Federal Budget 2023: Moving Canada forward

Our analysis highlights key measures announced in this year’s budget including an economic outlook, tax matters and a breakdown of key green initiatives, productivity and innovation, and people and affordability. As much as new and ongoing legislative measures introduce opportunities, they also may result in new complexities for businesses and individuals. Alongside our insights and analysis of potential impacts, we outline how we can help you navigate changes in the landscape ahead

Economic outlook | Tax matters | Green transition | Tax measures | Productivity and innovation | People and affordability | How KPMG can help

The budget comes at a challenging time for Canadian businesses. Legislative updates south of the border and economic uncertainty at home are creating headwinds for Canadian business leaders. According to the same recent KPMG survey, four out of five (79 per cent) Canadian companies feel the taxation they currently pay puts them at a competitive disadvantage with their American counterparts. A larger majority (93 per cent) are eager to see additional tax incentives aimed at encouraging investment and helping companies scale up and commercialize their products in Canada.

With economic forecasts in mind, this year’s budget moves several tax measures forward with draft legislation for public consultation and introduces new incentives to stimulate innovation and growth.

The Canadian government has renewed its commitment to clean technologies to help the industry stay competitive and meet net-zero emission targets. Many Canadian business leaders are committed to sustainability. A recent KPMG survey showed that 84 per cent of Canadian enterprises rely on clean energy incentives to reduce their environmental footprints. The same percentage want to see Canada pivot quickly to stay competitive with new green tax legislation in the United States and European Union.

The 2023 Federal Budget provided further details on the clean technology tax incentives introduced in the 2022 Fall Economic Update, including introducing new tax credits on clean manufacturing and processing and clean electricity.

• Clean Hydrogen Investment Tax Credit: refunds up to 40 per cent of the cost of purchasing and installing eligible equipment for qualifying projects that produce hydrogen from electrolysis or natural gas (subject to certain conditions) through their production process.
• Clean Technology Investment Tax Credit: helps businesses adopt eligible clean technology with up to a 30 per cent refundable tax credit on the capital cost of qualifying equipment, including electricity generation systems, stationary electricity storage systems, low-carbon heat and electricity equipment and industrial zero-emission vehicles and related equipment. Budget 2023 expands the credit to include specific geothermal energy equipment and systems.
• Investment Tax Credit for Clean Technology Manufacturing: refunds up to 30 per cent of the capital cost of eligible depreciable property used for clean technology manufacturing and processing, including for extraction and processing of critical minerals.
• Investment Tax Credit for Clean Electricity: provides a refundable 15 per cent credit applicable to certain eligible investments in non-emitting electricity generation systems, including wind, solar, hydro, nuclear, and specific electricity generation, storage, and transmission systems.

One anticipated tax measure in this year’s budget is the two per cent tax on the net value of share buybacks, which applies when a Canadian-resident public corporation whose shares are listed on a designated stock exchange buys back its own stock from current shareholders. This tax also applies to unit buybacks by real estate investment trusts, specified investment flow-through (SIFT) trusts and SIFT partnerships whose units are listed on a designated stock exchange. The tax applies to share and unit repurchases on or after January 1, 2024, with certain exceptions.

The budget also includes draft legislation to amend the General Anti-Avoidance Rules (GAAR), which is available for public comment until May 31, 2023. The budget says that these changes are intended to strengthen the legislation by providing additional interpretative certainty, introducing a lower threshold for the definition of an avoidance transaction, expanding the rules to consider the economic substance of certain transactions, and imposing penalties and an extended reassessment period in certain cases.

One new tax proposal with implications for financial institutions is the denial of the deduction for dividends they receive on shares of “mark-to-market property.” This change results in all income earned by financial institutions on mark-to-market property being taxed as ordinary business income and applies to dividends received after 2023.

