Canadian Tax

The Canada Emergency Business Account (CEBA) was previously introduced in early April 2020 to provide eligible businesses with financing up to $40,000, with 25 per cent of this being forgivable based on the terms of the CEBA loan program. In the early stages of the program, businesses were required to employ individuals with an aggregate employment expense between $40,000 and $1,000,000 in 2019. The program was modified to widen the employment scope to between $20,000 and $1,500,000, thus expanding the reach of the program.

Even with this expanded reach, some owner-operated small businesses with minimal to no employment expenses still could not meet these criteria and were deemed ineligible. We found that a lot of our farming clients fell in this category as well.

On June 19, owner-operated small businesses (including farmers) that had been previously ineligible for the CEBA program due to their lack of payroll may now apply under another expansion of the program rules.

To qualify under the expanded eligibility rules, CEBA applicants with payroll lower than $20,000 will need to meet the following additional conditions:

• A business chequing/operating account at a participating financial institution,
• A Canada Revenue Agency business number,
• A 2018 or 2019 filed tax return, and
• Eligible non-deferrable expenses (subject to adjustment) of between $40,000 and $1.5 million.

Those owner-operated small businesses applying under the newly expanded eligibility rules will follow a slightly different process. The applicant will start with the same process of submitting an application to their existing financial institution, but under the expanded eligibility rules the applicant will also be required to submit documentation to the Government of Canada supporting the eligible non-deferrable expenses.

The eligible non-deferrable expense categories are as follows:

• Wages and other employment expenses to independent (arm’s length) third parties,
• Rent or lease payments for real estate or capital equipment used for business purposes,
• Payments for insurance, property taxes, telephone and utilities in the form of gas, oil, electricity, water and internet,
• Payments for regularly scheduled debt service, and
• Payments incurred under agreements with independent contractors and fees required in order to maintain licenses, authorizations or permissions necessary to conduct business by the Borrower.

The 2020 eligible non-deferrable expenses are subject to adjustment if the borrower received benefits under other Government of Canada COVID-19 response programs such as CEWS, CECRA, 10% temporary wage subsidy, Futurpreneur Canada, Northern Business Relief Fund, Fish Harvester Grant, relief measures for Indigenous businesses and $250 million COVID-19 IRAP (Industrial Research Assistance Program) Subsidy Program.

The documentation to be provided supporting the non-deferrable expenses would consist of electronic or paper copies of receipts, invoices or agreements. As long as sufficient documentation has been provided to support the requirement to have between $40,000 and $1.5 million of 2020 eligible non-deferrable expenses, and assuming the pre-funding eligibility validation is successful, the applicant should expect to receive funding within 10-15 business days.

In times of crisis, people can be opportunistic, and this economic turmoil can allow for certain tax planning opportunities. The current economic downturn caused by the COVID-19 pandemic has negatively affected the valuation of many Canadian businesses. Accordingly, it is wise to revisit any estate freeze transactions that may have been implemented at a time in a prior year when the economy was booming.

What is an estate freeze?

An estate freeze is an estate planning technique by which the current value of shares in the capital stock of a private corporation is frozen and locked-in for one individual (commonly a parent) with any future increase in value of a private corporation accruing to another (e.g., the parent’s children or a trust settled for the benefit of their children).

An estate freeze is typically structured such that the parent retains control of the private corporation by exchanging, on a tax-deferred basis, their common shares of the corporation for voting, fixed value, redeemable and retractable preference shares, with the newly-issued common shares going to the children or a trust settled for the benefit of the children. The redemption value of the preference shares will be equal to the value of the old common shares at the time of the exchange.

The parent effectively divests themselves of the future growth in the value of the private corporation on a tax-deferred basis. In doing this, the parent is able to limit their potential capital gain upon death to the value at the time the freeze was executed.

Why a “refreeze” transaction?

In some cases, an estate freeze is undertaken at a time when the economy is booming, and the value of a private corporation is high. However, in times of an economic downturn, it may turn out that the value of the frozen corporation has since declined. This could result in situations where the redemption value of the preference shares that were issued on the initial estate freeze are higher than the company’s current market value. Under these circumstances, a “refreeze” transaction could be considered.

