6481 CorporateTaxPlanninarticle

ARTICLE REPRINT This article was rst published in Canadian Tax Journal
Corporate Tax Planning

Co-Editors: Derek G. Alty,* Brian R. Carr,** Michael R. Smith,*** and Christopher J. Steeves****
Limitation on Deferral of Partnership Income by a Corporation

Jeff Oldewening and Brian R. Carr*****
Recent amendments to the Canadian Income Tax Act limit the opportunity for a corporation to defer income through the use of a partnership with a scal period that differs from the taxation year of the corporation. Under the new rules, where the corporation owns a signicant interest in the partnership, the corporation must include in income an amount in respect of its share of the partnerships income for the portion of the partnerships scal period that falls within the corporations taxation year. On the transition to the new regime, the corporation may be required to include in income an amount that represents more than one year of partnership income. A transitional reserve apportions the incremental income over a ve-year period.
2012 KPMG LLP , a Canadian limited liability partnership and a member rm of the KPMG network of independent member rms afliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.
This article reviews the 2011 amendments in detail. The authors provide an overview of the amendments and the underlying policy rationale; discuss the application of the new rules, using simple examples to illustrate the concepts; and comment on selected policy considerations. They then highlight several interpretive issues arising from the technical language, and suggest a number of planning techniques that taxpayers may use to resolve some of the difculties presented by the amendments. The authors conclude that the policy of the provisions is sound but that the complexity of the new rules and the interpretive difculties they raise will result in increased compliance costs and disputes between taxpayers and the Canada Revenue Agency. KEYWORDS: PARTNERSHIPS n CORPORATE TAXES n DEFERRED INCOME n STATUTORY INTERPRETATION n TAX ANALYSIS n RESOURCES
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Of Ernst & Young LLP , Toronto. Of Moskowitz and Meredith LLP , Toronto. Of Deloitte & Touche LLP , Calgary. Of Fasken Martineau DuMoulin LLP , Toronto. Of Moskowitz and Meredith LLP , Toronto. We thank Chris Sheridan, student-at-law, and Torran Jolly for comments on our article.
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2 | Corporate Tax Planning
CONTENTS
Introduction......................................................................................................................................... 4 Overview of the Provisions................................................................................................................. 5 Detailed Review of the Provisions...................................................................................................... 6 Accrual Obligation......................................................................................................................... 6 Calculation of ASPA....................................................................................................................... 7 Formulaic Accrual...................................................................................................................... 7 Designation of QRE.................................................................................................................. 7 Designation for the Stub Period................................................................................................. 8 Interest Charge for Underaccrued Partnership Income.............................................................. 9 Prohibition of Amendment or Revocation of Designations..................................................... 10 Special Rule for a New Corporate Partner of a Partnership...................................................... 10
Deduction of ASPA and Apportioned Income............................................................................ 10 Alignment Elections.................................................................................................................... 10 Single-Tier Alignment Election.................................................................................................11 Multi-Tier Alignment Election...................................................................................................11 Transitional Reserve.................................................................................................................... 11 Computation of QTI.................................................................................................................11 Partnership Income Computation........................................................................................... 14 True-Up of QTI.......................................................................................................................... 14 Deduction of Reserve for QTI...................................................................................................... 14 Specied Percentage for the Year of QTI................................................................................. 14 Prior-Year Reserve Limit.......................................................................................................... 14 Income Limit........................................................................................................................... 14
Corporate Tax Planning | 3
Reserve Denial Rules................................................................................................................... 15 Relieving and Anti-Avoidance Provisions.................................................................................. 15 Adjusted Cost Base Adjustments............................................................................................... 15 Character of ASPA, Partitioned Income, and Reserve for QTI................................................... 16 Deemed Allowable Capital Loss................................................................................................. 16 Exceptions................................................................................................................................... 16 Joint Ventures.............................................................................................................................. 17 Issues and Tax-Planning Opportunities............................................................................................ 18 Policy Considerations................................................................................................................. 18 Signicant Interest Threshold.............................................................................................. 18 Specied Percentage of QTI................................................................................................... 18 Deadline To Make an Alignment Election................................................................................. 18 Multi-Tier Alignment Elections................................................................................................ 18 Interpretive Issues....................................................................................................................... 18