Canada, along with 137 other countries and jurisdictions agreed to certain key aspects of the OECD/G20 Inclusive Framework’s two-pillar proposal to address tax challenges of the digitalization of the economy in October 2021. Generally, Pillar One focuses on the allocation of taxing rights among jurisdictions and Pillar Two focuses on ensuring large Multinational Enterprises (MNEs) pay a minimum rate of tax. This year’s budget contains an update outlining the next steps of Canada’s implementation of both pillars.

Budget 2023 states that the government is participating with other countries in an OECD-led process to develop and finalize the model rules and the related multilateral convention, with a view to a signing of the convention for Pillar One by mid-2023, to bring it into force in 2024. The budget also reiterates the government’s earlier position on the proposed Digital Services Tax (DST), which could be imposed as of January 1, 2024, for revenues earned as of January 1, 2022, if the Pillar One framework has not come into force. The government also says it intends to release revised draft proposals on the DST for public consultation.

Budget 2023 also confirms the government’s intention to introduce legislation to implement Pillar Two rules including the Income Inclusion Rule (IIR), an Undertaxed Profit Rule (UTPR), as well as a domestic minimum top-up tax for Canadian entities of MNEs within the scope of the rules. Budget 2023 indicates that draft legislative proposals should be available for consultation in the near future regarding the IIR and the minimum top-up tax, which would apply to fiscal years beginning on or after December 31, 2023. Draft proposals on the UTPR will follow at a later date, effective for fiscal years that begin on or after December 31, 2024.

Until such time, organizations should consider the potential impacts of the future tax proposals. The rules around BEPS Pillars One and Two are multifaceted and complex and will continue to evolve. As Canada moves closer to finalizing its implementation of the OECD/G20 Inclusive Framework, KPMG tax consultants can assist by reviewing the tax position and developing strategies that anticipate future scenarios.

Budget 2023 also reaffirms the government’s previously announced intention to proceed with a public consultation on changes to the transfer pricing rules for MNEs, and confirms that Finance also intends to move ahead with other previously announced outstanding tax measures, such as the Excessive Interest and Financing Expenses Limitations (EIFEL) rules, rules addressing hybrid mismatch arrangements, and Mandatory Disclosure Rules (MDR), which have since been updated for transactions with new relieving amendments.

The EIFEL and mandatory disclosure rules (MDR) are particularly complex and introduce new reporting requirements. Planning can help organizations take the necessary first steps to verify their compliance obligations and streamline the reporting process in advance of regulatory implementation.

To help with the MDR rules, KPMG has developed a robust software tool that helps analyze transactions spanning multiple jurisdictions. To prepare for the EIFEL rules, KPMG's experienced tax consultants can help businesses conduct a high-level impact assessment and consider mechanisms to manage outcomes. Our cross-functional tax teams can help corporations understand the regulatory updates, consider the effects, and set a customized approach in motion.

As Canadian business owners reach retirement age, many plan to transfer their companies, farms, and fisheries to the next generation – whether to family members or employees. These transfers help sustain the Canadian economy and forge a pathway to ownership for younger Canadians.

The introduction of private member’s Bill C-208 in 2021 has made it easier for certain intergenerational transfers of family businesses, farms, and fishing companies, by removing the additional tax cost some families previously faced when transferring shares of their family business to corporations controlled by their children or grandchildren as opposed to third parties. However, shortly after the bill was enacted, the government indicated that it would introduce further amendments to ensure the relief only applied to genuine intergenerational transfers. To achieve this objective, this year’s budget introduces new restrictions (immediate or gradual transfer options) intended to narrow the application of the relief introduced in Bill C-208. Eligible transfers must also satisfy a range of new conditions to qualify for tax relief. These amendments are proposed to apply to transactions that occur on or after January 1, 2024.

