Under the new legislation, if a credit union claims a deduction pursuant to subsection 137(3) (Credit Union Deduction), the tax rate applicable to the "phased-out" portion of the Credit Union Deduction is subject to a federal income tax at the full rate of 28%. This is because the 13% general rate reduction is not available on this income to bring the federal rate down to 15%. Surprisingly, however, if the credit union does not claim the Credit Union Deduction at all, all of its taxable income (less any small business deduction claimed) should be subject to the 15% federal rate (the general rate reduction is available).
We understand that the Department of Finance is currently reviewing this unintended glitch and is determining the best course of action to fix the issue.
Credit unions have access to the small business deduction and an additional deduction that provides for a preferential income tax rate on taxable income that is not eligible for the small business deduction. The 2013 federal budget announced that the additional deduction for credit unions will be phased out over five years, beginning in 2013. According to the budget, in 2013, only 80% of the additional deduction otherwise claimed will be permitted and the percentage will be reduced to 60% in 2014, 40% in 2015, 20% in 2016 and will be eliminated for 2017 and subsequent years.
Bill C-60, which was enacted on June 26, 2013, contained the amendments to implement these changes, which generally apply to taxation years that end on or after March 21, 2013. For a taxation year that includes March 21, 2013, the measure applies only to the portion of the year that is on or after March 21, 2013. The rate is also prorated, based on the number of days in each calendar year.
Glitch in computation of "full rate taxable" income
The glitch is found in subparagraph (a)(iv) of the definition of "full rate taxable income" in subsection 123.4 of the Act. In particular, if the credit union claims a Credit Union Deduction, "full-rate taxable income" does not reflect the proration of the deduction for the phase-out, which leaves the "phased-out portion" technically subject to the 28% tax rate.
Since the definition refers to an actual deduction rather than an amount being deductible, if the Credit Union Deduction is not claimed, all of the credit union's taxable income in excess of the income to which the small business deduction is applied, should qualify as "full rate taxable income" and qualify for the general rate reduction.
Example — Tax rates for 2014
The following table, which is for illustrative purposes only, assumes that the credit union is not eligible for the small business deduction and all of its taxable income is eligible for the Credit Union Deduction (subject to the 60% proration applicable in 2014).
As illustrated above, under the proposed measures announced in the 2013 federal budget, a credit union could effectively claim the Credit Union Deduction on 60% of its taxable income in 2014, with the remainder taxed at the general corporate tax rate of 15%. By 2017, the Credit Union Deduction would be fully phased-out. However, under the rules actually enacted, if the Credit Union claims the Credit Union Deduction, it will be subject to the general corporate tax rate of 28%, without the application of the general rate reduction, on its taxable income in excess of the Credit Union Deduction.
Alternatively, if the credit union did not claim the Credit Union Deduction (which is a discretionary deduction), all taxable income would be taxable at 15% (general corporate tax rate with application of general rate reduction).
Although each credit union needs to conduct an analysis based on its own particular facts and circumstances, in many cases, it would be more beneficial for the credit union not to claim the Credit Union Deduction in 2014 and later years, effectively accelerating the phase-out of the Credit Union Deduction to two years from five.
For Accounting Standards for Private Enterprise (ASPE) and IFRS purposes, a corporation’s recorded income tax liabilities and assets in their financial statements should be measured using tax rates that are considered to be “enacted or substantively enacted” at the balance sheet date. Therefore, even though the legislation contains a technical flaw acknowledged by Finance and the CRA, the tax provision must be based on the legislation as enacted, and cannot reflect the assurances of the CRA and Finance that this glitch will be fixed.
Winnie notes that there is still some uncertainty about the interplay between the new federal legislation and existing provincial legislation. For example, the relevant provisions of the British Columbia legislation refer to federal provisions which no longer exist after the enactment of these amendments.
For more information, contact your KPMG adviser.
Information is current to August 27, 2013. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500