TaxMatters@EY – June 2023

1. Under paragraph 6(1)(a) of the Act. Case law has established the importance of the economic advantage and primary beneficiary tests in determining whether an employee must include a reimbursement in income. See, for example, Lowe v The Queen, 96 DTC 6226 (FCA).
   
2. Under subparagraph 6(1)(b)(v) of the Act, an allowance for reasonable travel expenses will generally be excluded from the employee’s income if the employee is engaged in selling property or negotiating contracts for their employer.
   
3. Under paragraph 6(1)(b)(vii.1) of the Act.
   
4. Under paragraph 6(1)(b)(vii) of the Act.
   
5. CRA document 2016-0643631E5.
   
6. CRA document 2012-0432671E5.
   
7. CRA Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment, paragraph 2.22.
   
8. CRA document 2022-0936671I7.
   
9. Under subparagraph 6(1)(b)(x) of the Act, a motor vehicle allowance must be based solely on the number of kilometres driven for employment purposes to be considered reasonable.

Kelsey Horning, Andrew Rosner and Lucie Champagne, Toronto

As announced in Ontario’s 2023-24 budget, the province is introducing the Ontario-made manufacturing investment tax credit (OMMITC) to encourage local manufacturers to invest in and expand the province’s manufacturing sector.¹ Broadly speaking, the credit is designed to encourage eligible Canadian-controlled private corporations (CCPCs) to make capital investments in buildings, machinery and equipment used in manufacturing and processing (M&P) activities in Ontario. A qualifying CCPC could receive a tax credit of up to $2 million per year.

The government estimates this new program will provide income tax support of $780 million over the next three years to qualifying CCPCs. The new credit is also intended to help create employment in Ontario’s manufacturing sector. 

The legislation to implement the credit is contained in Ontario Bill 85, Building a Strong Ontario Act (Budget Measures), 2023.²

The basics

The OMMITC is a 10% refundable corporate income tax credit for eligible expenditures of up to $20 million per taxation year made by a qualifying corporation, for a maximum credit of $2 million per year.

A corporation is a qualifying corporation for a taxation year if it:

• Is a CCPC throughout the year
• Carries on business in Ontario in the year through a permanent establishment in the province (e.g., an office, factory or workshop)
• Is not exempt from income tax

Sharing the expenditure limit

The $20 million annual limit must be shared by an associated group of corporations and will be pro-rated for short taxation years.

An associated group of qualifying corporations must agree on the allocation of the $20 million annual limit among the group, and this agreement must be filed with the Ontario minister. If the associated group fails to reach an agreement or file it with the minister, they cannot claim the credit.

Special rules apply if a qualifying corporation has more than one taxation year ending in the same calendar year, and it is associated in two or more of those taxation years with another qualifying corporation. Also, qualifying corporations will be deemed to be associated with each other if it is reasonable to believe that one of the reasons for their separate existence is to access or increase the amount of OMMITC claimed.

A qualifying corporation formed by way of an amalgamation cannot claim the credit for any expenditure incurred by a predecessor corporation if the latter was not a qualifying corporation at the time it incurred the expenditure.  

Eligible expenditures

Eligible expenditures for purposes of the OMMITC include eligible property used in M&P activities in Ontario. More specifically, these expenditures must be incurred to acquire certain capital property included in Class 1 or Class 53 for capital cost allowance (CCA) purposes.

Eligible expenditures in Class 1 include expenditures for the construction, renovation or acquisition of a building — or part of a building — that is located in Ontario and becomes available for use on or after March 23, 2023. The building must be eligible for the additional 6% CCA for eligible nonresidential buildings under federal income tax rules, in addition to the 4% CCA for other Class 1 buildings. Eligible nonresidential buildings acquired after March 18, 2007 and used 90% or more for M&P in Canada are eligible for the additional 6% allowance if a separate Class 1 election is filed, resulting in a total 10% CCA rate.³

Eligible expenditures also include machinery and equipment included in Class 53 and used in Ontario primarily to manufacture or process goods for sale or lease. The property must be acquired and available for use on or after March 23, 2023 and before 2026. After 2025, eligible machinery and equipment will include expenditures included in Class 43(a) that are used in the manufacturing or processing of goods for sale or lease. Broadly speaking, property included in Class 43(a) is eligible M&P property acquired after 2025 that would have been included in Class 53 if it had been acquired before 2026.

