Source: https://www.canada.ca/en/department-finance/services/publications/federal-tax-expenditures/2020/part-1.html
Timestamp: 2020-07-08 23:21:04
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Report on Federal Tax Expenditures - Concepts, Estimates and Evaluations 2020: part 1 - Canada.ca
Report on Federal Tax Expenditures - Concepts, Estimates and Evaluations 2020: Table of Contents
Report on Federal Tax Expenditures - Concepts, Estimates and Evaluations 2020: part 1
This report is intended to facilitate analysis of the tax expenditures and indicate their role within the tax system. Information provided includes a description of each measure and of its objectives, cost estimates and projections (for 2014 to 2021 in this year’s report), legal references, historical information, as well as references to key federal government spending programs that are relevant to the policy area of tax expenditure to better inform Canadians and Parliamentarians about related programs. The report will continue to be updated every year, providing a convenient, easily accessible point of reference for information on federal tax expenditures.
Evaluations and analytical papers addressing specific tax measures or aspects of the tax system are published every year as part of this report. This year’s edition includes a profile of trusts as taxfilers and taxpayers, a profile of the beneficiaries of the Refundable Medical Expense Supplement, and a Gender-based Analysis Plus (GBA+) of tax expenditures with a family component.
Also, as part of the Government’s efforts to enhance the reporting on federal tax expenditures, this edition identifies for the first time the income tax expenditures that are available to trusts and provides new estimates of the value of trust tax expenditures when the necessary data is available. Additional information on trust tax expenditures and their estimation can be found in Part 1 of the report.
Part 2 presents the estimates of the fiscal cost of federal tax expenditures for the years 2014 to 2021 and describes changes that have been made to tax expenditures since the last edition.
Part 4 presents a profile of trusts as taxfilers and taxpayers, a profile of the beneficiaries of the Refundable Medical Expense Supplement, and a GBA+ of tax expenditures with a family component.
Part 1 - Tax Expenditures and the Benchmark Tax System:
Concepts and Estimation Methodologies
The benchmark unit of taxation for the personal income tax is the individual or trust, while the benchmark unit of taxation for the corporate income tax is the single corporation as a separate legal entity.[2]
The possibility for income earned by a trust to flow through to a beneficiary without attracting tax at the trust level is considered to be part of the benchmark income tax system.
The benchmark taxation period is the calendar year for individuals and trusts and the fiscal period for corporations.[3] Income is taxed as earned, on an accrual basis.
The possibility for certain trusts and estates to have non-calendar taxation years is considered to be part of the benchmark tax system.
The benchmark personal and corporate income tax base comprises income from most sources, including income from employment, pension income, profits from a business and from investment, capital gains, and government transfers.[4] However, the following are considered not to be income subject to tax under the benchmark tax system:
The benchmark personal income tax rate and bracket structure is the rate and bracket structure as it exists at any given time. The credit for the Basic Personal Amount is viewed as being part of the existing rate structure, because this credit is universal in its application and effectively provides a zero rate of tax up to an initial level of income. The taxation of most trusts at the top personal income tax rate is intended to limit the use of trusts for tax planning, and is therefore considered to be part of the benchmark.
The benchmark corporate income tax rate is the statutory general corporate income tax rate in effect at any given time.[5]
Relief from double taxation in the international context is provided in Canada in respect of income from foreign sources earned by Canadians and Canadian corporations.[6]
Non-resident withholding tax is imposed on payments to non-residents at the statutory rate of 25% or at the general rate provided for the particular type of payments under the applicable treaty.[7]
The benchmark for the GST, as defined for the purpose of this report, has the following characteristics.[8]
The exemption from tax of certain taxpayers. Registered charities and non-profit organizations are exempt from income tax.
The exemption from income tax of certain items of income or gains. Capital gains realized on certain donated assets are not subject to income tax.
The exemption from GST or zero-rating of certain supplies of goods or services.[9] GST is not charged on basic groceries, health services and financial services.