Meaning of Character.......................................................................................................... 18 Corporate Tax Attributes.......................................................................................................... 20 Activities to Which the Reserve Relates.............................................................................. 21 Planning Opportunities............................................................................................................... 22 Accrual of Partnership Losses................................................................................................. 22 Revocation of an Alignment Election....................................................................................... 23 ASPA on Reassessment......................................................................................................... 23 No QTI.................................................................................................................................... 23 Deduction of Reserve for QTI in Short Taxation Years.............................................................. 24 Conclusion.......................................................................................................................................... 24
INTRODUCTION
For the purposes of the Canadian Income Tax Act,1 a corporation must include in income for a taxation year its share of the income of a partnership for a scal period of the partnership that ends in the taxation year of the corporation.2 Before the implementation of the legislation3 proposed in the 2011 federal budget,4 a corporation could defer recognition of partnership income if the corporations taxation year ended before the end of the partnerships scal period. The corporation could compound the deferral by using a tiered partnership structure. The budget contained a measure5 to limit the deferral of partnership income by a corporation that owns a signicant interest6 in the partnership. The measure provided that where the partnerships scal period ends after the corporations taxation year, the corporation must include in income an amount, referred to as adjusted stub period accrual (ASPA),7 in respect of the portion of the partnerships scal period that falls within the corporations taxation year (the stub period). The initial accrual could cause a corporation to include in income an amount that represented the corporations share
of partnership income for up to two scal periods of the partnership. Accordingly, the measure provided transitional relief to apportion the initial accrual over a ve-year period. Sections 34.2, 34.3, and 249.1 enacted by Bill C-13 implemented the budget measure,8 with minor modications in response to comments from the tax community.9 The provisions are based on amendments introduced in 1995 that limit a similar deferral opportunity for an individual or a professional corporation that earns income from a business with an off-calendar scal period or through a partnership.10 The budget disclosed that the government acted to limit the deferral opportunity in the corporate context for two reasons: 1. Deferral of corporate tax through the use of partnerships, whether or not intentional, is inequitable.11 The government intended to harmonize the treatment of partnership income earned by corporations with the treatment of business income earned by individuals, and to bring Canadian tax law into line with that of other countries such as the United States, the United Kingdom, and Australia.
RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as the Act). Unless otherwise noted, statutory references in this article are to the Act. Subsection 96(1). Bill C-13, Keeping Canadas Economy and Jobs Growing Act; SC 2011, c. 24; royal assent December 15, 2012 (herein referred to as the 2011 amendments). The 2011 federal budget was initially delivered by the Conservative minority government on March 22, 2011; however, the government fell before it could enact the budget measures. After re-election with a majority, the government reintroduced the budget, with only minor changes, on June 6, 2011: see Canada, Department of Finance, 2011 Budget, Budget Plan, June 6, 2011 (herein referred to as the budget). Resolution (41) of the Notice of Ways and Means Motion To Amend the Income Tax Act and the Income Tax Regulations, Budget Plan, supra note 4, annex 3, at 367 . Dened in subsection 34.2(1) and discussed below in the text accompanying note 24. Dened in subsection 34.2(1) and discussed below in the text accompanying note 25 and following. Sections 34.2 and 34.3 apply to taxation years of a corporation ending after March 22, 2011, the date of the rst budget: see Bill C-13, supra note 3, at section 3(2). Section 249.1 applies to the 2011 and subsequent scal periods of a partnership: ibid., at section 73(2). See, in particular, Tax Executives Institute, Re: June 6, 2011, Budget Proposals: PartnershipsDeferral of Corporate Tax, June 21, 2011, submission to the Honourable James M. Flaherty, Minister of Finance (www.tei.org/news/Documents/Budget_2011_Partnership_Proposals. pdf); and Tax Executives Institute, Re: August 16th Draft Legislation: Corporate Partner Income Inclusions, September 16, 2011, submission to Brian Ernewein, general director and senior assistant deputy minister, Tax Policy Branch, Department of Finance (www.tei.org/news/ Documents/Corporate%20Partner%20Income%20Inclusion%20August%2016%20Prop %20Legislation.pdf). In addition, the Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants (the joint committee) provided oral comments on the budget measure at a meeting with Finance ofcials in Ottawa on June 20, 2011. For additional comments on the provisions, see Lee-Lynn Gan, Roque Hsieh, and Tony Tse, Ending the Year Ending After the End of the Year, in 2011 British Columbia Tax Conference (Toronto: Canadian Tax Foundation, 2011), 12:1-31; Samuel Tyler and Steven Hurowitz, Partnerships Update, PowerPoint presentation in 2011 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2011), tab 9; Alycia Calvert and Thomas Copeland, Recent Developments Regarding Partnerships, PowerPoint presentation at the 2011 annual tax conference of the Canadian Tax Foundation, November 28, 2011; Brian R. Carr and Penny Woolford, Partnership Proposals: 2011 Federal Budget (2011) 17:2 Corporate Finance1969-75; Andrea Shreeram and Torran Jolly, The Proposed Partnership Accrual Rules: Issues and Opportunities for the Resource Industry (forthcoming article to be published by Federated Press); and Bruce Ball and Darcy Moch, Bill C-13Corporate Tax Deferral Rules in Sections 34.2, 34.3 and 249.1 of the Income Tax Act (Canada), November 14, 2011, letter to Brian Ernewein (www.cica.ca/about-the-profession/cica/ government-relations/submissions/2011-submissions/item54306.pdf) (herein referred to as the joint committee submission) at 18. Section 34.1, section 34.2 prior to the 2011 amendments, paragraph 249.1(1)(b), and subsection 249.1(4). These provisions (herein referred to as the 1995 amendments) were enacted in nal form by SC 1996, c. 21.