Types of “refreeze” transactions

There are a few different methods of implementing a “refreeze” transaction, but the most common method is having the holder of the high value preference shares exchange such shares for new preference shares, which would have a fixed redemption value equal to the currently declined value of the company. This exchange may be done on a tax-deferred basis.

Benefits of a “refreeze” transaction

The following are some of the benefits of implementing a “refreeze” transaction:

• A lower locked-in value will reduce the shareholders’ tax resulting from the deemed disposition that will occur upon their death in the event the company’s value rebounds.
• A lower locked-in value may allow dividends to be paid on other preference or common shares that could be restricted under the circumstances. Most preference shares issued in an estate freeze transaction have what is commonly referred to as a “non-impairment” clause. This clause prevents the payment of dividends on other shares of a corporation if the payment of such a dividend would impair the ability to redeem the “estate freeze” preference shares. The lower value of the new re-freeze preference shares may now allow for the payment of dividends and thus potentially improve income splitting opportunities. Any income splitting through corporate structures would be subject to the tax on split income (TOSI) rules.
• A lower locked-in value prior to the holder’s death may avoid issues with the Canada Revenue Agency (CRA) challenging the fair market value of the company upon an audit of the deceased’s terminal income tax return.  The “refreezing” effectively resets the redemption value of the preference shares. This lower redemption amount will be set by a directors’ resolution confirming the value and new redemption amount.

Providing the CRA with a copy of a bona fide directors’ resolution is more advantageous than trying to argue with them that the market value at time of death is below the documented redemption value of the preference shares. The CRA will likely presume that the original redemption amount is equal to the current value of such shares and assess a higher tax balance. Undertaking a refreeze transaction may allow the deceased estate’s executors and advisors to avoid such conflicts with the CRA.

• Similar to avoiding conflicts with the CRA, refreezing to a lower value prior to a marital breakdown may reduce any net equalization payments and avoid the additional aggravation in trying to refute that the original redemption amount is higher than the shares’ value at the time of the breakdown.

The CRA’s view on refreeze transactions

In the past, the CRA’s view was that if a refreeze transaction was implemented, a benefit to the common or preferred shareholders may result. However, recently in document 2010-0362321C6 dated June 8, 2010, the CRA clarified its administrative policy on whether a shareholder benefit is conferred as a result of an estate refreeze transaction.

In that document, the CRA stated that a benefit is not conferred on the common or preferred shareholders of a corporation that implement an estate refreeze transaction provided that the decrease in value of the corporation is not the result of stripping the company of corporate assets and the value of the new preferred shares is equal to the value of the old preferred shares at the time of the refreeze.

The CRA provided examples of what it views as “corporate asset stripping” and it listed the following two examples:

1. Dividends that would be paid by the corporation on the common shares of its capital stock and that would impair the value of the original freeze’s preferred shares (i.e., contravening the non-impairment clause typically found in the attributes of most preferred shares issued in an estate freeze transaction); and
2. The payment by the corporation of a bonus or salary to the beneficiary of the freeze in connection with a post-freeze asset sale by the corporation, and such a bonus or salary is not commensurate with the value of the services performed and the responsibilities assumed by the beneficiary of the freeze.

Therefore, no benefit should arise where a corporation pays dividends if the dividends paid out do not impair the value of the original freeze preference shares and the corporation has sufficient retained earnings. However, the risk that the CRA assumes the decline in value occurred because of the dividends is higher if the refreeze is carried out shortly after dividends are paid.

The payment of bonuses and salaries should not negatively impact a refreeze transaction undertaken shortly after the payment, provided that such a bonus or salary is commensurate with the value of the services performed by the recipient.

Finally, it is highly recommended that any holder of preference shares that have declined in value should engage a Chartered Business Valuator to support such an impairment in the event that the CRA scrutinizes the valuation and attempts to assert that there has been no such decline in value.

