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Budget 2005 - Budget Plan
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Chapter 4 - A Productive, Growing and Sustainable Economy
A Fair and Competitive Tax System

Highlights

• The amount of income that all Canadians may earn without paying federal income tax will increase to $10,000.

• 860,000 taxpayers will be removed from the tax rolls, including about 240,000 seniors.

• Over 70 per cent of the tax relief will go to those earning less than $60,000 per year.

Budget 2005 also makes the tax system fairer, notably by improving tax assistance for persons with disabilities—acting on the recommendations of the Technical Advisory Committee on Tax Measures for Persons with Disabilities (see Chapter 3).

Budget 2005 promotes jobs and economic growth by making Canada’s tax system more efficient and more competitive, and maintaining Canada’s corporate tax rate advantage over the U.S. Specifically, it proposes to:

• Eliminate the corporate surtax.

• Reduce the general corporate income tax rate by two percentage points.

• Improve the alignment of capital cost allowance (CCA) rates with the useful life of assets.

Legislation to implement the tax measures proposed in this budget will be introduced at the earliest opportunity.

The Government will do more, sooner, if the fiscal situation permits.

Introduction

Every year since balancing the budget, the Government of Canada has reduced taxes. Of particular significance was the $100-billion Five-Year Tax Reduction Plan, which was introduced in 2000. That plan provided broad-based tax relief, benefiting first those who need it most, in particular low-income families with children. It also included measures to encourage entrepreneurship and small business and to create a Canadian tax advantage for investment. Subsequent budgets built on the five-year plan to further enhance the fairness, efficiency and competitiveness of the tax system. These tax cuts have helped promote economic growth, create jobs and boost living standards in a fiscally sustainable manner.

The Government is committed to further reducing the tax burden for low- and modest-income Canadians and to making the tax system more internationally competitive—without compromising its overall commitment to balanced budgets and sound fiscal management.

Budget 2005 proposes tax reductions that will deliver total tax relief of $13.4 billion by 2009–10 (see Table 4.10).

Legislation to implement the tax measures proposed in the budget will be introduced at the earliest opportunity. If more resources become available, the Government will deliver more tax relief sooner.

Personal Income Tax Relief for Canadians

The Basic Personal Amount

The income tax system currently includes a basic personal amount and an amount for a dependent spouse or common-law partner, or wholly dependent relative, that allow individuals and families to earn a basic amount of income on a tax-free basis. These amounts are available to individuals at all income levels, but provide more tax relief to those with low- and modest-incomes relative to the amount of tax they pay.

To provide tax relief to all taxpayers, particularly those with low and modest incomes, Budget 2005 proposes to increase progressively the basic personal amount so that by 2009 the amount of income that all Canadians may earn without paying federal income tax will increase to $10,000. This change will provide about $7.1 billion in tax relief over the next five years, with over 70 per cent of the relief going to those earning less than $60,000 per year. When fully implemented, the measure will remove 860,000 low-income taxpayers from the tax rolls, including some 240,000 seniors.

The basic personal amount will be increased over a five-year period as follows: $100 in 2006, an additional $100 in 2007, $400 in 2008 and $600 in 2009. The amount for a dependent spouse or common-law partner, and the equivalent amount for a wholly dependent relative, will increase accordingly. These increases are over and above the inflation protection provided by full indexation.

Table 4.7
Personal Amounts

Encouraging Savings: Increasing the RPP/RRSP Limits

Private domestic savings play a key role in the economy and the individual well-being of Canadians. Savings support investment, which is critical for productivity, economic growth and prosperity. Savings allow Canadians to finance their retirement and meet other needs such as buying a home or supporting the education of their children.

Savings held in financial assets outside of tax-sheltered registered plans (e.g. registered pension plans (RPPs) and registered retirement savings plans (RRSPs)) are funded with after-tax income and the subsequent return on those savings is also taxable. This treatment creates a bias that favours consumption over saving. Economic models indicate that reducing taxes on savings is an efficient way to support economic growth.

The limits on tax-deferred retirement saving can also affect the attractiveness of Canada as a place to work. For example, comparable limits in the U.S. are significantly higher than those in Canada. Correspondingly, the RPP limits affect the cost to employers of attracting and retaining mobile employees.

Budget 2003 increased the RPP and RRSP limits. This budget proposes to increase these limits further.

• The annual dollar limit on contributions to money purchase RPPs will be increased to $22,000 by 2009 from $18,000 in 2005. Corresponding increases will be made to the maximum pension limit for defined benefit RPPs, bringing it to $2,444 per year of service by 2009.

• The annual dollar limit on contributions to RRSPs will be increased to $22,000 by 2010 from $18,000 in 2006.

• The RPP and RRSP limits will be indexed to average wage growth starting in 2010 and 2011 respectively.

Table 4.8 below provides the schedule according to which these increases will be phased in.

