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Tax Expenditures 1999: 5-1
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Chapter 5 - Description of Corporate Income Tax Provisions
The descriptions of the specific tax measures contained in this chapter are intended as a simplified reference and are not detailed descriptions of specific tax measures.
Many of the estimates and projections are provided using the corporate income tax micro-simulation model, which has been developed jointly with Revenue Canada.
Tax Rate Reductions
The following items are measures that reduce the statutory tax rate faced by a corporation. They are considered to be tax expenditures because income is taxed at a rate other than the generally applicable tax rate.
Low tax rate for small businesses
Corporations that are Canadian-controlled private corporations (CCPCs) are eligible for a small business tax rate reduction, known as the small business deduction. This deduction lowers the basic federal tax rate on the first $200,000 of active business income of CCPCs by 16 percentage points – from 28 per cent to 12 per cent.
Effective July 1, 1994, CCPCs with more than $15 million of taxable capital employed in Canada are no longer eligible for this rate reduction. In addition, CCPCs with between $10 million and $15 million of taxable capital employed in Canada have reduced access to the small business deduction.
Low tax rate for manufacturing and processing
Canadian manufacturing and processing income not eligible for the small business deduction is subject to a reduced tax rate, known as the manufacturing and processing profits deduction. This deduction lowers the basic federal tax rate on eligible income earned after 1993 by 7 percentage points – from 28 per cent to 21 per cent.
For 1993, the deduction lowered the basic federal tax rate on eligible income by 6 percentage points – from 28 per cent to 22 per cent.
The 1999 budget proposed a phased-in extension of the manufacturing and processing profits deduction to corporations that produce electrical energy or steam for sale.
Low tax rate for credit unions
Although not a private corporation for most purposes, a credit union is eligible for the small business deduction (i.e. 16 per cent of its taxable income). A credit union with more than $200,000 of active business income may be eligible for a deduction of 16 per cent of its taxable income where the total income of the corporation since 1971 is less than the corporation's "maximum cumulative reserve," which is equal to 5 per cent of amounts owing to members (including members' deposits and share capital). The purpose of this tax concession is to permit a credit union to accumulate capital on a tax-preferred basis up to a maximum of 5 per cent of deposits and capital.
Exemption from branch tax for transportation, communications, banking and iron ore mining corporations
The branch tax is imposed on that portion of the income of non-resident corporations derived from the carrying on of business in Canada through a branch. If a Canadian branch has ceased active business operations, non-residents are liable for tax on capital gains on dispositions of taxable Canadian property. The rate is 25 per cent, but is frequently reduced by bilateral tax treaties to 15 per cent, 10 per cent or 5 per cent.
A corporation is exempt from the branch tax if it is:
- a bank;
- a corporation whose principal business is:
– the transportation of persons or goods,
– communications, or
– mining iron ore in Canada; or - an exempt corporation such as a registered charity.
Legislation will be introduced in Parliament to make foreign bank branches subject to the branch tax effective in 1999.
No data are available.
Exemption from tax for international banking centres
A prescribed financial institution's branch or office carrying on certain business in the cities of Montreal or Vancouver may qualify as an international banking centre (IBC) and therefore be exempt from tax on its income. To qualify as an IBC under the Income Tax Act, the branch's income must be derived from accepting deposits and making loans to non-residents. This measure, introduced in 1987, is considered a tax expenditure because a financial institution can undertake business with non-residents through a Canadian permanent establishment without being subject to Canadian income taxes.
No data are available.
Tax Credits
Investment tax credits
The following measures are credits against federal income taxes otherwise payable. They are considered to be tax expenditures because they provide incentives to taxpayers which invest in certain activities, such as scientific research and experimental development (SR&ED), or in certain capital assets in designated regions of the country.
The amount of an investment tax credit (ITC) is calculated as a percentage of the cost of eligible expenditures. ITCs can reduce federal income tax revenues in one of two ways. They may be:
- used to offset federal income taxes otherwise payable; or
- fully or partially refunded in the year they are incurred in the case of smaller Canadian-controlled private corporations (CCPCs).