Eligible property also includes property — other than a building or part of a building — that is leased in the ordinary course of a business of a qualifying corporation in Ontario to a lessee who can reasonably be expected to use the property in Ontario primarily in manufacturing or processing goods for sale or lease.

Excluded property

Certain expenditures are specifically excluded for purposes of the OMMITC, including:

• Property that was owned at any time by a person or partnership with which the qualifying corporation did not deal at arm’s length at the time the property was acquired
• Property in which the qualifying corporation, or an associated corporation, held a leasehold interest at any time before acquiring the property
• Property that was acquired from a person or partnership that has a right or option to acquire or lease all or part of the property at any time
• Property for which, at the time it was acquired, the qualifying corporation granted any other person or partnership a right or option to acquire
• Property that is leased to a person that is exempt from tax under federal income tax rules⁴

Examples

The Ontario budget documents include two examples to illustrate the potential savings for 2023 where an eligible CCPC also takes advantage of temporary CCA measures that allow for the full expensing of capital property used in M&P activities.⁵

In the first example, A Co. is a small CCPC that produces sheet metal products in Ontario. All of A Co.’s income is subject to the Ontario small business corporation income tax rate. To modernize its production process, A Co. is considering purchasing new computer-controlled machinery in 2023 for a total cost of $500,000. A Co. could benefit from the following savings:

In the second example, B Co. is a large CCPC operating a plastics packaging manufacturing operation in Ontario. All of B Co.’s income is eligible for the Ontario M&P corporate income tax rate. To expand its operations to reach new markets, B Co is considering a $12 million investment in 2023 for new machinery for molding plastics. B Co. could benefit from the following savings:

Conclusion

The applicable forms to claim the OMMITC have not been released yet. The legislation also allows the government to introduce regulations that will prescribe additional types of property that would be eligible for the credit. At the time of writing, no regulations had been released.

A phase-out date for the OMMITC has not been set. However, the government will be required to conduct a review every three years to evaluate the credit for effectiveness, compliance burden and administrative costs.

The OMMITC provides a significant incentive for eligible CCPCs to invest in new buildings, machinery and equipment to increase their manufacturing activities in Ontario. Talk to your advisor for more information on how this new credit may apply to your business.

1. For more information on the 2023-24 Ontario budget, see EY Tax Alert 2023 Issue No. 16.
2. Bill 85 was enacted on May 18, 2023..
3. The election must be filed under subsection 1101(5b.1) of the federal Income Tax Regulations. This election generally allows a taxpayer to elect to establish a separate class for each eligible nonresidential building for which the taxpayer makes the election.
4. Under section 149 of the federal Income Tax Act.
5. Full expensing of M&P machinery and equipment was introduced in the 2018 federal fall economic update under the accelerated investment incentive property rules. An enhanced first-year allowance provides taxpayers with an immediate 100% deduction of the net cost addition for M&P machinery or equipment that becomes available for use before 2024. The enhanced first-year allowance is reduced to 75% for M&P machinery or equipment that becomes available for use in 2024 or 2025, and to 55% for M&P machinery or equipment that becomes available for use in 2026 or 2027. The enhanced first-year allowance is eliminated for property that becomes available for use after 2027. For more information, see EY Tax Alert 2018 Issue No. 40. Alternatively, a full write-off may also be claimed by a CCPC on up to $1.5 million of expenditures in 2023 under the immediate expensing rules. See EY Tax Alert 2022 Issue No. 30.
6. For more information with respect to Ontario’s corporate income tax rates, see EY’s Tax Calculators & Rates.
7. For more information with respect to Ontario’s corporate income tax rates, see EY’s Tax Calculators & Rates.

