September 15, 2011
Corporate Partnerships Lose Tax Deferral
Corporations that carry on business in partnership may have to comply with complex new rules designed to eliminate their ability to defer corporate tax by selecting a fiscal period for the partnership that differs from the corporate partners’ taxation years.
The Department of Finance released draft legislation on August 16, 2011 to implement these new rules, which were proposed in the 2011 federal budget. The draft legislation (and Explanatory Notes released September 1, 2011) generally implement the budget proposals as conceived but they also clarify certain concepts and contain some unexpected changes. Finance is accepting comments on the draft legislation but only until September 16, 2011. It is not clear whether this short deadline will be extended.
Inside this Issue
This TaxNewsFlash-Canada provides an overview of the corporate partnership proposals in the following areas:
· Highlights of the new rules
· Adjusted stub period accrual
· Reserve mechanism
· Qualifying transitional income
· Illustrative example of the new rules
· Under-reported stub period accrual
· Election to change a partnership’s fiscal period
· Special rule for new corporate partners
· Multi-tier partnerships
· Implications for joint ventures
Highlights of the new rules
The budget proposals limit the tax deferral opportunities for corporations with significant interests in partnerships that have a fiscal period different from the corporations’ taxation years. The proposals apply to corporations’ taxation years ending after March 22, 2011.
In general, a corporation has a “significant interest” in a partnership if the corporation (together with related or affiliated persons or partnerships) is entitled to more than 10 percent of the income or loss of the partnership or the assets (net of liabilities) of the partnership on its dissolution.
The proposed measures require the corporation to include not only the income of the partnership for the fiscal period that ends in the corporation’s taxation year, but also to accrue partnership income for a stub period of the partnership’s subsequent fiscal period which begins in the corporate partner’s taxation year and ends in the following one. This income is known as the “adjusted stub period accrual”. This adjusted stub period accrual is reversed in the following taxation year and a new one is calculated and included in income.
These measures could result in the inclusion of significant incremental partnership income for a corporation’s first taxation year ending after March 22, 2011. To mitigate the potential cash-flow impact of accruing a partnership’s stub period income, transitional relief will generally be available to recognize the incremental amount gradually over the five taxation years that follow the corporation’s first taxation year that ends after March 22, 2011.
Income exempt from
the new rules
The new rules will also not apply to a corporation that is bankrupt.
Adjusted stub period accrual
A corporation’s adjusted stub period accrual is determined by a three-part formula, essentially A minus (B plus C).
In general, A is a pro-ration over the stub period of the partnership that ends in the corporation’s taxation year of:
· the corporation’s share of the partnership’s income and taxable capital gains (other than dividends for which a deduction is available)
· less the corporation’s share of the partnership’s losses and allowable capital losses (to the extent of taxable capital gains).
B is an amount of qualified resource expenses designated by the corporation for the year in its return of income for the year.
C is a discretionary amount of stub period accrual designated by the corporation in its return of income for the year (other than for qualified resource expenses). The designation is intended to allow a corporate partner to reduce its stub period accrual to reflect its knowledge of the actual partnership income for the stub period.
Qualified resource expenses consist of Canadian exploration expenses, Canadian development expenses, foreign resource expenses and Canadian oil and gas expenses. They can be designated only to the extent that the corporation obtains from the partnership before the corporation’s filing-due date for the year information in writing identifying the qualified resource expenses.
No loss accrual
from partnership for stub period
Character of stub
As partnership income for more than one fiscal period may be included in income for a single taxation year of the corporation under the draft legislation, transitional relief is provided via a reserve mechanism to mitigate cash flow problems that otherwise could have resulted from the additional tax burden.
In particular, in certain circumstances, a corporation is allowed to include in income the additional adjusted stub period income gradually over the five taxation years that follow its first taxation year ending after March 22, 2011.
Where the transitional rules apply, the corporation may deduct as a reserve the “specified percentage” for the particular taxation year of the corporation’s “qualifying transitional income” from the partnership (discussed below).
