With the end of 2011 fast approaching, it is useful to keep in mind some key deadlines.
1. ACCRUED BUT UNPAID EXPENSES
Where a taxpayer owes an amount to a non-arm's length person that is deductible for tax purposes, there is a limit to how long it can go unpaid before the deduction gets reversed. An amount incurred by the taxpayer to a non-arm's-length person in one taxation year must be paid by the end of the second following taxation year of the payer. If it remains unpaid by that time, the amount is added back into the taxpayer's income in the immediately following taxation year, effectively reversing any deduction taken. This means that if a taxpayer incurred a deductible expense to a non-arm's length person in its 2009 taxation year, the taxpayer must pay the expense by the end of the 2011 taxation year to avoid having to add back the amount in income for the 2012 taxation year. Alternatively, the taxpayer and non-arm's length person can file a joint Form T2047 to deem the amount to have been paid and loaned back to the taxpayer, which will avoid the income add-back. However, this form must be filed by the time the taxpayer's income tax return for that following year (2012 in the above example) is due. A common situation where this arises is interest expense owing by one member of a corporate group to another.
Another rule applies to a taxpayer's accrued but unpaid employee expenses, i.e., salary, wages, pension benefits, retiring allowances and other remuneration (except reasonable vacation or holiday pay or a deferred amount under a salary deferral arrangement). The taxpayer must pay any such expense by 179 days after the end of the taxation year in which it was incurred. If the expense is not paid within that time period, the taxpayer will not be able to deduct it in the year it was incurred but only in the year when it is actually paid.
2. DEBTS OWING TO CORPORATIONS BY SHAREHOLDERS AND CONNECTED PERSONS
If a shareholder of a corporation (or someone connected to such a shareholder) owes to the corporation an amount that remains outstanding for too long, the amount will be treated as income from the corporation for tax purposes. Subject to some exceptions, the general rule is that if a person is a shareholder of a corporation (or a person not dealing at arm's length with such a shareholder) and has become indebted to the corporation (or to a related corporation), the amount of the debt is included in that person's income. The principal exception to this rule is where the indebtedness is repaid within one calendar year after the end of the corporation's taxation year in which the indebtedness arose, e.g., for a debt incurred during the taxation year of a corporation ending on December 31, 2010, the deadline for repayment is December 31, 2011. To qualify for the exception, the repayment cannot be part of a series of loans or indebtedness and repayments.
If a loan or indebtedness owed by a non-resident person is caught by the rules and is not repaid within the permitted time period, the amount of the loan or indebtedness is deemed to be a dividend received by the non-resident from the corporation and is subject to Canadian non-resident withholding tax at the 25% domestic rate (unless reduced under an applicable tax treaty).
These income inclusion rules do not apply to (1) debtors that are corporations resident in Canada, (2) amounts owing between non-residents of Canada, (3) certain loans to employees, or (4) debts arising in the ordinary course of the creditor's business where there are bona fide arrangements for repayment made at the outset. A debtor that is a foreign subsidiary of the corporation will generally not be caught by these rules; in other words, "downstream" loans are generally permitted.
3. INTEREST ON DEBTS OWING TO CORPORATIONS BY SHAREHOLDERS AND CONNECTED PERSONS
If a shareholder of a corporation (or a person connected to such a shareholder) has incurred a debt to the corporation (or to a related corporation), a specific rule requires the debtor to include in income for tax purposes at least a minimum amount of interest on the loan or debt. This rule applies even where the loan or debt has been outstanding for only part of a year. An interest benefit will be included in the debtor's income for a taxation year to the extent that interest on the loan or debt computed at a prescribed rate exceeds interest on the loan or debt for the period paid within 30 days after the end of the year.
If the debt was incurred for income earning purposes (e.g., a loan to buy common shares), the debtor may have an offsetting interest expense deduction. Otherwise, it will be important to ensure that an appropriate amount of interest is paid within 30 days of the end of the relevant taxation year, in order to prevent a deemed income inclusion. This interest inclusion rule does not apply (1) to debtors that are corporations resident in Canada, or (2) where the amount of the loan or indebtedness has been included in income under the rules described in section 2 above.
A similar income inclusion rule applies to a person who receives a loan or incurs a debt because of his/her previous, current or intended employment, as well as to a corporation carrying on a personal services business where the corporation receives a loan or incurs a debt because of the services performed or to be performed by it.