Yiyun Chen and Winnie Szeto, Toronto

In this recent case, the Tax Court of Canada confirmed that a tenant was liable for Part XIII withholding tax on rents he paid even if he was not aware of the landlord’s nonresident status.

The taxpayer’s due diligence defence was ultimately unsuccessful, and the court ruled that the taxpayer was liable for the Part XIII tax assessed, in addition to interest and penalties.

Part XIII tax scheme

Generally, nonresident persons who earn income from property in Canada — such as rents, royalties, dividends and interest — that is not attributable to a business carried on in Canada through a permanent establishment are not subject to Part I tax under the Income Tax Act (the Act). Instead, they may be subject to Part XIII tax, which imposes a 25% withholding tax on such income, with a possible rate reduction under an applicable tax treaty between Canada and the nonresident's country of residence.¹

To ensure proper collection of Part XIII tax, the onus is placed on payers to withhold and remit the appropriate tax amount when making payments subject to Part XIII. For instance, in the case of rental payments paid or credited to a nonresident, the payer, who could be the property manager or tenant, must usually withhold Part XIII tax at 25% of the gross rent at source.²

The payer must also report the gross rent and tax withheld on Form NR4, Statement of Amounts Paid or Credited to Non-Residents of Canada. If the payer fails to withhold and remit Part XIII tax to the Canada Revenue Agency (CRA), they remain liable for the tax and may recover the amount from other payments they are required to make to the nonresident.³

Facts

In 1996, Mr. X, a shareholder of Xco, the taxpayer, leased a residential rental unit in Québec from Aco. In 2006, the unit was sold to Ms. A, one of Aco’s shareholders. In 2010, Mr. X entered into a new lease agreement for the unit with Ms. A as the lessor. From July 2011 to January 2016, Xco paid rents to Ms. A on behalf of Mr. X and no Part XIII tax was withheld from these payments.

In 2018, the CRA assessed Xco, under subsections 215(1) and (6) of the Act, for failure to withhold and remit Part XIII tax on the rental income received by Ms. A for the 2011 to 2016 taxation years, as well as interest and penalties. The CRA’s basis for this assessment was that Ms. A was a nonresident during those years.

The taxpayer disagreed and appealed the assessments to the Tax Court of Canada.

Court’s analysis and decision

In this appeal, the court had to determine whether Xco paid rent to a nonresident person such that it is liable for the failure to withhold and remit Part XIII tax on the rental income. This can be further broken down into three separate questions:

1. Was Ms. A a nonresident during the relevant taxation years?
2. Was Xco liable for Part XIII tax if Mr. X was unaware that Ms. A was a nonresident?
3. Was a due diligence defence available to Xco under the circumstances?

Determination of residency

At trial, Mr. X stated that he was never informed that Ms. A was living outside of Canada and cited evidence supporting her residency in Canada, such as a Canadian address on the deed of sale of the rental unit in 2006 and on the lease agreement in 2010, even though the agreement showed that Ms. A signed the agreement in Italy. Additionally, Ms. A had a social insurance number (SIN), a Canadian bank account and family in Canada.

However, the CRA disputed the reliability of the Canadian addresses as evidence that Ms. A lived in Canada and found no address linking Ms. A to Canada other than the rental unit. The CRA also discovered that Ms. A had a SIN, but she did not file any Canadian income tax returns or information returns.

Furthermore, the CRA reached Ms. A using an Italian phone number and Ms. A herself confirmed to the CRA that she resided in Italy. Indeed, Ms. A had sought judicial review of a decision by the CRA that denied her request for an extension of time to file under a provision of the Act that applied only to nonresidents.

The judge did not consider Ms. A’s Canadian addresses on the deed of sale or lease agreement, which were unsworn statements, to be definitive regarding her residency; the judge agreed with the CRA that the Canadian addresses were not conclusive of her residence.

After reviewing the evidence presented by both parties, the judge found that the list of factors pointing to Ms. A’s nonresidency was compelling, leading to the conclusion that she was a nonresident during the relevant years.

