Canada: Business Income Tax Measures

Loss Trading

Corporate Loss Trading

Budget 2013 proposes to introduce a new rule to target what the Government describes as a form of corporate loss trading.  The Budget materials cite as an example the transfer by a profitable corporation (Profitco) of income earning assets to an unrelated corporation with tax attributes (Lossco), in return for shares of Lossco.  The acquisition of control loss-restriction rules of the Income Tax Act (Canada) (the ITA), which could otherwise constrain a corporation from using its tax attributes following an acquisition of control (the loss restriction rules), do not apply to Lossco on the basis that the shares of Lossco taken back by Profitco do not give Profitco voting control over Lossco, although they would represent the majority of the fair market value of all of Lossco's shares.  Lossco would then earn income sheltered by its tax attributes, and pay to Profitco tax-free inter-corporate dividends. 

The new rule applies at a particular time where:  (a) a person or a group of persons first holds shares of the capital stock of a corporation (Targetco) with an aggregate fair market value that exceeds 75% of the fair market value of all of the shares of the capital stock of Targetco, (b) the person or group does not control Targetco, (c) and it is reasonable to conclude that one of the main reasons that the person or group does not control Targetco is to avoid the application of one or more loss-restriction rules.  If the rule applies, then, for the purposes of the loss-restriction rules and certain other rules of the ITA, among other things, the person or group of persons is deemed at the particular time to acquire control of Targetco, and of each corporation controlled by Targetco.  In determining whether the 75% value test has been met, the person, or each member of the group, as applicable, is deemed to have exercised rights it holds to acquire shares of Targetco.  Certain measures are also introduced to prevent the effect of transactions entered into to avoid the application of the rule.  In applying the rule, if the fair market value of the shares of Targetco is nil at any time, Targetco is deemed to have a net asset value of $100,000, and income for the current taxation year of $100,000.

Trust Loss Trading

Budget 2013 also proposes to extend the application of the loss restriction rules and related rules to trusts.  The rules would apply to a trust if the trust is subject to a "loss restriction event".  Very generally, a trust will be subject to a loss restriction event when a person (including a partnership) becomes a majority-interest beneficiary of the trust, or a group of persons become a majority-interest group of beneficiaries of the trust.  The concepts of majority-interest beneficiary and majority-interest group of beneficiaries will be as they apply under the affiliated persons rules of the ITA, with appropriate modifications.  In general, these rules provide that a majority interest beneficiary of a trust is a beneficiary whose interest in the income or capital of the trust, together with the beneficial interests of persons or partnerships with whom the beneficiary is affiliated, has a fair market value that is greater than 50% of the fair market value of all the interests in the income or capital, respectively, of the trust. 

The proposed rules that determine when a loss restriction event occurs are lengthy and detailed.  Among other things, they ensure that the rules of the ITA that deem an acquisition of control of a corporation to have (or have not) occurred as a result of a particular transaction or event will apply, with appropriate modifications, to determine whether a loss restriction event has (or has not) occurred.  Budget 2013 states it is expected, and appropriate from a tax policy perspective, that typical transactions or events involving changes in the beneficiaries of a personal trust will not, because of continuity of ownership rules introduced as part of these measures, result in a loss restriction event.  Taxpayers are invited to submit, within 180 days after March 21, 2013 (Budget Day), comments as to whether additional transactions or events should be treated in a similar manner.

The new corporate and trust loss trading rules come into force as of Budget Day, but generally will not apply to an event or transaction that occurs on or after that time pursuant to obligations created by the terms of a written agreement entered into before Budget Day.  Budget 2013 states the Government will continue to monitor the effectiveness of the constraint on trading of losses and determine whether further action is warranted.

Benefits to the Manufacturing Sector

Certain manufacturing and processing machinery and equipment that would otherwise be included in Class 43 of Schedule II of the Income Tax Regulations currently qualifies for an accelerated capital cost allowance (CCA) under Class 29 if it is acquired by a taxpayer after March 18, 2007 and before 2014.  Budget 2013 extends this temporary measure by an additional period of two years so that manufacturing and processing machinery and equipment acquired in 2014 and 2015 will also qualify.

This extension forms part of a package of benefits to the manufacturing sector valued at $4.5 billion, including $1.4 billion in foregone tax revenues over three years for this extension, $1 billion over 5 years for aerospace development (previously committed), $200 million over five years for a new Advance Manufacturing Fund in Ontario and $92 million over two years for forestry innovation.  In addition, the Government proposes to expend $53.5 billion over five years on public projects.

Scientific Research and Experimental Development Program – Disclosure of Third Parties

Budget 2013 proposes to introduce additional information reporting measures with respect to Scientific Research & Experimental Development (SR&ED) claims where the risk of non-compliance is perceived to be high.  In particular, detailed information about SR&ED program tax preparers and billing arrangements will be required to be provided on program claim forms where one or more third parties have assisted with the preparation of a claim.  A claimant will otherwise be required to certify that no third party assisted in any aspect of the preparation of the SR&ED claim.

Budget 2013 also proposes that a $1,000 penalty be imposed on each SR&ED program claim for which the information about the SR&ED program tax preparers and billing arrangements is missing, incomplete or inaccurate. A third party preparer who has assisted in the preparation of the claim will be jointly and severally, or solidarily, liable for the penalty.

These proposals apply to SR&ED program claims filed on or after the later of January 1, 2014 and the day the enacting legislation receives Royal Assent.

Future Reclamation Costs

Under the ITA, a taxpayer earning income from a business may generally claim a reserve for amounts received in a taxation year in respect of services that may reasonably be expected to be rendered after the end of that taxation year. In the Government's view, this reserve is not intended to provide relief for taxpayers who have rendered services to customers, but who have future obligations to persons other than customers arising from the provision of such services.  Consequently, Budget 2013 proposes to amend the ITA to make the reserve inapplicable to amounts received in respect of future reclamation obligations. Budget 2013 states that taxpayers with future reclamation obligations are generally eligible to use the Qualifying Environmental Trust rules.

Mining Expenses

Budget 2013 proposes two new measures intended to more closely align the deduction rates for tangible and intangible costs incurred in the mining sector with those incurred in the oil and gas sector, including bituminous sands. First, the deduction rate for pre-production development costs (essentially intangible expenses incurred for the purpose of bringing a new mine into production in reasonable commercial quantities) will be reduced from 100% to 30% per year, on a declining balance basis. This change is effective as of 2018 for expenses incurred under an existing written agreement, or in respect of a new mine on which construction was started or engineering and design work began before Budget Day. For other costs, the change will be phased in on a gradual basis, beginning in 2015 until 2018. 

Budget 2013 also proposes to phase out the accelerated CCA deduction that currently applies, in addition to the normal 25% CCA rate, for the cost of most machinery, equipment and structures acquired for use in new mines or eligible mine expansions. Under the transitional measures proposed, the accelerated CCA deduction will continue to be available in respect of assets acquired before 2018 either under an existing written agreement, or in respect of a new mine or as part of an eligible mine expansion on which construction was started or engineering and design work began before Budget Day.  For other assets, the accelerated CCA deduction will be phased out on a gradual basis beginning in 2017 until 2021.

Taxation of Corporate Groups

Budget 2013 announces the completion of the Government's previously announced initiative to review whether new rules for the taxation of corporate groups - such as the introduction of a formal system for loss transfers or consolidating reporting - could improve the functioning of the tax system.  The Government has determined that moving to a formal system of corporate group taxation is not a priority as this time.  However, going forward, the Government will continue to work with provinces and territories regarding their concerns with current approaches to loss utilization.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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