2 3
6 7 8
10
11
Budget Plan, supra note 4, at 315.
2. Such deferral provides an incentive to corporations to establish captive partnerships for little purpose other than to defer income, a strategy that is not economically productive.12 It is common in some industries13 for related corporations to carry on business through a partnership and to choose a scal period for the partnership that ends after the taxation years of the corporations within the group in order to defer income. This deferral opportunity has existed for a very long time. Why the government acted only now, 16 years after the 1995 amendments relating to individuals and professional corporations, to limit the deferral opportunity remains a mystery. A conuence of factors may have prompted the government to change the law. These factors include a desire to raise revenue and recent litigation that may have caused the government to consider the general anti-avoidance rule (GAAR) inadequate to combat multi-year deferral of income through a tiered partnership structure. With respect to the rst of these possible motivations, the budget indicated that the measure would raise an estimated $2.85 billion from 2012 to 2016.14 This makes it one of the largest revenue-generating items in the budget. We infer that the government intended to raise such additional revenue to reduce projected federal budgetary decits. As regards recent GAAR litigation, one Tax Court judgment and a recent appeal have specically addressed the issue of deferral through the use of tiered partnership structures: In Fredette v. The Queen,15 individual taxpayers used a tiered partnership structure to effect a two-year deferral of income. The taxpayers transferred rental property to a partnership with a scal period that ended after the calendar year. The taxpayers then transferred their partnership interest to a second partnership with a scal period that ended after that of the rst partnership. The Tax Court found that a one-year deferral of income, which resulted from the selection of the scal period of the rst partnership, did not constitute abusive tax avoidance. The court held, however, that GAAR applied to deny the second year of deferral achieved through the use of the second partnership.
In a recent appeal, Vitalaire Canada Inc. v. The Queen,16 the minister reassessed the taxpayer under GAAR to deny a 21-month deferral of income achieved through a tiered partnership structure. In its notice of appeal, the taxpayer outlined valid business reasons for the use of the tiered partnership structure and the choice of the scal periods for the partnerships. The minister led a reply but then consented to judgment on the factual basis that there was no avoidance transaction to which GAAR could apply.17 The settlement in Vitalaire Canada may indicate that the minister thought that the courts may allow multi-year deferral of income where a taxpayer establishes a tiered partnership structure primarily for bona de purposes other than to defer income. Some speculate that Finance may have acted to restrict the deferral of partnership income in response to the outcome in this case.18
OVERVIEW OF THE PROVISIONS

A corporation that owns a signicant interest in a partnership must include in income for taxation years ending after March 22, 2011 its ASPA in respect of the partnership for a stub period. ASPA is determined by a mathematical formula that depends on the partnerships income for its scal periods that end in the corporations taxation year and the number of days in the stub period. A corporate partner may reduce ASPA by making two discretionary designations. The rst designation is relevant only to resource industries. A corporate partner of a partnership that incurs qualied resource expenses19 (QRE) may make a designation to reduce ASPA in recognition of such QRE. The designated amount is limited by the actual amount of resource expenses incurred by the partnership in the stub period that are identied by the partnership for the purposes of the corporations designation of QRE. Resource expenses receive special treatment because a partnership does not deduct such expenses in computing its income. Instead, resource expenses of a partnership are allocated to the partners, which include their share of those expenses in their resource accounts.
12 13 14 15 16 17
Ibid. Examples include the real estate and resource industries. Budget Plan, supra note 4, annex 3, at 263, table A3.1. 2001 DTC 621 (TCC). Docket no. 2009-1976(IT)G (TCC).
See Notice of Appeal of Vitalaire Canada Inc., June 5, 2009 and the Reply to the Notice of Appeal of Her Majesty the Queen, October 29, 2009. Shreeram and Jolly, supra note 9.
18 19
Dened in subsection 34.2(1) and discussed below in the text accompanying note 35 and following.
