The 2013 federal budget was delivered by Finance Minister Jim Flaherty just over two weeks ago. Usually we like to get something out that summarizes the budget very quickly, but in this case there were some directives in the budget that we required some clarification on before posting our thoughts. In a budget that has been labeled as a rebranded version of 2012’s budget, it was actually far from that as far as we were concerned. A few measures were included in the 2013 budget that actually have an impact on our clients in ways that past budgets have not (since the closing of income trusts).

I’ve highlighted some of the budget initiatives below but, since you have probably received plenty of information on the budget since it was delivered, I will not focus too heavily on each individual item. The focus for this will be the two items that have the greatest impact on investments in Canada. My comments on theses are italicized below:

• Small business owners will benefit from a $50,000 increase in the Lifetime Capital Gains Exemption to $800,000 effective 2014. The exemption will be indexed to inflation after 2014.
• Manufacturing companies get help from a two-year extension of the accelerated capital cost allowance for machinery and equipment. This line item lets business owners write down capital costs more quickly and reap tax advantages from equipment purchases before those goods begin to depreciate.
• Businesses owners needing to train employees will be able to take advantage of the Canada Job Grant, which will provide up to $15,000 per person for skills training.
• Philanthropy gets a boost from a Donor Super Credit which complements the existing Charitable Donations Tax Credit with an additional 25% credit for first-time donors. The existing federal charitable tax credit system provides a 15% credit on the first $200 of donations, and a 29% credit above the $200 level. The super credit adds 25% to each of those credit rates up to $1,000.
• Criticism about the over generous nature of the dividend tax credit system has led to a reduction of the gross-up factor applicable to non-eligible dividends from 18% to 25%, and the corresponding dividend tax credit to 13/18ths of the gross-up amount, from the current 2/3. (I would recommend that you discuss this item with your accountant if you are using a dividend strategy to be paid from your Opco)
• The budget will give CRA new tools to reduce international tax evasion and aggressive tax avoidance, including a new Stop International Tax Evasion Program.
• The government will close another loophole with measures ensuring derivative transactions can’t be used to convert fully taxable ordinary income into capital gains, which are taxed at a lower rate.
  • This is one of the more important items that came from the recent budget. It’s also the primary reason we have not sent out an update on the budget until now.  Initially there was a lack of clarity on what this meant to, in particular, the mutual fund industry. After much consideration by a number of legal and tax teams, the verdict does seem to be in. On a go forward basis, after the 180 day grace period, mutual structures will no longer be able to convert interest income into capital gains through the use of a forward contract. 
  • This does not mean that the corporate class structure (which we use in portfolios to shelter and defer income) is finished. In fact it is quite the opposite. This is still a very vibrant vehicle for individuals and corporation to shelter income on a go forward basis. The only difference going forward is that corporate class funds will have to go back to their roots, balancing the interest income generated with the overall expenses of the corporate class venture such that no interest income is trapped at the corporate level.
  • This move by the Feds has caused many fixed income (bond funds) to close to new purchases immediately based on the final interpretations of their tax and legal teams.  This is especially the case for corporate class funds that have recently been created at a time where demand for fixed income has far outweighed that of equities.
  • Fortunately, for us at Foundation PWM, we have been using long standing corporate class structures that will not be impacted in significant way from this change. Specifically, one of our primary fixed income positions with Russell Investments will remain open to new investment until the end of next week and actually has a long term contract that will allow them to continue to convert interest income to capital gains until 2016.
• Another rule change will eliminate unintended tax benefits relating to leveraged insured annuities and leveraged life insurance arrangements, commonly known as 10/8 arrangements.
  • This was another change that we thought, initially after reading the budget, could potentially affect our clients by reducing the capital dividend account created from the proceeds of life insurance paid to a corporation.
  • Since it was only the 10/8 structure under attack by the Feds, our clients will not be affected. Instead of the 10/8 structure, which hinges on the use of a contrived interest rate to be implemented, we’ve recommended a more conservative structure is still viable going forward.

As always, if you would like to discuss any of the changes to the budget with us further, please contact us anytime. 

In a general sense, we are disappointed with this budget as we feel it was an attack on several savings vehicles that are available to small business owners, like ourselves and many of our clients, in an effort to grab revenue.