Taxation

On November 2, 2023, in response to certain controversy, the Canada Revenue Agency (“CRA”) sought to clarify the application of the new disclosure rules, in force since June 22, 2023. The CRA’s comments relate, in particular, to the impact of reporting obligations on severance agreements, a topic we initially covered a few weeks ago1. We believe it is appropriate to go over these clarifications. As a reminder, the disclosure rules generally apply to so-called avoidance transactions carried out to obtain a tax benefit and presenting one of the following three generic hallmarks: contingent fee arrangements, confidential protection or contractual protection. At first glance, the interpretation of these hallmarks suggests that severance agreements involving an employee’s undertaking to indemnify their employer are subject to reporting obligations. However, in response to questions from a number of legal experts, the CRA commented on the disclosure rules, specifying, in particular, that a tax indemnity granted under a severance agreement is not subject to the reporting obligation where it occurs in a business or financial context between persons dealing at arm’s length, and acting freely and prudently. In this regard, the CRA pointed out that the contractual protection included in such an agreement would not be considered a generic hallmark insofar as it does not cover a tax treatment giving rise to an unwarranted benefit. The CRA gave as an example a settlement reached between an employer and employee further to dismissal, harassment complaints or other employment-related recourses, providing for severance pay or warranted damages. Even if the employee were to undertake to reimburse the employer in the event of unexpected tax treatment, this type of agreement would not give rise to reporting obligations. Although the CRA’s clarifications were meant to clear things up, they did not definitively establish how the mandatory disclosure rules apply to severance agreements. A certain level of uncertainty remains with regard to severance agreements with no real legal basis awarding tax-free damages to an employee. In such a case, it would be difficult to argue that the business context warranted a favourable tax treatment for the employee. In the case of an agreement providing for the payment of unwarranted damages, and where contractual protection extends to the tax treatment of the amount paid, the avoidance transaction may, despite the CRA’s comments, require disclosure to the tax authorities. One thing is certain: tax indemnity clauses may well disappear from severance agreements.  Ultimately, the new rules reinforce the principle that the granting of tax-free damages should be limited to circumstances that warrant it. Quebec case law has long established that the mere fact of losing one’s job does not give rise to damages, barring exceptional circumstances. In short, the CRA’s guidelines do not have the force of law, and may be amended or revoked at any time. Consequently, maintaining a cautious and conservative approach will be crucial when determining whether the new mandatory disclosure rules apply to severance agreements. Our team of employment law and tax professionals is available to answer your questions about these major changes and help you make informed decisions when negotiating severance agreements. Termination agreements: New reporting requirements apply!

Canada’s finance minister unveiled a series of legislative proposals on August 4, 2023 aimed at making significant changes to the flow-through share regime, particularly as regards lithium exploration. Although a number of these changes had already been announced in the 2023 federal budget, e.g. the inclusion of lithium brine in the “mineral resources” definition, they had not really affected junior exploration companies in Quebec since this type of lithium is virtually non-existent in the province. More targeted change However, the recent proposals include a more targeted change for mining companies exploring for traditional “hard rock” lithium, which is much more common in Quebec. These proposals include amending the definition of “mineral resources” to systematically includetraditional hard-rock lithium in the list set out in section 248 of the Income Tax Act (the “Act”). The consequences As a consequence of this change, the requirement for mining companies to obtain a certificate issued by Natural Resources Canada will be eliminated. The application process for this certificate represented a heavy administrative burden for exploration companies. Moreover, lengthy processing times often delayed the conclusion of flow-through share subscription agreements. This change is a timely one: growing numbers of companies are refocusing on exploring for lithium rather than for more traditional metals such as gold. This reflects not only the market’s infatuation with lithium, but also the recent 30% tax credit potentially available to investors incurring mining exploration expenses involving critical metals. Proceed with caution For the time being, however, these legislative proposals only apply to lithium; they do not cover all critical minerals. Mining exploration companies should proceed with caution if they plan to explore for other types of critical minerals such as graphite and rare earth elements, for example. This is because a mineral resources certificate issued by Natural Resources Canada may still required in those cases. Our team of professionals specializing in securities, mining law and taxation is available to answer any questions you may have concerning this new measure and to guide you in arranging a successful flow-through financing.