The second designation allows a corporate partner to reduce ASPA to an amount not less than nil in order to reect the corporate partners expectation or knowledge of the partnerships actual income for the stub period. If the ASPA resulting from the designation is less than a particular benchmark,20 however, the corporate partner must include in income an interest charge to compensate the government for the corporations underaccrual of partnership income for the stub period caused by the excessive designation. Under existing law that continues to apply (subsection 96(1)), the corporation must include in income for a taxation year its share of partnership income for a scal period of the partnership that ends in the corporations taxation year. Because the corporation previously accrued all or a portion of such amount as ASPA in a prior taxation year, the corporation may deduct the ASPA previously included in income to avoid double-counting of income. The provisions are designed to limit the ability of a corporation to defer partnership income. To completely eliminate the deferral opportunity, Finance could have forced each partner and the partnership to have the same scal period. In recognition that arms-length corporations may operate in partnership, the provisions preserve the discretion afforded to corporations and partnerships to choose any scal period. To relieve the compliance burden of the provisions, an election is available to change the partnerships scal period to align with the taxation year of one or more of the corporations. Each partnership in a tiered partnership structure is required to adopt a calendar scal period where a corporation owns a signicant interest in one or more of the partnerships, unless an election is made to choose an off-calendar scal period for all of the partnerships. If an election is not made, an election is deemed to have been made to adopt a calendar scal period for each partnership. On the transition to the new regime, a corporation may be required to include in income an amount that represents more than one year of partnership income. This results from
the corporations obligation to include in income its share of partnership income for the partnerships scal period ending in the corporations taxation year pursuant to the existing rules in subsection 96(1) and each of the following amounts: the corporations ASPA in respect of the partnership for the stub period; and if an election to change the partnerships scal period is made, the corporations share of partnership income for the partnerships scal period that ended within the corporations taxation year because of the election that otherwise would have been deferred by the corporation (referred to as eligible alignment income [EAI]).21 To mitigate hardship that might result from tax payable on the incremental income, a corporation may claim transitional relief in the form of a reserve. The reserve allows the corporation to treat the total of such ASPA and EAI as qualifying transitional income22 (QTI), which may be included in income over a veyear transitional period.
DETAILED REVIEW OF THE PROVISIONS

Accrual Obligation
Subsection 34.2(2) requires a corporation23 to include in income for a taxation year ASPA in respect of a partnership where the corporation has a signicant interest in the partnership at the end of the partnerships last scal period that ends in the corporations taxation year; another scal period of the partnership begins in the year and ends after the year; and at the end of the year, the corporation is entitled to a share of an income, loss, taxable capital gain, or allowable capital loss of the partnership for that other scal period. A signicant interest24 is a partnership interest of a corporation that, alone or together with related or afliated 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 dissolution.
20 21 22 23 24
Discussed below in the text accompanying note 45 and following. Dened in subsection 34.2(1) and discussed below in the text accompanying note 75 and following. Dened in subsection 34.2(1) and discussed below in the text accompanying note 70 and following. The provisions do not apply to a professional corporation. A professional corporation may be subject to accrual under section 34.1. Dened in subsection 34.2(1).
Calculation of ASPA
ASPA estimates a corporations share of partnership income for a stub period and approximates the partnership income that the corporation would otherwise defer. For a single-tier partnership,25 ASPA equals the difference between 1. a formulaic accrual of partnership income for the stub period26 and the total of the following designations made by the corporation in its return of income: 2. a designation of QRE27 and 3. a designation for the stub period.28 Formulaic Accrual Formulaic accrual prorates forward over the stub period the corporations share of a partnerships net income from a business or property and net taxable capital gains for the partnerships scal periods that fall within the corporations taxation year.29 Consistent with the scheme of the Act, in computing formulaic accrual, allowable capital losses are deductible only against taxable capital gains.30 Formulaic accrual excludes deductible dividends to prohibit a double deduction by the corporation for the portion of ASPA attributable to dividends.31
Formulaic accrual reduces but does not eliminate deferral of partnership income. If partnership income rises from year to year, ASPA underestimates the actual income of the partnership for the stub period. ASPA permits the corporation to defer some partnership income for the stub period until the following year. Designation of QRE A partnership is not permitted to deduct resource expenses;32 instead, such expenses incurred by the partnership are allocated to the partners at the end of each scal period. The partners then add those resource expenses to their resource accounts.33 A partner may claim a deduction in respect of a resource account in computing its income for a taxation year. Formulaic accrual does not take into account a corporate partners deductions in respect of its resource accounts that relate to resource expenses incurred by the part-nership in the stub period.34 The omission leads to overaccrual by the corporation of partnership income for the stub period. Therefore, as a relieving measure, the cor-poration may designate QRE35 in its return for a taxation year to reduce its ASPA.36
25