Where a loan or debt incurred by a non-resident person is caught by this rule, the interest benefit is deemed to be a dividend received by the non- resident and is subject to Canadian non-resident withholding tax at the 25% domestic rate (unless reduced under an applicable tax treaty).
4. INTEREST ON DEBTS OWING BY NON-RESIDENTS TO CANADIAN-RESIDENT CORPORATIONS
Where a non-resident person owes an amount to a Canadian-resident corporation, a specific rule applies to ensure that the Canadian corporation reports at least a minimum amount of interest on that debt for tax purposes. To the extent that (1) the debt has remained outstanding for more than one year, and (2) the Canadian corporation includes in its income for a taxation year an amount that is less than a "reasonable" rate of interest on the debt, the Canadian corporation must include in income for the year an amount equal to interest on the outstanding debt computed at a prescribed rate, minus any interest actually received or included in income for that year. This rule governing direct debts is supported by an indirect debts provision, which applies where a Canadian corporation has made a loan or transfer to an intermediary that in turn makes a loan or transfer to the non-resident. In those circumstances, the non-resident is deemed to owe an amount directly to the Canadian corporation, so that the direct-debt rules apply.
These rules make it important to ensure that no or low-interest debts are repaid within the one-year period allowed. Certain debts are excluded from the application of these rules, including:
- a debt, described in section 2 above, that has been deemed to be a dividend and subjected to non-resident withholding tax;
- amounts owing by an unrelated non-resident where the amount arose in respect of goods sold or services provided by the Canadian resident corporation in the ordinary course of its business and on arm's length terms and conditions; and
- a debt owing by a closely-held controlled foreign affiliate (CFA) of the Canadian corporation which relates to an active business carried on by the CFA (or another CFA of the taxpayer).
5. REPORTABLE TRANSACTIONS
Under the proposed mandatory reporting regime for "aggressive" tax avoidance transactions, a taxpayer must file an information return in respect of a tax avoidance transaction entered into after 2010 (or that is part of a series of transactions that began before 2011 but is completed after 2010) if it satisfies two out of three "hallmarks" regarding its fee structure, confidential protection and/or contractual protection.
The filing deadline for the information return in respect of a reportable transaction is on or before June 30 of the calendar year following the year in which the transaction first became a reportable transaction in respect of the person. However, for a transaction that is part of a series of transactions that began before 2011 but is completed after 2010, the Department of Finance Canada has indicated in the Explanatory Notes to the draft legislation that the information return will be deemed to have been filed by the June 30, 2011 deadline as long as it is filed by the end of 2011 (see http://www.fin.gc.ca/drleg-apl/ita-lir10n-eng.pdf at page 210).
6. CORPORATE MEMBERS OF PARTNERSHIPS
As a result of the 2011 federal budget, corporate members of partnerships generally can no longer defer the taxation of income earned through a partnership that has a fiscal year-end different from the corporation's own taxation year-end. For taxation years ending after March 22, 2011, a corporation that has a significant interest in a partnership (generally, an entitlement to more than 10% of the income or loss of the partnership either alone or together with related and affiliated persons) must include in income its accrued share of the partnership's income for the portion of the partnership's taxation year that falls within the corporation's taxation year. For partnerships already in existence prior to the budget announcement, a corporation may be eligible to benefit from transitional relief that allows the initial 2011 stub period income to be reported over a five-year period from 2012-2016.
In many cases taxpayers will seek to avoid these complex new rules by electing to change the fiscal period of the partnership to correspond with the taxation year of one or more corporate partners. The deadline for filing such an election is the first filing due date of any corporate partner for its first taxation year ending after March 22, 2011. The Canada Revenue Agency has stated that no elections will be accepted after the due date (see http://www.cra-arc.gc.ca/tx/bsnss/tpcs/crprtns/dfrrl/chngfscl-eng.html).
These new rules also apply to joint venture arrangements, which in the past had benefited from the CRA's now withdrawn administrative policy allowing the joint venture to establish its own fiscal period. Income from a joint venture must now be computed for each participant based on the participant's own fiscal period. At the 2011 Canadian Tax Foundation Annual Conference held in November 2011, the CRA announced that joint venture participants will be allowed to elect to receive the five-year transitional relief applicable to partnerships. However, to claim such relief the CRA requires joint venturers to file an election to that effect on or before the filing due date for their first taxation year ending after March 22, 2011 (see CRA document 2011-0429581E5, dated November 29, 2011).About BLG
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