Increasing the RPP and RRSP limits will support savings and investment, thereby contributing to productivity improvements and economic growth. This is key to helping meet demands associated with an aging population.

The proposed limit increases are expected to reduce federal revenues by $70 million for 2005–06, rising to $180 million by 2009–10.

Table 4.8
Existing and Proposed Registered Pension Plan/Registered Retirement Savings Plan Limits

Maintaining Canada’s Corporate Tax Advantage

In today’s global economy, capital is highly mobile internationally and a competitive tax system is critical to fostering business investment in Canada. Investment in new capital improves productivity, leading to economic growth, and higher wages and living standards.

Starting with Budget 2000, the Government’s approach to creating a Canadian advantage for investment and supporting productivity has been to reduce tax rates while improving the tax structure. This has included establishing a common tax rate across all sectors and aligning capital cost allowance rates to the useful life of assets, so that investment flows to its most productive uses. Key federal initiatives have included:

• The Five-Year Tax Reduction Plan introduced in 2000, which reduced the general rate of corporate income tax to 21 per cent from 28 per cent, levelling the playing field for Canada’s service sector and creating a tax advantage for investment in Canada.

• The 2003 and 2004 budgets, which further enhanced Canada’s tax competitiveness by phasing out the capital tax by 2008, reducing the tax rate on resource income to 21 per cent by 2007 while improving the tax structure applying to this sector, increasing capital cost allowances for computers and data network infrastructure equipment to reflect changes in the useful lives of these assets, and increasing support for small business and entrepreneurship.

The chart above illustrates the impact of recent federal and provincial measures on corporate tax rates.

Budget 2005—Reducing Corporate Tax Rates

Improving the competitiveness of the tax system is particularly important at a time when most industrialized countries are significantly reducing their corporate tax rates (see box below).

Last year the U.S. legislated a plan to reduce its corporate tax rate on manufacturing income by an equivalent of 3.15 percentage points by 2010. Ensuring the competitiveness of Canada’s business taxes vis-à-vis the U.S. is particularly important because our economies are highly integrated. For example, two-thirds of foreign direct investment in Canada is from U.S. investors, and about 40 per cent of Canada’s outbound direct foreign investment is made in the U.S.

In 2004, Canada’s average federal-provincial corporate tax rate was 2.3 percentage points lower than the average federal-state rate in the U.S. Due to the recently announced corporate tax reductions in the U.S., absent new measures, Canada’s tax advantage would be significantly diminished for certain types of income—for manufacturing income, falling to only 1.4 percentage points by 2010. More than 40 per cent of foreign direct investment in Canada is made in the manufacturing sector. It is important that Canada maintain a tax rate advantage for manufacturing as well as other sectors of the economy.

To ensure that Canada’s business taxes are internationally competitive and foster investment, productivity and growth, Budget 2005 proposes the elimination of the corporate surtax in 2008 and a 2-percentage-point reduction in the general corporate income tax rate to 19 per cent from 21 per cent, by 2010. Table 4.9 shows corporate tax rates to 2010, with the proposed changes to the surtax and general corporate income tax rate.

The corporate surtax was originally introduced in 1987 as a deficit reduction measure. Its elimination is equivalent to a 1.12 percentage point reduction in corporate income tax rates and will benefit both large and small businesses. Eliminating the surtax will also simplify the tax system.

Table 4.9
Federal Corporate Income and Capital Tax Rates

The proposed tax reductions will establish a solid corporate tax rate advantage for all sectors. For manufacturing income, Canada’s tax rate advantage will be 4.5 percentage points in 2010 (see chart below). A strong signal to investors is necessary to influence the location of investment.

Aligning Capital Cost Allowance Rates With Useful Life

Lower statutory tax rates are a key component of a tax system that fosters investment. In addition, it is important that the structure of the tax system be sound. A key area in this regard is the treatment of capital assets.

Businesses use capital assets over a number of years. The capital cost allowance (CCA) system determines how much of the cost of a capital asset a business may deduct in a particular year. CCA rates that reflect useful life ensure the accurate measurement of income for tax purposes by providing appropriate recognition of capital costs over time. Alignment of CCA rates with the useful life of assets can enhance productivity and standards of living through a more efficient allocation of investment across classes of assets. The Government reviews CCA rates on an ongoing basis. As part of this review, Budget 2005 proposes the following modifications to CCA rates to better reflect useful life:

• The rate for combustion turbines that generate electricity will increase from 8 per cent to 15 per cent.

• The rate for electricity transmission and distribution assets will increase from 4 per cent to 8 per cent.

• The rate for oil and gas transmission pipelines will increase from 4 per cent to 8 per cent, and a 15 per cent rate will be set for compression and pumping equipment on such pipelines.

• The rate for cables used for telecommunications infrastructure will increase from 5 per cent to 12 per cent.

These CCA changes are expected to reduce federal revenues by $15 million in 2005–06 and $30 million in 2006–07.