ASPA is computed differently on a multi-tier alignment. A multi-tier alignment (as dened in subsection 34.2(1)) occurs on an actual or deemed multi-tier alignment election to match the scal periods of partnerships in a tiered partnership structure. ASPA under a multi-tier alignment is a special case that applies only for the rst taxation year of the corporation in which the alignment occurs. The expression [(A B) C/D] in the formula in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1). The description of E in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1). The description of F in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1). More than one scal period of a partnership may fall within the corporations taxation year as a result of a 53-week taxation year of the corporation pursuant to paragraph 249.1(1)(a) or a single-tier alignment election: see Canada, Department of Finance, Explanatory Notes Relating to the Income Tax Act and Related Regulations (Ottawa: Department of Finance, October 2011), at the description of A in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1). The description of B in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1). Dividends are deductible by a corporation but not by a partnership. If ASPA included deductible dividends, paragraph 34.2(5)(a) would deem that portion of ASPA to be a dividend. The corporation could deduct under section 112 or 113 such portion of ASPA as a dividend in the year and deduct under subsection 34.2(4) the same amount as the prior years ASPA in the following year. Paragraph 96(1)(d). Resource accounts consist of cumulative Canadian exploration expenses (CCEE) as dened in subsection 66.1(6), cumulative Canadian development expenses (CCDE) as dened in subsection 66.2(5), adjusted cumulative foreign resource expenses in respect of a country (ACFRE) as dened in subsection 66.21(1), and cumulative Canadian oil and gas property expenses (CCOGPE) as dened in subsection 66.4(5). A corporation may deduct up to 100 percent in respect of its CCEE account under subsection 66.1(2); 30 percent and 10 percent annually on a declining balance basis in respect of its CCDE and CCOGPE accounts, respectively, under subsections 66.2(2) and 66.4(2); and 10 percent annually on a declining basis in respect of an ACFRE account in respect of a country and an additional 20 percent annually on a declining balance basis against income from the resource property in that country under subsection 66.21(4). Subsection 34.2(1) denes qualied resource expenses as Canadian exploration expenses (CEE), Canadian development expenses (CDE), foreign resource expenses (FRE), and Canadian oil and gas property expenses (COGPE) incurred by the partnership in the stub period. The description of E in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).
26 27 28 29
30 31
32 33
34
35
36
QRE consist of resource expenses incurred by the partnership in a stub period. A corporation may designate QRE only if the corporation obtains from the partnership information in writing identifying the QRE within six months after the end of the corporations taxation year.37 The corporations share of such identied QRE is based on its share of resource expenses of the partnership for the partnerships last scal period that falls within the corporations taxation year, because the QRE are determined as if they had been incurred by the partnership in its last scal period that ended in the corporations taxation year.38 The corporations share of the actual resource expenses incurred by the partnership in the stub period is not relevant in determining the corporations QRE. The corporations designation of QRE cannot exceed the maximum amount of the QRE identied by the partnership that would be deductible in computing the corporations income for the taxation year determined as if39 the only resource expenses of the corporation for the taxation year were those identied by the partnership; the partnerships scal period that includes the stub period were to end co-incidentally with the corporations taxation year; and the corporations share of QRE incurred by the partnership in the stub period were deemed40 to have been incurred by the corporation.
of the partnerships scal period.41 A corporation may defer partnership income for a stub period through a designation of QRE to reduce ASPA notwithstanding that the proceeds from the dis-position of resource properties realized by the partnership in the stub period reduce or eliminate the net amount added to the resource accounts as a result of the partnership incurring QRE in the stub period.42 Example 1 illustrates the application of these rules. Example 1 Corporation A has a signicant interest in partnership B. Corporation As taxation year-end is November 30. Partnership B has a scal period ending January 31. As of November 30, corporation A has CCEE, CCDE, and CCOGPE accounts of $100, $500, and $2,000, respectively. Partnership B identies as corporation As QRE for the stub period CEE of $10, CDE of $30, and COGPE of $150 in respect of corporation A as of November 30. The designation of QRE that corporation A may claim is determined as if its CCEE, CCDE, and CCOGPE accounts were $10, $30, and $150, respectively, so that the maximum designation is $34, consisting of deductions of $10, $9, and $15 in respect of its notional CCEE, CCDE, and CCOGPE accounts. The maximum deduction that corporation A may claim at the end of its taxation year in respect of its resource expense is $450, consisting of deductions of $100 (100 percent), $150 (30percent), and $200 (10 percent) in respect of its CCEE, CCDE, and CCOGPE accounts actually existing at the end of that taxation year. Designation for the Stub Period The corporation may make a designation for the stub period in its return to reduce ASPA to an amount not less than nil.43 The corporation may wish to do so if formulaic accrual would result in overaccrual of partnership income for a stub period.
The designation of QRE does not affect the computation of the corporations resource expense accounts. Similarly, the computation of the corporations resource expenses does not affect the designation of QRE. Proceeds from the disposition of resource properties realized by the partnership in the stub period do not reduce QRE eligible for designation. The proceeds of disposition are not income of the partnership but rather reduce the resource accounts of its corporate partners when allocated to them at the end
37 38 39 40 41
Paragraph 34.2(6)(a), the denition of ling-due date in subsection 248(1), and paragraph 150(1)(a). Subparagraphs 34.2(6)(a)(i) through (iv). Paragraph 34.2(6)(b). Subsection 66(18). A corporation must include the proceeds of disposition in income for a taxation year if they produce a negative CCDE account or negative cumulative foreign resource expense (CFRE) account. See subsections 66.2(1) and 66.21(3). Shreeram and Jolly, supra note 9. The description of F in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).