For these purposes, “specified percentage” generally means:
· 100 percent for 2011
· 85 percent for 2012
· 65 percent for 2013
· 45 percent for 2014
· 25 percent for 2015.
In effect, the reserve is included in income starting with 15 percent in 2012, 20 percent in each of 2013, 2014 and 2015 and the remaining 25 percent in 2016.
Depending on the circumstances, a corporation eligible for transitional relief may realize qualifying transitional income in its 2012 or 2013 taxation years. In such a case, the specified percentage is modified accordingly.
Qualifying transitional income
“Qualifying transitional income” includes “adjusted stub period income” of the corporation from the partnership for the corporation’s first taxation year ending after March 22, 2011. Further, if a single-tier alignment election is made (discussed below) and a partnership has a second fiscal period that ends in a corporate partner’s first taxation year ending after March 22, 2011, the corporation will have “eligible alignment income” for such period, which is included in qualifying transitional income.
A corporation has qualifying transitional income only if the corporation is a member of the partnership on March 22, 2011.
calculating transitional income
For these purposes, the income or loss of the partnership for a fiscal period is generally computed as if the partnership deducted the maximum amount of any expense, reserve, allowance or other amount and elected not to include in income any amount for work-in-progress.
The particular year is normally the taxation year immediately following the taxation year in which the corporation’s qualifying transitional income is first determined, unless one or more short taxation year-ends precede the fiscal period-end of the partnership.
qualifying transitional income
· At the end of the partnership’s fiscal period that begins before March 22, 2011 and ends in the year of the corporation that includes March 22, 2011,
· At the end of the partnership’s fiscal period commencing immediately after such fiscal period and until after the end of the year of the corporation that includes March 22, 2011, and
· Continuously since before March 22, 2011 until the end of the year.
An anti-avoidance rule disallows a corporation an entitlement to a reserve if it is reasonable to conclude that one of the main reasons the corporation is a member of a partnership in a taxation year is to avoid the rules that prohibit a reserve.
Situations where a
reserve is not available
Further, the reserve is not available if the corporation’s taxation year ends immediately before another taxation year at the beginning of which the partnership no longer principally carries on activities to which the reserve relates, in which the corporation becomes bankrupt, or in which the corporation is dissolved or wound up (other than a tax-deferred wind-up).
reserve in the following year’s income
A further reserve is deductible in that following taxation year, generally in the amount of the least of the specified percentage for the particular year of the corporation’s qualifying transitional income, the amount of the reserve added back into income for the year, and the corporation’s income for the particular year computed before deducting any amount as a reserve.
Illustrative example of the new rules
The following example illustrates the adjusted stub period accrual and the transitional reserve for a corporate partner.
· A corporation (Corporate Partner) owns a greater than 10 percent interest in a partnership (Partnership)
· Corporate Partner has a December 31 year-end
· Partnership has a January 31 fiscal period
· Corporate Partner’s share of Partnership’s taxable income is:
$1.2 million for Partnership fiscal period ended January 31, 2011
$1.5 million for Partnership fiscal period ended January 31, 2012
$2.4 million for Partnership fiscal period ended January 31, 2013.
1. In the above example, Corporate Partner is effectively required to initially include 23 months of income from Partnership ($1.2m and $1.1m) in its taxation year ended December 31, 2011. Corporate Partner is then allowed to claim a $1.1m qualifying transitional reserve in 2011.
2. The qualifying transitional reserve of $1.1m claimed in 2011 is “trued-up” for Corporate Partner’s 2012 taxation year to $1.375m at the end of the period (i.e., actual income for the February 1, 2011 to December 31, 2011 stub period computed as $1.5m × 11/12).
3. Technically, the proration factor is based on the number of days in the fiscal period. For ease of illustration, we have shown the proration based on a monthly proration.
Under-reported stub period accrual
Under the draft legislation, if a designation is made that results in an income shortfall, the corporation may be required to include in income in the following taxation year an additional amount determined by a formula that consists of an income shortfall adjustment and a penalty. This rule deters an excessive designation to defer the recognition of adjusted stub period accrual.