Prior to 1994, there was a limitation on the amount of ITCs that could be utilized in a taxation year. Specifically, in most cases, ITCs could only be used to offset up to 75 per cent of a taxpayer's federal income tax and surtax otherwise payable. For CCPCs, a special rule permitted the full offset of federal tax on their business income eligible for the small business deduction. The annual ITC limitation had been introduced to reduce the number of large corporations that were profitable but did not pay income tax. However, as announced in the 1993 budget, the introduction of the large corporations tax eliminated the need for the annual ITC limitation and investment tax credits became fully deductible for all taxpayers for taxation years beginning after 1993.
Certain ITCs earned in a year may be refunded to individuals and qualifying corporations that cannot use them to reduce federal income taxes otherwise payable. The rate of refundability for these ITCs is generally 40 per cent. However, a qualifying CCPC may receive a refund of 100 per cent on SR&ED ITCs earned at the 35-per-cent rate in respect of up to $2 million of eligible current expenditures.
Prior to 1994, a qualifying corporation for the purposes of the refund was generally a CCPC with taxable income not exceeding $200,000 in the preceding year. However, the 1993 budget modified this rule in the case of the SR&ED ITC so that, after 1993, refundability phases out as the prior-year taxable income of a CCPC (or associated corporate group) rises above $200,000 and is eliminated entirely at $400,000. This change was made to reduce the negative consequences of exceeding the $200,000 limit by even a small amount. The change eases the transition between the start-up phase and the period of expansion that small businesses typically experience and provides more certainty to their business planning. In order to focus ITC benefits on smaller CCPCs, the 1994 budget introduced a further change to phase out refundability after 1995 for CCPCs with taxable capital employed in Canada exceeding $10 million and to fully eliminate refundability for CCPCs with taxable capital employed in Canada exceeding $15 million.
All refunds reduce the amount of ITC for carry-over purposes. Unused ITCs may be carried forward 10 years or back 3 years.
ITCs utilized or refunded in a year reduce either the undepreciated capital cost of the asset for capital cost allowance purposes or, in the case of SR&ED, the SR&ED pool. Credits earned in respect of a property acquired after 1989 and not immediately available for use may not become claimable or refundable until the property is available for use or has been held by the taxpayer for 2 years.
Issues in calculating the value of ITCs
To maintain consistency with the other estimates in this document, the amounts reported in the table estimate the forgone revenue for the year in question from each ITC. In other words, the estimates show how much additional revenue would have been collected by the government in the year if the ITC had been eliminated in that particular year. To do this, the amount of ITCs used in the year are separated into two components: ITCs that were both earned and used in the year, and ITCs that were earned in prior years but were carried forward and used in the year. The former represents credits in respect of current year expenditures. The costs of any applicable refunds of ITCs earned are included in these estimates. The latter item – ITCs earned in past years but not used until the current year – is itemized separately as an aggregate for all ITCs.
Another perspective on the revenue cost of each ITC may be obtained by looking at the amount of ITCs earned in a specific year. This information is provided in the following table for 1994 and 1995. However, it should be recognized that ITCs earned in the year are not necessarily used in the year – they may be used in a subsequent or previous year, subject to the carry-over rules. As a result, had the ITCs been eliminated, government revenues for the year would not have been higher by the amounts shown in the following table since it may take a number of years for ITCs earned in a year to be used by the taxpayer to reduce federal taxes.
| Investment tax credits earned in the year | ||
|---|---|---|
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| 19941 | 1995 | |
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| ($ millions) | ||
| SR&ED ITC | 1,563 | 1,596 |
| Atlantic ITC | 151 | 259 |
| Special ITC | 119 | 56 |
| Small business ITC | 203 | 0 |
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1
These 1994 figures are based on final data and may differ from the figures in last year's edition of this document, which were based on preliminary data.SR&ED investment tax credit
There were three rates of SR&ED ITC prior to 1995: a general rate of 20 per cent; an enhanced rate of 35 per cent for CCPCs with prior-year taxable income of less than $200,000; and a rate of 30 per cent for the Atlantic provinces and the Gaspé region. The latter rate was eliminated in the 1994 budget effective after 1994. The maximum amount of SR&ED expenditures that can earn ITCs at the 35-per-cent rate in a year is $2 million.