42 43
If a corporation makes a designation for a stub period, the resulting ASPA of a qualifying partnership44 is tested against a benchmark in a subsequent taxation year of the corporation to verify that the corporation adequately accrued partnership income for the stub period.45 The concept of a qualifying partnership identies all of the partnerships subject to the new regime whose scal periods end in the corporations subsequent taxation year in order to x the timing of verication. Verication normally occurs in the corporations taxation year that follows the year of the designation, but could occur in a subsequent year if short taxation years of the corporation intervene before the end of the partnerships scal period that contains the stub period.46 The benchmark is the lesser of formulaic accrual (less any designation of qualied resource expenses) and actual stub period accrual. 47 Actual stub period accrual recalculates the ASPA without reference to the designation for the stub period to produce a positive or negative amount based on actual partnership income for the partnerships scal period that contains the stub period. Actual stub period accrual is not purely a partnership-by-partnership computation. In computing actual stub period accrual, allowable capital losses of a qualifying partnership are deductible to the extent of the difference between the total of all taxable capital gains of all other qualifying partnerships and all allowable capital losses of all other qualifying partnerships.48
taxation year in which verication occurs.50 The corporation also may be required to include in income for the year an interest charge to compensate the government for the deferral of income, as discussed below.51
Interest Charge for Underaccrued Partnership Income

The interest charge consists of regular and penalty components. The regular component consists of the total of a corporations income shortfall adjustment52 for each qualifying partnership for a taxation year.53 An income shortfall adjustment is a positive or negative amount that represents interest on underaccrued or overaccrued partnership income for a stub period of a qualifying partnership. The income shortfall adjustment is computed at the average prescribed rate applicable to underpayments of tax54 for the period from the end of the corporations taxation year in which the corporation made the designation for the stub period to the end of the corporations taxation year in which the corporation included the underaccrued partnership income in computing its income. The penalty component of the interest charge applies if underaccrued partnership income for the stub period exceeds 25 percent of the benchmark. More specically, the penalty component applies if the total of income shortfall adjustments for all qualifying partnerships exceeds 25 percent of the amount that would be the income shortfall adjustments if no ASPA were included in income for the prior year. The amount of the penalty component of the interest charge is 50 percent of the excess.55
If the benchmark exceeds ASPA, the difference represents the corporations under-accrued partnership income for the stub period of a qualifying partnership.49 The corporation must include in income the underaccrued partnership income for the
44
Subsection 34.3(1) denes a qualifying partnership as a partnership whose scal period began in a preceding taxation year of the corporation and ends in the particular taxation year of the corporation, and in respect of which the corporation was required to calculate ASPA for the preceding taxation year. Paragraph 34.3(2)(a). Paragraph 34.3(2)(b) provides that, where the corporation has QTI (qualifying transitional income), verication does not occur in the corporations rst taxation year to which subsection 34.2(17) applies. Verication is not necessary in that year because the corporation did not defer partnership income under the designation for the stub period. While the designation reduced ASPA, the designated amount would have been deductible by the corporation under the reserve for QTI. Under subsection 34.2(17), the ASPA included in QTI is recalculated in the year without reference to the corporations designation for the stub period. Dened in subsection 34.3(1). The description of B in the denition of actual stub period accrual in subsection 34.3(1). Conversely, if ASPA exceeds the benchmark, the difference represents the corporations overaccrued partnership income for the stub period of a qualifying partnership. The partnerships income for the scal period that contains the stub period is allocated to the corporation by the partnership under subsection 96(1), and the corporation may deduct under subsection 34.2(4) ASPA in respect of the partnership for the stub period that was previously included in income for a prior taxation year. Subsection 34.3(3). Dened in subsection 34.3(1). Element A of the formula in subsection 34.3(3). Regulation 4301(a). The expression 0.50 (A B) in the formula in subsection 34.3(3).