Tax rates that depart from the benchmark tax rates. The income of small incorporated businesses is taxed at a preferential tax rate.
Tax credits, rebates and refunds. A credit can be claimed against income tax payable in respect of above-average medical expenses incurred by individuals.
Provisions that permit the transfer of tax attributes among taxpayers or otherwise extend the unit of taxation. Couples are allowed to split pension income for income tax purposes.
Provisions that permit the deferral of tax or the depreciation of a capital asset faster than its useful life. Taxation of contributions to a Registered Retirement Savings Plan and investment income earned within such a plan is deferred until these amounts are withdrawn from the plan.
Recognition is given for income tax purposes to expenses incurred to earn employment income or income that is not subject to income tax. Employed artists can deduct certain costs related to their employment.
The value of a tax expenditure is calculated by estimating the revenues that the federal government forgoes as a result of the measure. This involves comparing the amount of revenues actually collected with the amount of revenues that would be collected in the absence of the measure, accounting for any changes in income-tested entitlements and assuming all else is unchanged. The method used to derive cost projections, as well as the period over which these projections are to be derived, vary depending on how the cost estimates are obtained. The cost of federal tax expenditures is projected up to 2021; as a result of delays in the availability of data, however, some of the values developed for the historical period are also projections.
The majority of the personal income tax expenditure estimates are calculated using the Department of Finance Canada’s personal income tax micro-simulation model. This edition of the Report on Federal Tax Expenditures marks the first time that the newly enhanced T1 micro-simulation model (base year 2017) is used to complete the estimates of personal income tax expenditures. Among other improvements, the new T1 model references the entire population of taxfilers (about 28 million) provided by the Canada Revenue Agency rather than the stratified sample of approximately 700,000 individual tax returns that was used by the previous model. For this reason, there may be breaks in the series of estimates starting with the 2017 tax year. The micro data used in the T1 model is based on initial assessment data available roughly one year after the close of the respective tax year. Tax expenditure estimates based on the T1 model may be slightly underestimated relative to estimates based on a more mature database, with the degree of underestimation varying by measure.
Each tax expenditure accounts for changes in federal personal income tax as well as changes in income-tested entitlements delivered by the Canada Revenue Agency (e.g., child benefits and the GST/HST Credit). Tax expenditures whose costs cannot be estimated using the T1 model due to the complexity of these measures or the absence of individual tax return data are estimated using supplementary data obtained from the Canada Revenue Agency, Statistics Canada and a number of other sources (e.g., other government departments and industry associations).
There is a two-year lag in the availability of the income tax return data used in the T1 model, and the value of personal income tax expenditures presented in this edition are therefore typically estimated using observed data up to 2017. Projections of personal income tax expenditures for subsequent years are calculated using the T1 model, which projects population, income and tax parameters to future years. Population growth is assumed to follow Statistics Canada’s medium-growth population forecast by age, gender and province. Income growth assumptions, which vary by main sources of income, are consistent with the underlying forecasts used in the Department of Finance Canada’s 2019 Economic and Fiscal Update. In addition, the projected costs of personal income tax expenditures account for future changes to tax parameters, such as legislated changes and the indexation of tax parameters. Assumptions related to indexation are consistent with the observed Consumer Price Index and forecasts used in the Economic and Fiscal Update. In many cases, projections derived using the T1 model are also complemented by comprehensive aggregate statistics for the most recent taxation year available.