On June 22, 2023, the federal government significantly expanded the reporting requirements for certain so-called avoidance transactions, in particular with respect to termination agreements.1 The new rules will make it easier for the Canada Revenue Agency (CRA) to detect certain avoidance schemes, conduct tax audits and issue notices of assessment and penalties more quickly when warranted. The reporting requirements now apply to reportable transactions defined as avoidance transactions, which are primarily aimed at obtaining a tax benefit. If these avoidance transactions involve one of the three markers set out by the Minister of Finance: contingent fee arrangement, confidential protection or contractual protection, they must be reported to the CRA in accordance with the rules in force. These enhanced rules cover a large number of transactions, in particular those which are part of agreements made specifically in the context of end-of-employment negotiations. In settlements between an employer and an employee following termination, harassment complaints or other employment-related disputes, damages may be awarded as part of the negotiation process. However, the award of these damages, which are normally granted in situations where the employee has suffered personal or moral harm, may not always have a strong legal foundation. In some cases, these damages may be part of a tax-driven strategy: while severance payments are taxable as employment income or as a retirement allowance, damages may be tax-exempt. This type of agreement allows the employer to pay less while maximizing the net amount for the recipient. An agreement providing for the payment of a tax-free amount for damages usually includes an undertaking by the employee to indemnify the employer when a tax audit concludes that the payment should be taxable. The new reporting requirements are likely to prevent these types of settlements in cases where it is reasonable to conclude that their main purpose is to obtain an unfair tax benefit. These avoidance transactions also exhibit the hallmark of contractual protection, which refers to a protection or guarantee against any failure of the transaction to produce a tax advantage. This is the case when the employee agrees to compensate the employer following a tax recalculation. Such contractual agreements now meet the new reporting criteria. In these transactions, the reporting obligation is incumbent on the employee (i.e., the person who obtains the tax benefit), the employer (i.e., the person who completes the transaction), and the advisor who obtains fees for setting up the transaction. They have 90 days from the time they entered into the transaction to submit Form RC312 to the CRA. Failure to do so will result in penalties and an extension of the normal reassessment period. As a result, it is inevitable that these updated rules will be taken into account when negotiating termination settlements, and it will be particularly important to review all agreements made since June 23, 2023. Our team of employment law and tax professionals is available to answer your questions about this major change and help you make informed decisions when negotiating termination agreements. Bill C-47: An Act to implement certain provisions of the budget tabled in Parliament on March 28, 2023

On March 21, 2023, during his traditional budget speech, the Minister of Finance of Québec announced that Quebecers will benefit from a general reduction in personal income taxes starting in 2023. The effect will be a reduction in the tax rates that apply to the first two taxable income brackets of the personal income tax table. In addition to having a positive impact on Quebecers’ disposable income, the tax cut will also have repercussions on source deduction rates applied to certain payments and remuneration. The fixed rates used for provincial income tax source deductions on lump-sum payments have been changed. Employers will therefore have to adjust their calculations for such payments. This will be the case, for example, where sums are paid as retiring allowances, as is frequently the case in the settlement of certain employment termination agreements. Previously, the rate used to calculate provincial income tax source deductions on a retiring allowance payment was 15% for amounts up to $5,000, and 20% for payments over $5,000. The income tax deductions on such payments made after June 30, 2023, is now 14% for amounts up to $5,000, and 19% for payments over $5,000. Table of provincial and federal income tax source deduction rates for lump-sum payments, effective July 1, 2023, by amount of lump-sum payment (e.g. retiring allowance): $5,000 or less Provincial tax rate 14% Federal tax rate 5% Over $5,000 up to $15,000 Provincial tax rate 19% Federal tax rate 10% Over $15,000 Provincial tax rate 19% Federal tax rate 15% Although it may seem trivial, this review of provincial income tax source deduction rates has far-reaching implications, given that these are often used by parties especially in the negotiation of employment termination agreements. Human resources and payroll professionals must use the new income tax source deductions in their employment termination negotiations to ensure that they are tax compliant. A positive outcome of these rates is that employees will now have more disposable income after tax for the same amount paid by their employer. Such a measure could make reaching an agreement easier in the context of tough negotiations. As an employer, it is essential that you update your payroll systems and processes to correctly reflect the new income tax rates and ensure tax compliance. Our team of labour law and tax professionals is available to answer your questions about this change and help you make informed decisions that will benefit your business.