Knowledge requirement for Part XIII tax

The taxpayer further contended that it should only be liable for failure to withhold and remit Part XIII tax if it had knowledge that Ms. A was a nonresident; otherwise, it would be unfair and contrary to the legislative intent.

To support this argument, the taxpayer cited Curragh Inc. v The Queen, 94 DTC 1894, where the judge indicated that if a Canadian payer made payments to a Canadian agent without knowing that the beneficial owner was a nonresident, it would be difficult to see why the Canadian payer should be liable for failure to withhold and remit Part XIII tax under subsection 215(6).

However, the judge found that the decision in Curragh was inapplicable to the taxpayer’s case because the circumstances differed. In Curragh, the payment was made to a Canadian agent of the nonresident payee, and the payer in that case had knowledge that the payee was a nonresident. Additionally, the judge in Curragh did not directly address whether subsection 215(6) depended on the payer’s knowledge.

The court also reviewed the history of section 215, finding that no knowledge requirement existed when it was first introduced, and none had been added since. The court noted that if the legislators had intended to limit a resident's liability to cases where they had knowledge or belief, it would have expressly done so, as seen, for example, in subsection 116(5). Under this provision, a purchaser’s obligation to remit may be relieved if, after a “reasonable inquiry”, the purchaser had no reason to believe that the vendor was not a resident of Canada.

Due diligence defence

The taxpayer also sought to mount a due diligence defence, which is recognized by the courts with respect to some penalty provisions. However, the judge rejected this defence, citing J.K. Read Engineering Ltd. v The Queen, 2014 TCC 309, and stating that subsection 215(6) was not a penalty provision and the actual penalty provision was subsection 227(8).⁴

While a due diligence defence may have been available to Xco for subsection 227(8), the court found that the taxpayer failed to exercise a high degree of diligence by taking no steps to ensure compliance. Additionally, the taxpayer’s argument that it had no reason to believe Ms. A was a nonresident fell short of meeting the required high standard.

Ultimately, the court ruled that subsection 215(6) was devoid of any requirement that the payer must have knowledge that the payee was a nonresident. Therefore, the court agreed with the CRA that the taxpayer was liable for Part XIII tax under subsection 215(6) and was also responsible for penalties and interest under subsections 227(8) and (8.3).⁵

Lessons learned

As can be seen from the results of this case, the consequences of not complying with a Part XIII tax obligation can be harsh and there is little remedy available. Therefore, even though it might be challenging to determine a payee’s residency in some cases, a payer should always take active steps to verify. For example, payers should not rely solely on unsworn statements but must make inquiries of their own to determine a payee’s residency status. Even minor indicators suggesting nonresidency should prompt further inquiries and documentation. If it is determined that the payee is a nonresident, the payer should withhold and remit the proper amount of Part XIII tax based on the relevant income tax provisions and tax treaties. 

Last, because 3792391 Canada Inc. is an informal procedure case, the results are not binding on the CRA or any other court, even where the facts are very similar. However, informal procedure decisions can offer informative lessons and they often have influential value for other judges.

1. Paragraphs 212(1)(b), 212(1)(d) and subsection 212(2) of the Act, and section 805 of the Income Tax Regulations.
2. Subsection 215(1) of the Act.
3. Subsection 215(6) of the Act, and section 202 of the Income Tax Regulations.
4. Subsection 227(8) of the Act provides that any person who fails to deduct or withhold an amount as required under section 215 is liable to a penalty equal to 10% of the amount that should have been withheld. The penalty increases to 20% if the failure was made knowingly or under circumstances amount to gross negligence.
5. Subsection 227(8.3) of the Act provides that any person who fails to deduct or withhold an amount as required under section 215 is liable to pay interest on the amount that should have been withheld.

Tax Alerts – Canada

Tax Alert 2023 No. 22 – Prince Edward Island budget 2023-24

Tax Alert 2023 No. 23 – Supreme Court of Canada applies GAAR in Deans Knight

Summary

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