The COVID-19 pandemic has resulted in a significant economic downturn that has led to devaluations of many private corporations. However, this may prove to be an opportunity for some to modify a previously implemented estate freeze and possibly reduce future taxes.

In today’s business and social environment, more and more owner-managers are struggling to keep their businesses alive. Many find it necessary to inject capital, including personal funds, into their companies. These funds might come from mortgaging their home, drawing on personal credit lines, or even friends and family. But investing in a business when there is an increased risk of struggle or failure requires that any investment should be planned with potential future loss in mind. Where such investments are made to private corporations, the investors or owner-managers may be entitled to a special type of loss known as a business investment loss (BIL). A BIL is a type of capital loss with one important advantage.

Advantage to claiming a BIL

Unlike regular capital losses, which may only be applied against capital gains, a BIL may be applied against any source of income. The deductible portion, which is equal to 50 per cent of the loss, is called an allowable business investment loss (ABIL). If the loss exceeds other sources of income for the current year, the remainder becomes a non-capital loss for that year, and may be carried back three years and carried forward ten years. If it cannot be deducted within that time frame, it becomes a net capital loss and may be applied against future taxable capital gains.

When does a loss become a BIL?

A BIL occurs when a taxpayer disposes (or is deemed to dispose) of either of the following types of qualifying property:

• debt owed by a small business corporation (SBC)¹; or
• shares of an SBC.

BIL – actual disposition

A BIL includes a capital loss from a disposition to an arm’s-length person of:

• a share of the capital stock of an SBC; or
• debt in a Canadian-controlled private corporation (CCPC) that is¹:
• an SBC;
• bankrupt and that was an SBC at the time it became bankrupt; or
• a corporation that was insolvent and an SBC at the time a winding-up order was made in respect of the corporation.

Generally, an SBC is a CCPC in that all or substantially all of the fair market value of its assets is attributable to assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation connected to it, or debt or shares in other SBCs. The Canada Revenue Agency interprets “all or substantially all” as usually meaning 90 per cent or more. Although these criteria can be met at the time of the disposition of the shares or debt of the corporation, the corporation can also qualify as an SBC if it meets the criteria at any time in the 12 months preceding the disposition of the shares or debt.

A BIL can also occur when a taxpayer is required to repay a debt of a corporation resulting from a guarantee made by the taxpayer. The loss will qualify as a BIL only where the lender was an arm’s-length party and the corporation was an SBC both at the time the debt was initially incurred and at any time during the 12 months before an amount first becomes payable under the guarantee.

BIL – deemed disposition

In addition, a loss on a “deemed disposition” of the debt or shares, does not require an arm’s length party in order to qualify as a BIL. As long as a taxpayer makes a prescribed election in their tax return, a deemed disposition will occur in respect of:

• a debt owing to the taxpayer at the end of a taxation year that is established to be a “bad debt” (it is wholly uncollectable) in the year; or
• a share in a corporation owned at the end of the year, where:
• the corporation has become bankrupt during the year;
• the corporation is insolvent and a winding-up order has been made in the year; or
• the corporation is insolvent, neither the corporation nor a corporation controlled by it carries on business, the fair market value of the share is nil, and it is reasonable to expect that the corporation will be dissolved or wound up and will not carry on business again.

When a taxpayer makes this election, there will be a deemed disposition of the qualifying property for $nil proceeds, which will result in a capital loss on the share or debt, leading to the BIL.

ABIL – reduced by previous capital gains exemption claimed

The amount of an individual’s ABIL is reduced to the extent that the individual previously claimed the capital gains exemption. That exemption allows an individual to receive tax-free capital gains of up to $883,384 for 2020 ($441,692 for taxable capital gains) during their lifetime from disposition of certain types of property, such as qualified SBC shares.

The reduced BIL remains a capital loss, one-half of which is an allowable capital loss that may be deducted against taxable capital gains.