45 46
47 48 49
50
51 52 53 54 55
The corporation aggregates income shortfall adjustments of qualifying partnerships. The interest charge does not apply in the event of a full offset of underaccrued and overaccrued partnership income for the stub period of all qualifying partnerships.
at the end of the particular period, the corporation has a signicant interest in the partnership as dened in subsection 34.2(1). The corporation apportions partnership income for a particular period in the taxation year in which the corporation acquired the partnership interest by making a designation in its return for the year in any amount up to a maximum determined by formula.60 The maximum amount is determined by prorating backward over the stub period the corporations share of the actual income of the partnership from all sources (other than deductible dividends) for the particular period. A corporation may wish to apportion partnership income for a particular period in a taxation year in order to use non-capital losses that would otherwise expire. Alternatively, a corporation may decline apportionment in order to defer partnership income for the particular period without risk of interest on underaccrued partnership income in a subsequent taxation year.61
Prohibition of Amendment or Revocation of Designations

A corporation cannot amend or revoke a designation of QRE or a designation for the stub period.56 Otherwise, a corporation might, for example, alter a designation for the stub period with the benet of hindsight to avoid an interest charge for underaccrued partnership income. The prohibition has signicant consequences because the minister cannot waive or cancel an income inclusion under the taxpayer relief provisions.57
Special Rule for a New Corporate Partner of a Partnership

A corporation may acquire a signicant interest in a partnership after the last scal period of the partnership that falls within the corporations taxation year. In these circumstances, ASPA for the partnership would be nil, since no scal period of the partnership would fall within the corporations taxation year. However, the corporation may include in income for the taxation year of acquisition a designated amount of partnership income if58 the corporation acquires a partnership interest during a scal period of the partnership (the particular period);
Deduction of ASPA and Apportioned Income

Subsection 96(1) requires a corporation to include in income for a taxation year its share of partnership income for a scal period of the partnership that ends in that taxation year. To avoid double taxation on an earlier accrual of such partnership income, a corporation may deduct for a taxation year ASPA or apportioned income, as the case may be, included in income for its prior taxation year.62
the particular period spans the end of the corporations taxation year in which the corporation acquired the partnership interest; the particular period ends within six months after the end of the corporations taxation year;59 and
Alignment Elections
To relieve the accrual obligation, the corporate members of a partnership may elect to change the scal period of the partnership to coincide with the taxation year of one or more
56 57 58 59 60 61
Subsection 34.2(10). Subsection 220(3.1). Subsection 34.2(3). The denition of ling-due date in subsection 248(1) and paragraph 150(1)(a). The formula A B/C in paragraph 34.2(3)(b). The 1995 amendments contain a parallel rule in subsection 34.1(2). The progressive rate structure for individuals provides an incentive for an individual to apportion business income between calendar taxation years straddled by an off-calendar scal period of the business. If the individual includes all of the income for the scal period of the business in the second calendar taxation year, a higher marginal tax rate may apply to the business income. The same incentive does not arise in the corporate context because corporate tax rates are at. Subsection 34.2(4).
62
of its corporate partners. Separate rules apply depending on whether the partnership structure is single-tier or multi-tier.63 If corporate partners have different taxation years, the election will be available to align the partnerships scal period to the taxation year of only one of the corporations.64 Single-Tier Alignment Election A single-tier alignment election enables the corporate members of a partnership in a single-tier structure to elect to change the scal period of the partnership where at least one of those members has a signicant interest in the partnership. Certain substantive and procedural elements must be met to make the election. The elements are restrictive. Subsection 249.1(8) contains the substantive elements. Since an election may result in income included in QTI eligible for the reserve, the substantive elements serve to restrict access to, and income that qualies for, such transitional relief. Subsection 249.1(10) contains the procedural elements. The procedural elements prescribe the method to be used to make an election and serve to ensure that all corporate partners are bound thereby. Among other things, the election must be led in prescribed form on or before the earliest ling-due date of any corporate partner for its rst taxation year ending after March 22, 2011.65 Further, the election must be made by a corporation with authority to act for the members of the partnership,66 and no other election may have been led that species a contradictory date for the partnerships scal period.67
period for all of the partnerships.68 The obligation arises even if the nexus between the partnerships is negligible. An election is available if the substantive elements in subsection 249.1(9) and the procedural elements in subsection 249.1(10) are met. If a multi-tier alignment election is not made to adopt an off-calendar scal period for all of the partnerships in a multitier partnership structure, subsection 249.1(11) deems the members of each of the partnerships to have made a multi-tier alignment election to end the scal period of the partnership on December 31, 2011. The deemed election causes income allocated to a corporation by a partnership by reason of the partnerships forced adoption of a calendar scal period to qualify as QTI eligible for the transitional reserve. Finance has stated that GAAR could apply where it is reasonable to conclude that the primary reason for a multi-tier partnership structure created after March 22, 2011 is to produce QTI articially under the deemed election.69
