The federal budget tabled on March 22, 2011 (the 2011 Budget) contains a number of proposed amendments to Canada's Income Tax Act (Tax Act). In this bulletin, we focus on (i) certain business income tax measures designed to limit tax deferrals and strengthen "stop-loss" rules; (ii) certain business income tax incentives relating primarily to capital cost allowance (CCA) claims; (iii) certain business income tax measures relating to oil sands properties; (iv) certain anti-avoidance personal income tax measures; and (v) certain personal income tax benefits primarily in the form of additional tax credits.
Proposed Business Income Tax Measures to Limit Deferrals and Losses
Partnership Tax Deferrals for Corporate Partners
The 2011 Budget contains proposals to limit partnership tax deferrals for corporate partners. These proposals are aimed at preserving $2.8 billion of forgone tax revenues over the next five years. Under the current rules, a corporate partner of a partnership is required to include in its income for a taxation year its share of the partnership's income for the fiscal period of the partnership that ends in the taxation year of the corporate partner. By "staggering" the corporate partner's taxation year-end in relation to the fiscal period of the partnership, income tax could be deferred. For example, a corporate partner may have a taxation year-end of December 31, whereas the partnership may have a fiscal period ending January 31. In that case, the corporate partner would include in its income for its year ending December 31, 2009, its share of the income of the partnership for the fiscal period ending January 31, 2009, which would essentially represent a deferral of income for an 11-month period. This deferral could be extended for a longer period by means of tiers of partnerships, with the corporate partner as a partner of the top partnership and the partnerships having different and conveniently staggered year-ends.
The proposed change contained in the 2011 Budget would require the corporate partner (i) to include in income its share of the partnership's income for the partnership's fiscal period that ends in the corporate partner's taxation year; and (ii) to accrue partnership income for the stub period of the partnership's subsequent fiscal period, which begins in that corporate partner's taxation year and ends in the following one. In the example given above, the corporate partner would report for its year ended December 31 not only its share of the partnership's income for the fiscal period ending the previous January 31, but also its share of the partnership's income for the stub period commencing February 1 and ending December 31. The stub period income would be reversed in the corporate partner's subsequent taxation year, and a new stub period income would then be calculated and included in income. This will affect partnership interests where the corporate partner, together with affiliated and related parties, is entitled to more than 10% of the partnership's income (or more than 10% of the assets in the case of a windup) at the end of the last fiscal period of the partnership that ended in the corporation's taxation year.
This change would likely result in the inclusion of a significant one-time amount of incremental income in the first year in which it would apply to the corporate partner (the corporation's first taxation year ending after March 22, 2011). A special transitional rule allows this one-time incremental amount to be gradually included in income over the five taxation years that follow the corporate partner's first taxation year ending after March 22, 2011. A special one-time written election is also available in certain cases in the event that a partnership wishes to change its fiscal period as a result of these proposals.
For tiered partnerships, the approach taken is somewhat different in that each partnership in a tiered partnership will be required to have the same fiscal period (whether or not it aligns with the fiscal period of any corporate partner). Tiered partnerships will be allowed a special one-time written election to choose a common fiscal period.
Stop-Loss Rules on Share Redemption
The Tax Act includes "stop-loss rules" that reduce, in certain cases, the amount of a loss otherwise realized by a corporation on a disposition (including a redemption) of shares by the amount of tax-free dividends received or deemed received on the shares on or before the disposition (including a redemption). According to the 2011 Budget, some corporations have been entering into tax avoidance arrangements to claim a double deduction on a redemption of shares by relying on certain exceptions to the existing stoploss rules; in such situations, the corporations claiming the double deduction may not have suffered a true economic loss. The 2011 Budget (i) proposes to broaden the application of the stop-loss rules to any deemed dividend received on a redemption of shares held by a corporation (whether the shares are held directly, or indirectly through a partnership or trust), regardless of level of ownership and period of ownership; but (ii) provides for a narrow exception for a redemption of shares of the capital stock of a private corporation that are held by another private corporation (other than a financial institution) whether directly, or indirectly through a partnership or trust (other than a partnership or trust that is a financial institution). The new provisions will apply to redemptions that occur on or after March 22, 2011.
Proposed Business Income Tax Incentives Relating to CCA
Accelerated Capital Cost Allowance for Manufacturing and Processing Equipment
In the 2007 Budget, the Department of Finance announced a temporary incentive for businesses engaged in manufacturing and processing activities in Canada, providing for an accelerated 50% straight-line CCA rate, subject to the "half-year rule," for qualifying machinery and equipment acquired after March 19, 2007 and before 2009. Subsequently, the 2008 and 2009 Budgets extended the accelerated CCA treatment to property acquired before 2012. The 2011 Budget proposes to extend the accelerated CCA treatment for two additional years in respect of qualifying machinery and equipment acquired before 2014. Qualifying machinery acquired by a manufacturer after 2013 will be eligible to be depreciated at a 30% declining balance CCA rate. For these purposes, qualifying machinery and equipment include property used by the manufacturer in Canada primarily in the manufacturing or processing of goods for sale or lease.