Procedure for claiming a BIL

BILs must be recorded on a taxpayer’s income tax return for the taxation year in which the business ceased active operations. In addition, for a deemed disposition to occur, the taxpayer must file an election stating that the taxpayer wants the deemed disposition rules to apply. The election should be filed with the income tax return on time to avoid relying on the Minister’s discretion to accept a late-filed election. Be careful not to wait too long when deciding whether to file the election. The election deems the loss to have occurred at the end of the claimant’s taxation year; if the business ceased active operations more than 12 months prior to that deemed date, the BIL will be denied.

The CRA tends to audit BILs regularly. It is thus important to maintain proper supporting documentation. A BIL requires that the loan be made for the purposes of earning income. One way to ensure this requirement has been met is to charge an appropriate rate of interest on the loan. It is prudent to have that stipulation documented in writing in a loan agreement or other contract, along with supporting documentation showing the actual cash advance.

In a press conference today, Minister Morneau announced details of the new Canada Emergency Wage Subsidy (CEWS). The announcement by Minister Morneau, followed by details from Department of Finance, provides some important information about this new wage subsidy program.

The 75 per cent wage subsidy will be available to qualifying businesses for a twelve-week period, March 15, 2020 to June 6, 2020, and is intended to support employers who have experienced a decrease in gross revenues of at least 30 per cent in March, April or May of 2020 (compared to the same period in 2019). The CEWS will be retroactive to March 15, 2020. Employers will be required to attest to the decrease in revenue and maintain records demonstrating this decline.

Employers can be structured as sole proprietors, taxable corporations, partnerships, non-profit organizations or charities. Public sector entities such as municipalities, local governments, Crown corporations, public universities, colleges, schools and hospitals are excluded from this program.

For the purpose of the subsidy, revenue will be defined as earnings from arm’s length sources for business carried on in Canada based on the business’ normal accounting methods (with some exclusions).

There is no overall limit on the subsidy amount an eligible employer may claim. The subsidy is based on eligible remuneration paid between March 15, 2020 and June 6, 2020, and is equal to the greater of A and B, where:

• A equals 75 per cent of the amount of remuneration paid, up to a maximum benefit of $847 per employee per week; and
• B is the lesser of C and D:
• C is the amount of remuneration paid, up to a maximum of $847 per employee, per week: and
• D is 75 per cent of the employee’s “pre-crisis” weekly remuneration.

Eligible wages will include the amounts employers would normally use to calculate payroll remittances, but will not include things like severance pay, stock option benefits or automobile benefits. Further guidance on “pre-crisis” weekly remuneration used in the above formula will be provided in the coming days by the Department of Finance. A special rule will apply to employers that do not deal at arm’s length with an employee to restrict the amount of the subsidy and prevent sudden, arbitrary increases in remuneration during the twelve-week period.

Currently, employers are encouraged – not required – to make the 25 per cent top-up for employees to bring their salaries to 100 per cent of normal salaries. Employers may be required to repay all or a portion of the subsidy if they do not meet eligibility requirements. Penalties, fines or even imprisonment may also apply in cases of fraudulent claims.

Application will be through CRA’s online My Business Account portal with a web-based application process being developed over the next three to six weeks.

It is important to note organizations who do not meet the eligibility criteria for the CEWS may still qualify for the previously announced 10 per cent wage subsidy (on wages paid March 18, 2020 to June 20, 2020, to a maximum of $1,375 per employee and $25,000 per employer).

Note that the CEWS will not be available to employers for amounts paid to an employee during a week from one of the four-week periods for which the employee is also eligible for the Canadian Emergency Response Benefit (CERB). Where employers are not eligible for the CEWS and have laid off employees, the employee will still qualify for the CERB of up to $2,000 a month (provided they meet all eligibility criteria).

As expected, the information contained in today’s announcement will require legislative approval and is therefore subject to change.

As part of the Government of Canada’s response and commitment to supporting businesses during the COVID-19 pandemic, a Temporary Wage Subsidy for employers (lasting a period of three months) was announced on March 18, 2020.  The details of this subsidy have now been released, but they are subject to legislation being passed by the government in the coming days.

The Temporary Wage Subsidy for Employers is a three-month measure that will allow eligible employers to reduce the amount of payroll deductions required to be remitted to the Canada Revenue Agency (CRA).