Personal income tax expenditures accruing to trusts are estimated using a micro-simulation for trust income taxation, and are projected on the same basis as personal income tax expenditures accruing to individuals or corporate income tax expenditures, depending on the measure. In general, forgone revenues are estimated under the assumption that there is no change in the amounts of trust income that are allocated to beneficiaries. Exceptions to this approach are noted in the methodological information provided in Part 3 of this report. Forgone revenues are also estimated under the assumption that there is no change in the level of unit redemptions by mutual fund trusts. Mutual fund trusts are eligible, upon the redemption of trust units, to a refund of the tax paid at the trust level on taxable capital gains (see the description of the measure “Refundable capital gains tax for investment corporations, mutual fund corporations and mutual fund trusts” in Part 3 of this report for more details). As such, the cost that may be associated with a particular tax expenditure that is of benefit to mutual fund trusts (such as the partial inclusion of capital gains) could ultimately be offset by lower capital gains refunds claimed by mutual fund trusts. This interaction is not accounted for in the estimation model (as each measure is estimated independently); therefore care should be taken in interpreting the estimates.
The value of corporate income tax expenditures that are calculated using the T2 model must be projected for years beyond 2017. Projections are not derived from the T2 model, but rather are mainly based on the Department of Finance Canada’s forecast of total corporate taxable income in the 2019 Economic and Fiscal Update and on legislative changes to corporate tax parameters. In many cases, preliminary data from the most recent income tax returns are also used to inform the projections. Projections for other corporate income tax expenditures are based on forecast changes in underlying economic variables (again relying on the Economic and Fiscal Update) or on historical trends. The years of the projections are indicated in the descriptions of the tax expenditures found in Part 3.
There is a one- to two-year lag in the availability of complete administrative data used to estimate the tax expenditures associated with most GST rebates and certain other measures. Projections for years beyond 2016 are derived from the most recent complete administrative data and forecasts of related economic variables provided in the Department of Finance Canada’s 2019 Economic and Fiscal Update or by third parties. As for GST expenditures estimated using the Goods and Services Tax Model, the values shown for 2014 and 2015 for these tax expenditures are based on the most recent Supply and Use Tables (which are available with a three-year lag) and projected for the following years. Projections are derived from forecasts of related economic variables provided in the Fall Economic Statement or by third parties. In many cases, preliminary aggregate data for 2016 and 2017 are also used to inform the projections.
For instance, there may be interactions between deductions and between non-refundable income tax credits in situations where a taxpayer has more deductions than needed to reduce his or her taxable income to zero or more non-refundable credits than needed to reduce tax payable to zero. As an example, in a situation where a taxpayer has $1,000 in income and claims two deductions of $600 each, eliminating each deduction independently would only increase the taxpayer’s taxable income by $400 (since the other $600 deduction would still be claimed), but the combined impact of simultaneously eliminating the two deductions would be to increase taxable income to $1,000. Similarly, some taxpayers may need to use only one of several non-refundable credits available to reduce their tax liability to zero. As a result, in some cases, the revenue gain obtained from eliminating such credits one by one would be zero but their combined effect would be positive.
A similar example is the interaction between GST exemptions and GST rebates. A number of services that are provided in a non-commercial context are exempt from GST, and institutions that provide these services are generally eligible for rebates on GST paid on their purchases. Although the exemptions and rebates are presented as two different tax expenditures, they are not independent. If one of these exemptions were repealed, the institutions providing the exempt services would begin charging GST on their supplies and receive input tax credits. The institutions would no longer require rebates since the GST paid on their purchases would be relieved by the input tax credits, effectively repealing the related rebate as well. In this report, the value of GST exemptions is calculated as the tax revenues the government would raise by taxing exempt services, net of the input tax credits that providers would then receive. However, the value of GST exemptions does not account for the portion of the GST paid by the providers that would be received as input tax credits should the services become taxable, but that are currently claimed as rebates. The value of GST rebates is presented separately, and should be netted out of the value of GST exemptions in order to obtain a closer approximation of the revenue impact of eliminating these measures.
In order to further advance the Government’s priorities for gender equality and strengthen the use of GBA+ in decision-making, the Government has committed to better integrate gender into the budget priority-setting process. Through the Canadian Gender Budgeting Act of 2018, GBA+ was made part of the federal government’s budgetary and financial management processes, requiring that, once a year, the Minister of Finance make available to the public analysis on the impacts in terms of gender and diversity of tax expenditures. In keeping with the requirements of the legislation, this edition of the report features a GBA+ of the personal income tax system, focusing on tax expenditures with family components and analyzing the distribution of these tax expenditures’ claims and benefits within families.
