of Canadian firms will (as described below) be exempt from Canadian tax; otherwise, that income will be taxable in Canada as earned.

Foreign-Source Business Income: Exempt Surplus

Although its mismatch with interest deductibility has been a long-standing problem, the "exempt surplus" rule in itself is a key competitive advantage of the Canadian tax system. The rule allows a Canadian company to earn business income through a foreign affiliate in any tax-treaty country, and bring that income back to Canada, with no Canadian tax. Since the only tax on this business income will be that paid to the foreign country in which it is earned, the system ensures that Canadian firms are able to operate on a level playing field with their foreign competitors.

With the proposal above to resolve the interest deductibility problem, it is no longer necessary to link the exemption to the presence of a tax treaty. In the current environment, it is more appropriate to link the exemption to the presence of a comprehensive exchange of information agreement.

Budget 2007 therefore proposes to extend the exemption to active business income from non-treaty jurisdictions as well as treaty countries, provided those jurisdictions agree to exchange tax information with Canada. This will give Canadian firms more scope to expand internationally, especially into new and emerging markets, without our tax system imposing additional costs that could reduce their competitiveness, while also maintaining tax fairness. It will also encourage non-treaty jurisdictions to join in the efforts of Canada and our treaty partners to control international tax evasion.

Improved Auditing and Enforcement

The CRA will be provided with additional resources to strengthen the enforcement of Canada’s tax system in relation to foreign income and cross-border transactions. Particular emphasis will be placed on transfer pricing transactions and complex international tax avoidance cases.

Further resources will also be provided for the CRA to verify and collect taxes owing on income and sales generated in Canada. These resources will be used to find and challenge taxpayers participating in aggressive tax shelters, who fail to report all of their income, or who have made unsubstantiated GST/HST refund claims.

Other Tax Measures

Encouraging Mineral Exploration

The temporary 15-per-cent mineral exploration tax credit is an incentive available to individuals who invest in flow-through shares that are used to finance mining exploration. The credit, which is intended to assist companies raise capital for exploration, was reintroduced in Budget 2006 and is currently scheduled to expire on March 31, 2007.

Budget 2007 proposes to extend the credit for an additional year, until March 31, 2008. The one-year "look-back" rule will allow funds raised with the benefit of the credit in 2008, for example, to be spent on eligible exploration activity up until the end of 2009. Extension of the credit for a limited period will support continued exploration for new mineral reserves.

The net fiscal cost of this extension is estimated at $75 million over the next two fiscal years.

Foreign Convention and Tour Incentive Program

The tourism industry contributes to the strength of the Canadian economy and is an important source of employment in many regions. Large organizations and special groups looking for scenic, safe and affordable venues for conventions and tour destinations are, by nature, the most competitive and price-sensitive segments of the global market for tourism.

To promote Canada as a destination of choice for group travel, Budget 2007 proposes to introduce a new incentive for foreign conventions and the accommodation portion of non-resident tour packages. This new federal incentive will be provided through the GST/HST system and will serve as a more focused, effective and accountable replacement to the former Visitors’ Rebate Program.

The measure will be effective starting April 1, 2007. In addition, Budget 2007 proposes to accompany this new measure with the introduction of a more effective incentive claims process that will also take effect April 1, 2007.

The new Foreign Convention and Tour Incentive Program is expected to reduce federal revenues by approximately $15 million in 2007–08 and $15 million in 2008–09.

48-Hour Travellers’ Exemption

The travellers’ exemption allows returning residents of Canada to bring back goods up to a specified dollar limit without having to pay duties or taxes, including customs duty, GST/HST, federal excise taxes and provincial sales and product taxes. Canada’s 48-hour exemption threshold is currently $200 and has remained unchanged since 1995.

Budget 2007 proposes to double the value of goods that may be imported duty- and tax-free by returning Canadian residents after a 48-hour absence, to $400 from $200. This measure is intended to facilitate cross-border travel by streamlining the processing of returning Canadian travellers who have made only incidental purchases while outside Canada. This change will be effective beginning on March 20, 2007. It is estimated that this measure will reduce federal revenues by $5 million in 2007–08 and $5 million in 2008–09.

Prescribed Stock Exchanges

The Income Tax Act currently provides for the prescription of stock exchanges for a wide variety of provisions in the Act. These include determining eligible investments for RRSPs, the exemption from the requirement for capital gains clearance certificates in respect of the disposition by non-residents of shares of certain Canadian corporations, and the application of special tax rules relating to securities lending.

In some cases, the provisions look to the listing on a prescribed stock exchange for prudential purposes requiring a high degree of confidence in the exchange (RRSPs for example), while in other cases the requirement serves simply to guarantee the existence of a public market (e.g. the securities lending rules).

However, in determining whether a stock exchange should be prescribed, the most stringent requirements must be met for all purposes, requiring in some cases over-qualification and extensive delay in determining eligibility for prescription. Budget 2007 proposes to streamline this process and in some cases simplify compliance by creating three categories of recognition for stock exchanges (see Annex 5 for more details) which will better reflect the purposes for which the exchanges are referenced in the various provisions of the Act.

Hosting the 2010 Olympic and Paralympic Winter Games in Vancouver

The Government is committed to making Canada a successful host country for the 2010 Olympic and Paralympic Winter Games in Vancouver. As hosting the Games has significant social, cultural and economic benefits, it is an established practice for host countries to provide tax relief in order to facilitate the Games. It is important to Canada to honour this long-standing tradition and, to this end, Budget 2007 proposes to waive non-resident withholding tax payable by the International Olympic Committee and International Paralympic Committee, and income tax payable by non-resident athletes participating in the Games, as well as all or a portion of the customs duties, excise taxes and GST/HST on goods imported into Canada in connection with the Games.

Table 5.9
Tax Advantage (millions of dollars) 

	2006–07	2007–08	2008–09	Total
More Personal Income Tax Relief
New $2,000 child tax credit	355	1,445	1,475	3,275
Fairness for single-earner families	70	270	280	620
Strengthening our commitment to promoting public transit		10	20	30
Increasing the lifetime capital gains exemption	5	85	90	180
Meal expense relief for truck drivers		15	25	40
Increasing the age limit for maturing RPPs and RRSPs	10	130	135	275
Subtotal	440	1,955	2,025	4,420
Building a Business Tax Advantage
Assistance for Canada’s manufacturing sector		170	565	735
Aligning capital cost allowance rates with useful life		60	145	205
Subtotal		230	710	940
International Tax Fairness
Withholding tax on interest payments		70	180	250
International Tax Fairness Initiative		-10	-40	-50
Improved auditing and enforcement		15	50	65
Subtotal		75	190	265
Other Tax Measures
Encouraging mineral exploration		105	-30	75
Foreign Convention and Tour Incentive Program		15	15	30
48-hour travellers’ exemption		5	5	10
GST/HST Remission Order1		20		20
Subtotal		145	-10	135
Total—Tax Advantage	440	2,405	2,915	5,760
Note: Totals may not add due to rounding. 1 See Annex 5 for further information.

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¹ The marginal effective tax rate (METR) on business investment is a comprehensive indicator of the impact of the tax system on the decision to invest. It takes into account federal and provincial statutory tax rates as well as deductions and credits available in the corporate tax system and other taxes paid by corporations, such as provincial capital taxes. The methodology for calculating METRs is described in the 2005 edition of Tax Expenditures and Evaluations (Department of Finance).[Return]

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