You are an eligible employer if you:

• are a non-profit organization, registered charity or a Canadian-controlled private corporation (CCPC);
• have an existing business number and payroll program account with the CRA on March 18, 2020; and
• pay salary, wages, bonuses or other remuneration to an employee.

CCPCs are only eligible for the subsidy if their taxable capital employed in Canada for the preceding taxation year – calculated on an associated group basis – is less than $15 million.

How much is the subsidy?

The subsidy is equal to 10 per cent of the remuneration you pay between March 18, 2020 and June 20, 2020, up to $1,375 per employee and to a maximum of $25,000 total per employer.

Associated CCPCs will not be required to share the maximum subsidy of $25,000 per employer. For example, if you have five employees, the maximum subsidy you can receive is $6,875 ($1,375 x five employees), even though the per employer maximum is $25,000.

The subsidy must be calculated manually. For example, if you have five employees earning monthly salaries of $4,100 for a total monthly payroll of $20,500, the subsidy would be 10 per cent of $20,500 or $2,050.

How do you receive the subsidy?

Once the subsidy is calculated, the employer can reduce their current remittance of federal, provincial or territorial income tax that is sent to the CRA by the amount of the subsidy.

Important: The employer is not permitted to reduce the remittance of Canada Pension Plan contributions or Employment Insurance premiums.

This Temporary Wage Subsidy for Employers allows eligible employers to reduce remittances made to the CRA only. Remittances made to Revenue Quebec are not eligible for the wage subsidy. For example, if the subsidy is calculated at $2,050, the employer would reduce the current remittance of federal, provincial or territorial income tax by $2,050. They would continue reducing future income tax remittances (up to the maximum of $25,000) for all remuneration paid before June 20, 2020.

What is the applicable time frame?

Employers can start reducing remittances of federal, provincial or territorial income tax in the first remittance period that includes remuneration paid between March 18, 2020 and June 20, 2020. For example, if you are a regular remitter, you can reduce your remittance that is due to the CRA on April 15, 2020.

What happens if subsidies exceed the remittance?

If the income taxes you deduct are not sufficient to offset the value of the subsidy in a specific period, the employer can reduce future remittances to benefit from the subsidy. This includes reducing remittances that may fall outside of the application period for the wage subsidy (after June 20, 2020).

For example, if the employer calculates a subsidy of $2,050 on remuneration paid between March 18, 2020 and June 20, 2020, but only deducted $1,050 of federal, provincial or territorial income tax from his or her employees, the employer can reduce a future income tax remittance by $1,000, even if that remittance is in respect to remuneration paid after June 20, 2020.

The employer will continue deducting income tax, Canada Pension Plan contributions and Employment Insurance premiums from salary, wages, bonuses or other remuneration paid to the employees, as they would normally do. The subsidy is only calculated when the employer remits these amounts to the CRA.

What if the reduction is not taken during the year?

If an eligible employer chooses not to reduce their payroll remittances during the year, the employer can calculate the temporary wage subsidy on remuneration paid between March 18, 2020 and June 20, 2020. They can either choose to ask for the subsidy to be paid at the end of the year or request that it be transferred to the next year’s remittance.

Necessary books and records

An eligible employer will need to keep information to support their subsidy calculation. The required documentation would include:

• the total remuneration paid between March 18, 2020 and June 20, 2020;
• the federal, provincial or territorial income tax that was deducted from that remuneration; and
• the number of employees paid in that period.

The CRA is currently updating the reporting requirements. More information on how to report this subsidy will be released in the near future.

The subsidy will have to be reported as taxable income to the employer in the year in which the subsidy is received.

Unfortunately, if the eligible employer does not pay salary, wages, bonuses or other remuneration to an employee between March 18, 2020 and June 20, 2020, they cannot receive the subsidy, even if they are an eligible employer. This means CCPCs remunerating their shareholders exclusively through dividends would not be factored into the subsidy calculation.

The information provided by the CRA and reported in this Tax Alert is subject to change.