The SR&ED ITC is earned on eligible current and capital expenditures in respect of SR&ED in Canada performed by, or on behalf of, a taxpayer and related to a business of the taxpayer.
Atlantic investment tax credit
Prior to 1995, the Atlantic investment tax credit (AITC) was available at a rate of 15 per cent in respect of eligible expenditures in the Atlantic region – i.e. Newfoundland, New Brunswick, Nova Scotia, Prince Edward Island, the Gaspé region and their associated offshore areas. The 1994 budget reduced the AITC rate to 10 per cent for eligible expenditures incurred after 1994.
The AITC is earned on eligible expenditures on new buildings, machinery and equipment employed in the following qualifying activities: farming, fishing, logging, mining, oil and gas, and manufacturing and processing.
The AITC is refundable at a rate of 40 per cent for qualifying CCPCs and individuals.
Special investment tax credit
Prior to 1995, the special investment tax credit (SITC) was provided at a rate of 30 per cent for eligible expenditures on new buildings, machinery and equipment used in qualifying activities in qualifying regions of Canada. The SITC was eliminated in the 1994 budget, effective January 1, 1995. However, certain activities in the Atlantic region continue to be eligible for the AITC.
Qualifying activities were defined under the Regional Development Incentives Act and its regulations, and generally included manufacturing and processing facilities located in a qualifying region with the exception of certain primary processing of natural resources.
Qualifying regions included northeastern British Columbia, northwestern Alberta, northern Saskatchewan, most of Manitoba, northern Ontario, northern Quebec and the Gaspé region, and areas of Atlantic Canada.
Small business investment tax credit
The small business investment tax credit was available at a rate of 10 per cent for eligible expenditures on machinery and equipment acquired after December 2, 1992 and before 1994 by unincorporated businesses, partnerships and CCPCs, other than those subject to the large corporations tax. The credit was not refundable.
ITCs claimed in current year but earned in prior years
These are tax credits that were earned by corporations in previous years but not claimed until the current year. There is a revenue cost to the government when the credits are used by corporations to reduce federal taxes payable. While the aggregate amount of these credits is known with some confidence, there is not enough information available to identify separately the amounts for each credit.
Political contribution tax credit
A non-refundable tax credit is available for contributions to registered federal political parties or candidates. The credit is earned at a rate of 75 per cent on the first $100 contributed, 50 per cent on the next $450 contributed and 33 1/3 per cent on the next $600 contributed. The maximum credit is $500 and is available when the taxpayer has contributed $1,150.
This measure constitutes a tax expenditure because political contributions are not incurred to earn income.
Canadian film or video production tax credit
The Canadian film or video production tax credit was introduced in the 1995 budget for certified Canadian film productions produced by qualified corporations. It provides a refundable investment tax credit of 25 per cent of the cost of eligible salaries and wages expended after 1994, except where the financing of the film is eligible for transitional relief from the termination of the capital cost allowance (CCA) film incentive. Eligible salaries and wages are limited to 48 per cent of the cost of production, so that the credit provides assistance of up to 12 per cent of the cost of the production. Canadian film or video productions are certified by the Minister of Canadian Heritage.
This tax credit was intended to retarget government assistance available to Canadian film productions in order to maximize the benefit to such productions. It replaced a tax shelter of accelerated CCA deductions used principally by higher-income individuals, with a refundable tax credit for eligible films produced by qualified taxable Canadian corporations.