Newfoundland and Labrador—Estimates 2019, Appendix I
Nova Scotia—Budget 2020-21, Revenue Outlook
Ontario—Taxation Transparency Report 2019
Saskatchewan—2019-20 Provincial Budget, Technical Papers, “Saskatchewan’s Tax Expenditures”
Alberta—Budget 2019—2019-23 Fiscal Plan, “Tax Plan”
British Columbia—Budget and Fiscal Plan 2020/21 - 2021/22, Appendix A1 “Tax Expenditures”
The rate at which certain capital costs can be deducted for tax purposes is, in some cases, more rapid than would be permitted under the useful life benchmark. Examples are the provision of accelerated CCA or immediate expensing for certain tangible capital assets (e.g., machinery and equipment used in manufacturing and processing, specified clean energy equipment, Canadian vessels) and of the immediate deduction of certain intangible expenses that are capital in nature in that they contribute to earnings over several years (e.g., advertising costs, expenditures on research and development).
More information on the estimation of the tax expenditures associated with the accelerated deductibility of capital costs can be found in the study “Tax Expenditures for Accelerated Deductions of Capital Costs” that was published in the 2012 edition of this report.
Historically, annual tax expenditure estimates were not usually provided for accelerated deductibility provisions because adequate data are not generally available to calculate them with a reasonable degree of accuracy, and because many simplifying assumptions would be required to model the pattern of deductions that would be claimed in the absence of these provisions. However, last year’s report presented the combined incremental tax expenditure estimates of the three accelerated capital cost allowance measures announced in the 2018 Fall Economic Statement under “Accelerated Investment Incentive”. Going forward, tax expenditure estimates will generally be provided for new accelerated deductibility provisions. These estimates/projections are made possible by the availability of additional taxpayer information, including detailed investments and depreciation allowance amounts claimed by asset class from partnerships.
An investor buying a flow-through share, in addition to receiving an equity interest in the issuing corporation, is also entitled to claim deductions on account of Canadian Exploration Expenses, Canadian Development Expenses and Canadian Renewable and Conservation Expenses transferred to the investor by the corporation.[11] On a cash-flow basis, the cost of this tax expenditure, for a given year, is equal to the amount of revenue forgone as a result of the transferred deductions claimed by investors in that year less the estimated incremental revenue gain associated with the zero cost base for flow-through shares sold by investors in that year. The transfer of unused deductions from the issuing corporations to the investors entails a cost to the government when the deductions are claimed by the investors earlier than they would have been claimed by the corporations or where the investors face higher tax rates than the issuing corporations. The fact that flow-through shares are deemed to have a zero cost base for tax purposes means that the gains realized by investors when the shares are sold will be larger than they would otherwise have been, resulting in more taxes being paid on the incremental capital gains.[12] On a present-value basis, the cost of this tax expenditure would be calculated by comparing the discounted present value of the deductions and capital gains, with and without the flow-through mechanism.
The inclusion of trust income in taxable income twice—once when earned and a second time when withdrawn—offsets in whole or in part (depending on whether the corporation’s discount rate equals or exceeds the net rate of return earned by the capital invested in the trust) the present value benefit to the corporation of bringing forward the deduction for reclamation costs to the time when the funds are first contributed. The nominal value (ignoring the time value of money) of this tax expenditure over the life of a particular project may be negative as a result of the double inclusion in taxable income of the trust earnings. It will tend to be positive, however, if the company is taxable at the time of the contribution to the trust (so that the upfront deduction is available), but not taxable at the time of withdrawal (which could well be the case for a single-mine operation once the mine ceases to operate).
