Canadian Tax Changes in 2021 Economic and Fiscal Update

Record fiscal and monetary stimulus has been injected into the Canadian economy over the past 21 months since the outbreak of the COVID-19 pandemic in March 2020. Many market observers have become increasingly wary of tax increases on the horizon. After all, record federal deficits of $314B were racked up in fiscal 2020/2021, and are projected to be $144.5B in fiscal 2021/2022. Whether the size of these deficits is justified is outside of the scope of this discussion, but the fact is that debts will eventually need to be paid for by the Canadian taxpayer in one way or another.On December 14^th, the Government of Canada released its long awaited 2021 Economic and Fiscal Update outlining (among other topics) the current state of the economy, priorities for the upcoming year, and new tax measures that will be adopted. The update proved to be more consequential from a taxation perspective for the items that were not included, rather than those which were.Below are a few key items from the 2021 Economic and Fiscal Update:

Changes

Underused Housing Tax

In another real estate-related topic, the budget affirmed that the tax on underused housing in Canada will become effective in 2022. This tax applies to Canadian residential real estate owned by non-residents that is vacant or underused. A tax in the amount of 1% annually will be applied on the market value of a property that fits this category. There are some situations that would exempt a property that otherwise fits this category from the tax. One new exemption that was brought forward is for vacation/recreational properties if they are located in a region with under 30K residents and is used by the owner or their spouse for at least four weeks in the calendar year. It’s key to note this tax only applies to non-residents.

Digital Services Tax

A new tax of 3% on revenue in excess of $20M will apply to digital services that use data, content contributions or engagement of Canadian users starting effective January 1^st, 2022. This tax will only apply to companies who have global revenue of over 750M Euros in the previous year, and more than $20M of digital services revenue within Canada within the calendar year. Canada has been working to create a multi-lateral approach with the OECD and the G20 to tax these types of revenues since 2013 but has decided to adopt its own tax until a consensus has been reached and can be adopted.Even with record fiscal and monetary stimulus, we have yet to see major tax changes here in Canada. This may change if interest rates increase and the cost of borrowing increases for the government. We constantly monitor potential tax changes at Northwood to help identify potential planning opportunities ahead of prospective changes.

No Changes

Capital Gains Inclusion Rate Increase

It has been widely speculated that the capital gains inclusion rate might increase, however, this was not indicated in the fall update. As advisors, we have seen rumors of this change several times in recent years, yet the inclusion rate has remained at 50% since October 2000. This speculation has led to some Canadians pursuing tax planning measures to pre-emptively crystalize gains ahead of fiscal updates to realize capital gains before any potential increase in the inclusion rate. If the capital gains inclusion rate were to increase to 75%, capital gains would be taxed similar to public company dividends at around 40%. While the capital gains inclusion rate was not increased this time, it will remain on the radar of advisors and tax planners in 2022.

Elimination of the Principal Residence Exemption

It seems that Canadians just can’t stop talking about real estate following the extreme price increases within the country following the global financial crisis and that has only accelerated since the COVID-19 pandemic. The most recent rumblings have been that the government is going to eliminate the principal residence exemption that allows homeowners to shelter any capital gains realized through the sale of their principal residence (or set limits similar to the US). This measure was also not mentioned in the fall update, and during the 2021 election campaign, the Liberal Party of Canada specifically denied that they would pursue the elimination of this exemption. However, with housing affordability rapidly deteriorating, look out for other measures to be debated and potentially introduced related to housing in the near term.

Tax on Select Luxury Goods

In the 2021 federal budget, a “luxury tax” was proposed on retail sales of vehicles and personal aircraft valued at over $100K, and boats over $250K. The proposed tax amount would be the lesser of 10% of the full value of the purchased goods, or 20% of the value over $100K in the case of vehicles and personal aircraft, and over $250K for boats. This tax generally seems more about optics and isn’t expected to raise a great deal of tax revenue, but it was not mentioned in the fall update that the tax would be implemented on the date originally projected of January 1^st, 2022. Tax legislation on this matter is expected to be introduced for the next federal budget. If you are considering purchasing a luxury car, boat, or plane – it might be best to do so ahead of the spring budget (typically in March).