Film or video production services tax credit
The production services tax credit applies to film or video production services that are provided in Canada for films that do not have sufficient Canadian content to qualify for the Canadian film or video production tax credit. It is a refundable credit of 11 per cent of salaries and wages paid to Canadian residents for services performed in Canada after October 31, 1997. The Canadian Audio-Visual Certification Office of Canadian Heritage provides certificates of eligibility.
The tax credit is designed to provide economic development assistance to film and video productions produced in Canada and to enhance Canada as a location of choice for film and video productions. It was designed to retarget government assistance by making the benefit available directly to the production services provider. Previously, this assistance was provided through syndicated tax shelters for such productions.
Exemptions and Deductions
The following exemptions and deductions are considered tax expenditures because they deviate from the benchmark tax system.
Partial inclusion of capital gains
Three-quarters of net realized capital gains are included in income. The amount of the tax expenditure is the additional tax that would have been collected had the remaining one-quarter of the capital gains been included in income. However, this amount is likely an overestimate of the true amount of this tax expenditure. To the extent that the capital gains are from shares that have increased in value due to retained earnings, and which have already been taxed at the corporate level, the partial inclusion of the capital gains provides some relief from double taxation and, therefore, should be part of the benchmark tax system.
The 1997 budget reduced the inclusion rate on capital gains arising from certain donations to charities (other than private charitable foundations) from 75 per cent to 372 per cent. Donations eligible are those of securities that are listed publicly on a recognized stock exchange in Canada, where the donation is made between February 18, 1997 and the end of the year 2001.
Royalties and mining taxes
Non-deductibility of Crown royalties and mining taxes
The current tax system does not permit a deduction for Crown royalties or mining taxes. The deduction has been denied since May 6, 1974. From that time to the end of 1975, oil and gas and mining companies were eligible for a resource tax abatement, which provided a lower rate of tax on oil and gas and mining income. A resource allowance (discussed below) was introduced in the June 1975 budget and replaced the resource tax abatement after 1975.
A negative tax expenditure is calculated for the non-deductibility of Crown royalties and mining taxes. A negative tax expenditure implies that the government collects more income taxes than would have otherwise occurred in the benchmark system. The issue arises as to whether the benchmark tax system would include a deduction for all Crown royalties and mining taxes. Two generic types of non-deductible Crown charges are levied on the extraction of natural resources. One type is a simple royalty system where the Crown charge is based only on gross revenues. There are also more complex systems of Crown charges that are based on net resource profits – i.e. resource profits after the deduction of numerous costs, including capital, operating costs and sometimes a return on capital employed.
In the case of Crown charges based on gross revenues, the benchmark system would include a deduction for these royalties since they are analogous to costs of production. However, the benchmark tax system would not include a deduction for the latter type of profit-related Crown royalties and mining taxes because they are structured more like income taxes. Provincial income taxes are not considered to be a deductible expense in the benchmark system. Provincial payroll and capital taxes, on the other hand, are deductible and they are not treated as tax expenditures.
The calculations shown in this report represent the federal corporate income tax revenues generated by the current rules which deny the deductibility of all Crown royalties and mining taxes. No attempt has been made to divide the disallowed royalties into the two categories described above. This is in part due to the fact that many royalty systems include characteristics of both a gross and net calculation. Thus, the calculation represents an overestimate of the actual negative tax expenditure.
Resource allowance
Since 1976, the income tax system has provided a resource allowance deduction equal to 25 per cent of a taxpayer's annual resource profits, computed after operating costs and capital cost allowances, but before the deduction of exploration expenses, development expenses, earned depletion and interest expenses. These latter expenses were excluded from the resource profit calculation primarily to encourage companies to undertake exploration and development activities in Canada. The resource allowance is provided in lieu of the deductibility of Crown royalties, mining taxes and other charges related to oil and gas or mining production. The measure allows the provinces room to impose royalties or mining taxes on the production of natural resources while maintaining the federal income tax base. For analytical purposes, the value of the tax expenditure for the royalties and mining taxes is broken down into two components:
- the federal tax revenue earned by disallowing royalty deductibility (a negative tax expenditure, described above); and
- the federal tax revenue forgone resulting from the resource allowance deduction (a positive tax expenditure).