Election to change a partnership’s fiscal period
The draft legislation permits, in certain circumstances, corporate partners of a partnership to elect to change the fiscal period of the partnership to align to the taxation year of one or more of the corporations.
If, by reason of the election, a corporate partner has a taxation year that coincides with the fiscal period of the partnership, the corporation may compute income from the partnership under existing rules and thereby avoid the complexity of the draft legislation. Corporate partners, however, often have different taxation year-ends. If so, the election can be used to align the fiscal period of the partnership to only one of those taxation years. The corporate partners that have a taxation year that is different from the newly elected fiscal period of the partnership will be required to apply the draft legislation to accrue income from the partnership for the stub period of the partnership that falls in such corporation’s taxation year.
A partnership may elect to change its fiscal period to align with the taxation year of one or more of its corporate partners under a one-time “single-tier alignment election” but only if certain conditions are met, including:
· Only one election is filed in writing in prescribed form by a corporation that is a member of the partnership on or before the day that is the earliest filing due-date of any corporation that is a member of the partnership for its first taxation year ending after March 22, 2011,
· The fiscal period of the partnership to which the election applies is not more than 12 months, and
· The election was made by a corporation with authority to act for the members of the partnership.
Special rule for new corporate partners
A special rule applies to a corporation that acquires a significant interest in a partnership during a fiscal period of the partnership that begins in the corporation’s taxation year and ends on or before the filing-due date for the taxation year. The special rule is intended to permit a new corporate partner to apportion its income from the partnership between its two taxation years straddled by the fiscal period of the partnership.
Under the special rule, the corporation may at its option include in income a designated amount up to its pro-rated income from the partnership (other than dividends for which a deduction is available) for the stub period.
deductible in the following year
The income inclusion under the special rule is not included in qualifying transitional income, and so no reserve is available for the amount.
New rules require a partnership to adopt a calendar fiscal period in certain circumstances. A partnership that is a member of a tiered partnership structure (other than a partnership having a professional corporation as a member or a partnership that makes a “multi-tier alignment election,” as discussed below) is generally required to have a calendar fiscal period under certain circumstances.
Implications for joint ventures
A joint venture is not an entity or a partnership, but is instead a relationship formed by an agreement. Therefore, each participant must report its proportionate interest in the assets and operations of the joint venture. Joint venture ownership arrangements are commonly used in the real estate and oil and gas industries.
Real estate investors often have many joint venture investments, each representing a proportionate interest in real estate (for example, rental property or residential real property development).
The CRA has publicly stated that the 2011 federal budget proposals to limit the tax deferral opportunities available to certain corporations requires that it change its existing administrative position that allows a joint venture to establish a fiscal period that differs from the fiscal periods of the joint venture participants. The CRA says it would not be appropriate to allow a deferral through a joint venture that is not available through a partnership. Thus, joint venture participants will no longer be eligible to compute income as if the joint venture had a separate fiscal period.
The CRA also said it would offer “transitional relief” for joint ventures that will be consistent with the transitional relief available to members of a corporate partnership and that it would consult with affected taxpayers prior to providing detailed guidance in writing.
We can help
Your KPMG adviser can help you assess the effect of the complex new corporate partnership proposals on your business, and point out ways to take advantage of any benefits arising from the proposals or help mitigate their impact. For more details on these measures and their potential impact, contact your KPMG adviser.
Information is current to September 14, 2011. The information contained in this TaxNewsFlash-Canada 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.
KPMG LLP, the audit, tax and advisory firm (kpmg.ca), a Canadian limited liability partnership established under the laws of Ontario, is the Canadian member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 140,000 professionals, including more than 7,900 partners, in 146 countries.
The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss entity. Each KPMG firm is a legally distinct and separate entity, and describes itself as such.
KPMG's Canadian Web site is located at http://www.kpmg.ca/
© 2011 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.