Last year’s federal budget proposed the creation of Employee Ownership Trusts (EOT) to give business owners a tax-effective way of transferring ownership to employees. Budget 2023 follows through on this proposal with the introduction of new rules that facilitate the transfer of shares to employees for eligible businesses, effective January 1, 2024. Highlights include the extension of the five-year capital gains reserve to a ten-year reserve for qualifying business transfers, as well as an exception to the current shareholder loan rules that extends the repayment period from one to 15 years for amounts loaned to the EOT by a qualifying business to purchase shares. In addition, a qualifying EOT will not be subject to the 21-year deemed disposition rule that applies to certain trusts. Several conditions must be met for the trust to qualify as an EOT.

Consultants in our KPMG Enterprise and Private Company Tax practices can provide the necessary advice to help owners understand the full range of options available to them, from intergenerational transfer, to EOT, third-party sale, merger, acquisition, or restructuring. Across these options, KMPG tax advisors can help organizations understand the tax implications, manage due diligence, and supervise the transaction to ensure a positive, compliant outcome, and a smooth transition.

This year’s budget contains another anticipated tax measure focused on some high-income Canadians who pay a low rate of tax. Changes to the Alternative Minimum Tax (AMT) regime are proposed that broaden the AMT base for calculation, raise the AMT tax rate (from 15 to 20.5 per cent) and increase the AMT exemption (from $40,000 to approximately $173,000). The budget estimates that under these changes, more than 99 per cent of the AMT paid by individual Canadians would be paid by those that earn more than $300,000 per year, and about 80 per cent would be paid by those that earn more than $1 million per year. The budget notes that more details on these proposed changes will be shared later this year and the new rules would apply for taxation years beginning after 2023.

The budget also includes several measures that help Canadians plan and budget for work, education and retirement. The following are among the changes and additions:

• Beneficiaries of Registered Education Savings Plans (RESPs) gain certain new withdrawal opportunities and divorced and separated parents become eligible to open RESPs for their children.
• The budget removes the 50% refundable tax from certain fees and premiums paid with respect to specific Retirement Compensation Arrangements
• Specific qualifying family members – now expanded to include brothers and sisters – will be able to open and hold a Registered Disability Savings Plan for certain eligible adults until December 31, 2026
• The allowable deduction for tradespeople’s tool expenses will increase from $500 to $1,000, effective for 2023 and subsequent taxation years.

Professional advisors in KPMG’s Tax and Family Office practices can help Canadian families, individual taxpayers, and business leaders navigate new tax rules, determine their impact, and leverage incentives in support of a variety of objectives – from education, to retirement, family wealth planning, and business growth.

With a contribution of $1 billion over five years, beginning in 2022-2023, the government committed to undertaking a program review of Canada’s longstanding Scientific Research and Experimental Development (SR&ED) program.

This year’s budget reaffirms a continuation of that review with the intention of furthering the development, retention, and commercialization of intellectual property (IP). That process will consider the adoption of a patent box regime, a system which could reduce the tax rate on income from Canadian IP.

Other budget measures that may spur economy activity support “Made in Canada” creativity and prioritize sustainable innovation. For instance, the budget commits $500 million over ten years to the Strategic Innovation Fund (SIF) to support the development of Canadian clean technologies and up to $1.5 billion of current SIF resources towards projects that advance clean technologies, critical minerals, and industrial transformation. Regional priorities and Indigenous-led projects, and electricity grid projects will be supported with $3.0 billion over 13 years provided through Natural Resources Canada to the Smart Renewables and Electrification Pathways Program.

Other initiatives support productivity and innovation by indirect means – for instance, through enhanced cooperation between provincial and federal governments. Tailored bilateral agreements that support labour mobility, strengthen long-term care, and strengthen trade corridors can help achieve a multiplier effect with provinces and the government working together.

At the same time, some areas were not prioritized this year that received attention in previous budgets. Among these are investments in digital infrastructure, cybersecurity, and transparent and open government. Agile and digital procurements for defense purposes were also not reflected.

KPMG in Canada’s tax professionals have extensive knowledge and experience to help businesses navigate the road ahead as budgetary measures take effect. With insight across industry sectors in Canadian and global marketplaces, our consultancy can assist businesses achieve stability, leverage opportunities, and stay ahead in a changing economy.