[1] International Monetary Fund, Manual on Fiscal Transparency, Fiscal Affairs Department, 2007; Organisation for Economic Co-operation and Development, OECD Best Practices for Budget Transparency, 2002.
[2] For income tax purposes, trusts are deemed to be individuals and are thus subject to tax as individuals. Unless otherwise specified, a reference to personal income taxation encompasses the taxation of trust income.
[3] A corporation’s fiscal period is any period of 53 weeks or less.
[4] The benchmark income tax base can be considered a variant of the comprehensive income tax base as was first defined by economists Robert M. Haig and Henry C. Simons. The comprehensive income tax base would require the taxation of real current additions to purchasing power, or real increases in wealth, which would cover worldwide income from all sources—labour income, rents, dividends, interest and capital gains (adjusted for inflation), transfers, imputed rent on owner-occupied dwellings, the imputed value of household services, and gifts and inheritances. A strict application of the Haig-Simons base would make corporate income tax redundant since income earned at the corporate level would be taxed as it accrues to individuals.
[5] It represents the statutory rate after the federal abatement and general rate reduction. As such, the benchmark corporate income tax rate has been 15% since 2012.
[6] There are three possible benchmarks for taxing the active business income of foreign affiliates of Canadian corporations: (i) that income could be taxable in Canada as it accrues, with relief provided to the extent foreign taxes were paid on the income, consistent with a pure worldwide taxation approach whereby Canadian resident taxpayers are taxed on their worldwide income as it is earned; (ii) that income could be taxable in Canada at the time it is paid out as a dividend to the Canadian corporation; or (iii) that income could be exempt from tax in Canada, both when that income is earned and at the time it is paid out as a dividend to the Canadian corporation, consistent with a territorial approach whereby only Canadian-source business income is taxed in Canada. The three possible benchmarks would have different implications for measuring tax expenditures—see the description of the measure “Tax treatment of active business income of foreign affiliates of Canadian corporations and deductibility of expenses incurred to invest in foreign affiliates” in Part 3 of this report.
[7] Non-resident withholding tax is often considered to act as a proxy for the income tax that would be payable had the payments been made to Canadian residents; hence the inclusion of this tax in the scope of this report.
[8] A number of provinces have replaced their retail sales taxes with the Harmonized Sales Tax (HST). The base of the HST is virtually identical to that of the GST, and the HST is applied at a rate equal to the rate of the GST plus a provincial component that varies by province and is determined by each province. Sections of this report that refer to the GST/HST apply to both the federal and provincial portions of the tax whereas references to the GST apply only to the federal portion.
[9] No GST is charged on exempt goods and services, while the GST applies on zero-rated goods and services, but at a zero GST rate. Vendors of zero-rated goods and services are entitled to claim input tax credits to recover the full amount of GST they paid on inputs used to produce zero-rated products; in contrast, vendors of exempt goods and services are not entitled to claim input tax credits to recover the GST they paid on their inputs.
[10] The determination of the useful life of an asset involves the assessment of a variety of factors, including statistical estimates of the rate of economic depreciation applying to the asset, industry data on the engineering life of the asset and the repairs needed to keep it operating, and the treatment accorded to the asset for financial accounting purposes.
[11] For additional information on flow-through shares, see the study “Flow-Through Shares: A Statistical Perspective” published in the 2013 edition of this report.
[12] The incremental portion of the gain is the difference between the zero cost base and the price at which the company would have been able to issue regular common shares.
[13] Limited data is available to determine when, if ever, the expenses being flowed through would otherwise have been deducted by the issuing corporations. Available data indicates, for example, that 96% of corporations that flowed through expenses to investors for the 2013 taxation year were not taxable in that year and thus not in a position to immediately deduct the expenses themselves. Many junior exploration corporations in Canada, particularly in the mining sector, never become taxable entities. It is a common business model that once an exploitable resource is found, the resource will be sold to a larger corporation or group with more experience developing and operating extraction projects.