The Government will continue to review CCA rates which, as a general principle, should reflect useful life. As elaborated in the section of Chapter 5 addressing environmental tax measures, new accelerated CCA will only be considered for investments in green technology.

Small Business—Acting on Priorities of the House of Commons Standing Committee on Finance

The tax system provides considerable support to small businesses (see box). Recent tax changes have encouraged growth by helping small businesses to retain more of their earnings and by enhancing incentives for investment in small business ventures.

In recent years, the Canadian Federation of Independent Business has suggested measures to support the growth of small businesses—many of which the Government has acted on. In addition, other small business representatives and the cooperative sector have proposed a range of measures to support the emergence, capitalization and growth of enterprises.

In Budget 2004, the Government indicated that it would seek the advice of the House of Commons Standing Committee on Finance on the merits of proposed measures and on the relative priority that should be accorded to them, taking into account limited fiscal resources.

Since then the Committee undertook a study of federal tax measures to help small businesses in certain sectors, including excise tax and duty relief for jewellers, small brewers and wine-makers and measures to improve access to capital for agricultural cooperatives. Budget 2005 responds to the Committee’s reports.

Review of Excise Duties and Taxes

In its October 2004 report, Study on Small Business Tax Measures: Tax Assistance to Prosper—Canada’s Wine-Makers, Small Brewers and Jewellers, the Committee recommended that the Government take immediate action to phase out the excise tax on jewellery. Mindful that the number of proposals exceeds the ability of the Government to finance them in a fiscally responsible manner, the Committee recommended that its first priority be followed by reductions in the excise duties on beer produced by small brewers and on wine produced from Canadian grapes.

Consistent with the priority recommendation from the Committee, Budget 2005 proposes that the excise tax on jewellery be phased out through a series of rate reductions over the next four years. The rate of the tax will be reduced to 8 per cent from 10 per cent, effective February 24, 2005, and will be reduced by an additional 2 percentage points each year thereafter, starting on March 1, 2006, until the tax is eliminated.

Phasing out the excise tax on jewellery ensures equitable treatment of the Canadian jewellery industry and recognizes that jewellery is available at all price levels and enjoys widespread consumption among Canadian households. This measure will reduce federal revenues by $20 million in 2005–06 and by an additional $20 million each year thereafter, to $100 million per year when fully implemented.

With respect to beer and wine, the Committee acknowledged that limited fiscal resources narrow the range of tax relief measures that can be funded. The recommendations with respect to beer and wine will remain under consideration.

Canada’s Agricultural Cooperatives

In its December 2004 report, Study on Small Business Tax Measures: Canada’s Agricultural Cooperatives, the Committee recommended that the Government immediately allow the deferral of tax on patronage dividends paid in shares; create a cooperative investment plan to encourage agricultural cooperative members and employees to invest in their cooperatives; and undertake a review of tax and non-tax measures that would enable the cooperative sector to meet its capitalization needs.

The Committee’s report noted that, due to a number of factors, agricultural cooperatives may have difficulty raising capital. The report identified a number of reasons to support the capitalization of agricultural cooperatives: they play an important role in regional development and the rural economy; they are an important part of Canada’s agricultural sector; and their presence supports and sustains family farms and small agricultural businesses throughout rural Canada.

This budget proposes to allow members of agricultural cooperatives to defer paying tax on patronage dividends they receive in the form of shares until the shares are disposed of. This measure is expected to reduce federal revenues by about $10 million in 2005–06 and $30 million in 2006–07 and subsequent years. The cooperative investment plan, which was also recommended by the Committee, will remain under consideration.

The Government will monitor the effectiveness of this measure and, as the Committee recommended, will continue to assess the capitalization challenges of the agricultural cooperative sector.

Improving Tax Administration

For Canadians to have confidence in the administration of the tax system, they must be assured that taxes owed are in fact paid. Correspondingly, the fair and effective functioning of the tax system requires that ongoing attention be paid to the level and allocation of resources for audit and enforcement, and that appropriate mechanisms be in place to facilitate and encourage compliance with Canada’s tax laws. This budget strengthens the capacity of the Canada Revenue Agency (CRA) to administer the tax system in areas where aggressive tax planning and compliance risks have the potential to erode the tax base. Specifically, Budget 2005 proposes to:

• Increase audit and enforcement resources of the CRA by $30 million annually to discourage aggressive tax planning through international transactions and, in particular, the use of tax havens. Additional revenue generated by increased audit and enforcement activity is expected to offset this expenditure.

• Allocate $8 million over the next five years to enhance federal tobacco tax compliance and enforcement.

• Strengthen liability provisions in the Excise Tax Act to provide that directors of corporations may be held liable for wrongful claims of net GST/HST credits.

• Establish a publicly accessible web-based GST/HST registry from which businesses will be able to verify the GST/HST status of their suppliers.

Table 4.10
A Fair and Competitive Tax System

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