Accelerated Capital Cost Allowance for Clean Energy-Generation Equipment
The 2011 Budget provides an incentive for investment in waste heat energy-generation equipment by providing an accelerated CCA depreciation deduction in respect of such equipment. Currently, class 43.2 provides an accelerated CCA for specified clean energy-generation and conservation equipment at a rate of 50% per year on a declining balance basis, subject to the half-year rule. The 2011 Budget proposes to expand class 43.2 to include equipment that is used by the taxpayer or a lessee of the taxpayer to generate electrical energy in a process in which all or substantially all of the energy input is from waste heat. The proposal would apply only to eligible equipment that is acquired on or after March 22, 2011.
Proposed Business Income Tax Measures Relating to Oil Sands Properties
In the conventional oil and gas sector, the cost to a taxpayer of acquiring the following in Canada is treated as "Canadian oil and gas property expense" (COGPE): (i) rights to explore for, drill for or take petroleum, natural gas or related hydrocarbons, and (ii) an oil or a gas well. By contrast, the cost of acquiring oil sands and oil shale properties is generally treated as "Canadian development expense" (CDE). COGPE is deductible at a rate of 10% per year on a declining balance basis, whereas CDE is deductible at a rate of 30% per year on a declining balance basis.
The 2011 Budget proposes to align the treatment of the cost of oil sands and oil shale properties (and leases in such properties) with the treatment of the cost of acquiring conventional oil and gas properties. In particular, the cost of oil sands and oil shale properties acquired on or after March 22, 2011 will be treated as COGPE and eligible for deduction at 10% per year on a declining balance basis.
Proceeds from the disposition on or after March 22, 2011 of a taxpayer's oil sands and oil shale properties will be credited to reduce the taxpayer's cumulative CDE or cumulative COGPE, consistent with the original treatment of the acquisition.
In addition, the cost of clearing land or removing overburden for oil sands and oil shale properties will be treated as CDE rather than "Canadian exploration expense" (CEE), which would have been fully deductible. However, under the transitional relief provisions, the current CEE treatment will generally be maintained for expenses incurred before 2015 for new mines on which major construction began before March 22, 2011.
Proposed Anti-Avoidance Personal Income Tax Measures
Anti-Avoidance Measures Aimed at RRSPs and RRIFs
In October 2009, the Department of Finance announced several measures aimed at addressing abusive transactions involving tax-free savings accounts (TFSAs). In general, these measures targeted overcontributions, ineligible investments and asset transfers. To prevent a loss of an estimated $500 million in forgone tax revenues over the next five years, the 2011 Budget proposes to introduce comparable antiavoidance measures aimed at transactions involving registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs). In particular, the 2011 Budget proposes to introduce TFSAlike advantage rules, prohibited investment rules and non-qualified investment rules for RRSPs and RRIFs. Subject to two exceptions, these new provisions are to be effective for transactions occurring and investments acquired after March 22, 2011. Notably, until the end of 2012, swap transactions can be undertaken to ensure that an RRSP or a RRIF complies with the new rules by removing an investment that would otherwise be considered a prohibited investment or an investment that gives rise to an advantage under the new proposals.
Donation of Publicly Listed Flow-Through Shares
Under the Tax Act, flow-through shares are deemed to have a nil cost to their investors. As a result, a significant capital gain normally occurs when the shares are ultimately sold or disposed of. When the 2006 Budget eliminated the tax on capital gains accruing on donations of publicly traded securities to registered charities, some purchasers of publicly listed flow-through shares saw an opportunity to avoid one of the downsides of their investment. In addition, donation tax shelters were set up specifically to take advantage of this opportunity. The 2011 Budget aims to preserve $185 million of forgone tax revenues over the next five years by introducing measures that allow the exemption from capital gains tax on donations of publicly listed flow-through shares only to the extent that the capital gain on the donation exceeds the amount originally paid for the shares (determined without regard for the deemed nil adjusted cost base). These new provisions will apply where a taxpayer acquires shares issued pursuant to a flowthrough share agreement entered into on or after March 22, 2011.
Proposed New Personal Income Tax Benefits
The Budget also introduces a number of new personal income tax benefits primarily in the form of additional tax credits aimed at various different constituencies. From a monetary perspective, the most significant tax credit proposals include the Children's Arts Tax Credit and the Family Caregiver Tax Credit.
Based on similar parameters to the Children's Fitness Tax Credit, the Children's Arts Tax Credit will allow parents to claim a 15% non-refundable tax credit based on an amount of up to $500 in eligible expenses for a child who is under 16 years of age at the beginning of the year, in a eligible program of artistic, cultural, recreational or developmental activity. This new proposal will apply to eligible expenses paid in the 2011 and subsequent taxation years.
Beginning in 2012, the Family Caregiver Tax Credit will allow caregivers of dependants with a mental or physical infirmity, including spouses, common-law partners and minor children, to claim a 15% nonrefundable tax credit based on an amount of $2,000. Caregivers will benefit from the Family Caregiver Tax Credit by claiming an enhanced amount for an infirm dependant under one of the existing dependency-related credits. The $2,000 Family Caregiver Tax Credit amount is proposed to be indexed to account for inflation for 2013 and subsequent taxation years.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.