An approximation of the overall impact of the resource allowance measure (compared to the benchmark tax system) can be obtained by netting the two above effects.
Earned depletion
Earned depletion is an additional deduction from taxable income of certain exploration and development expenditures and other resource investments. Prior to 1990, taxpayers were entitled to earn an extra deduction of up to 33 1/3 per cent of most exploration and development expenses or the costs of assets related to new mines or major expansions. The deductions for earned depletion are generally limited to 25 per cent of the taxpayer's annual resource profits, although mining exploration depletion can be deducted against non-resource income. As in the case of a Canadian exploration expense or a Canadian development expense, earned depletion could be pooled (i.e. placed in a special account, and any remaining balance could be carried forward indefinitely for use in later years).
Additions to the depletion pools for earned depletion and mining exploration depletion were eliminated as of January 1, 1990. Deductions can still be made on the basis of existing depletion pools.
Under the benchmark tax system, a deduction for earned depletion would not be available.
Deductibility of charitable donations
Donations made by corporations to registered charities are deductible in computing taxable income within certain limits. Unused deductions may be carried forward for up to five years.
For years prior to 1996, this deduction was limited to 20 per cent of net income. The 1996 budget announced that the deduction limit would be raised to 50 per cent of net income plus 50 per cent of taxable capital gains resulting from the donation of property. The 1997 budget announced a further increase in the limit to 75 per cent of net income plus 25 per cent of the amount of taxable capital gains arising from the donation of appreciated capital property and 25 per cent of any capital cost allowance recapture arising from the donation of depreciable capital property.
This deduction would not be permitted under the benchmark tax system because these expenditures are not incurred to earn income.
Deductibility of gifts to the Crown
Gifts made by corporations to Canada or a province are deductible in computing taxable income within certain limits. Unused deductions may be carried forward for up to five years.
Prior to 1997 the amount deductible was limited only to the amount of income in a particular year. The 1997 budget restricted the deductible amount to 75 per cent of net income plus 25 per cent of the amount of taxable capital gains arising from the donation of appreciated capital property and 25 per cent of any capital cost allowance recapture arising from the donation of depreciable capital property. The limit would not apply to gifts of ecologically sensitive land and certain gifts of cultural property.
This deduction would not be permitted under the benchmark tax system because these expenditures are not incurred to earn income.
Interest on small business financing loans
Small businesses in financial difficulty are able to treat interest paid on small business financing (SBF) loans entered into between February 25, 1992 and the end of 1994 as a non-deductible payment, and SBF lenders are permitted to treat the interest received as a dividend – resulting in such interest being non-taxable to corporate lenders and individual lenders being eligible for a dividend tax credit. This tax treatment permitted lenders to reduce the interest charges to such small businesses while maintaining their after-tax rates of return.
Non-deductibility of advertising expenses in foreign media
Expenses for advertising in non-Canadian newspapers or periodicals or on non-Canadian broadcast media cannot generally be deducted for income tax purposes if they are directed primarily to a market in Canada. Deducting the cost of advertising in foreign periodicals or on television stations is not restricted if the advertising is to promote sales in foreign markets.
This treatment results in a negative tax expenditure since the deduction of an expense incurred to earn income is denied. Under the benchmark tax system, advertising expenses in foreign media incurred to gain or produce income from a business or property would be deductible whether targeted at foreign or domestic markets.
No data are available.
Non-taxation of provincial assistance for venture investments in small business
Government assistance received by a corporation is normally either included in the corporation's income or reduces the cost basis of the assets to which the assistance relates for capital cost allowance purposes. There are a number of exceptions to this rule, including provincial assistance provided for venture capital investment under specified provincial programs. Under the benchmark tax system, this type of assistance would be included in the corporation's income or would reduce the cost basis of the related assets.
No data are available.
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