Transitional Reserve
Computation of QTI A corporation may deduct a reserve for QTI to provide relief from additional tax payable on the inaugural accrual of partnership income for the stub period and partnership income allocated to the corporation on an alignment election.70 The corporation must include in income for a taxation year the reserve deducted by the corporation for its immediately preceding taxation year.71 QTI arises only if a corporation is a member of a partnership on March 22, 2011.72 A corporation that joins an existing partnership after March 22, 2011, or forms a new partnership after March 22, 2011, will not have QTI. QTI is computed differently depending on whether the partnership structure is single-tier or multi-tier.73
Multi-Tier Alignment Election If a corporation owns a signicant interest in a partnership in a multi-tier partnership structure, each partnership in the structure must adopt a calendar scal period unless a multitier alignment election is made to adopt an off-calendar scal
63 64
Subsections 249.1(8) and (9), respectively. If the requirements for an election cannot be met, a corporation or a partnership may apply to the minister under subsection 249.1(7) for leave to change the scal period of the corporation or the partnership, respectively. The minister may grant leave if sound business reasons other than obtaining tax benets prompted the request: see Interpretation Bulletin IT-179R (Archived), Change of Fiscal Period, May 28, 1993. Alignment of a scal period of a partnership with a taxation year of a corporation ought to be a sound business reason unless manipulation of the computation of QTI eligible for the transitional reserve prompted the request. Alignment with leave does not produce QTI because EAI included in QTI consists of partnership income allocated to the corporation by the partnership by reason of an alignment election only: see the denitions of eligible alignment income, single-tier alignment, and multi-tier alignment in subsection 34.2(1). Paragraph 249.1(10)(a). Paragraph 249.1(10)(c). Paragraph 249.1(10)(d). Paragraph 249.1(1)(c) and subsections 249.1(9) and (10). Explanatory Notes, supra note 29, at subsection 34.2(13). Subsection 34.2(11). Subsection 34.2(12). Preamble of the denition of qualifying transitional income in subsection 34.2(1). See the denitions of qualifying transitional income, eligible alignment income, and adjusted stub period accrual in subsection 34.2(1).
65 66 67 68 69 70 71 72 73
Computation of QTI for a Single-Tier Partnership For a single-tier partnership, QTI includes ASPA for the corporations rst taxation year ending after March 22, 201174 and EAI (eligible alignment income) that arises on a single-tier alignment election.75 Partnership income for a particular period apportioned by the corporation for a taxation year under the special rule that applies to new corporate partners does not qualify. 1.EAI Included in QTI on a Single-Tier Alignment On a single-tier alignment election, EAI may arise if there is an eligible scal period of the partnership that ends in the corporations taxation year and the corporation is a member of the partnership at the end of the eligible scal period. An eligible scal period is the rst aligned scal period of the partnership that ends in the rst taxation year of the corporation ending after March 22, 2011.76 The undened phrase aligned scal period refers to the rst scal period of the partnership that aligns with the taxation year of a corporate partner under the election.77 If the eligible scal period is the partnerships rst scal period that ends in the corporations rst taxation year ending after March 22, 2011, EAI is nil.78 QTI excludes such partnership income because without the election, the corporation would have been required to include the amount in income for its taxation year.79 If, however, the eligible scal period follows another scal period of the partnership that ends in the corporations rst taxation year that ends after March 22, 2011, and the corporation is a member of the partnership at the end of the eligible scal period, EAI arises in recognition that the corporation must include in income additional partnership income as a result
of the election. EAI includes the corporations share of the partnerships income (other than deductible dividends) and taxable capital gains.80 Deducted from this amount is the corporations share of the partnerships losses and allowable capital lossesbut only to the extent of such taxable capital gains81for the eligible scal period. EAI excludes deductible dividends so that the corporation does not defer the partnerships dividend income as a reserve for QTI while deducting the dividends immediately in the year of allocation.82 EAI is computed on the basis that the corporation deducts under any of sections 66.1, 66.2, 66.21, and 66.4 the maximum amount in respect of resource expenses of the partnership incurred in the stub period that would be allocated to the partner if the scal period of the partnership ended at the time of the alignment election.83 This limitation on EAI included in QTI deters an election in the resource sector, since a corporation will prefer to compute QTI on the basis of ASPA without a designation of QRE.84 The reason is that ASPA included in QTI is not reduced in a similar fashion unless the corporation designates QRE. In computing ASPA included in QTI, the corporation ought to forgo a designation of QRE. Computation of QTI for a Partnership in a Multi-Tier Structure On a multi-tier alignment, QTI includes the corporations ASPA in respect of the part-nership for the corporations taxation year that contains the multi-tier alignment85 and EAI that arises on an actual or deemed multi-tier alignment election.86 QTI includes ASPA for the year of a multi-tier alignment (rather than the corporations rst taxation year ending after March 22, 2011, as on a single-tier alignment) because a multi-tier alignment could
74
Subparagraph (b)(ii) of the denition of qualifying transitional income in subsection 34.2(1). Paragraph (a) of the denition of qualifying transitional income in subsection 34.2(1).
75 76
Paragraph (a) of the denition of eligible alignment income in subsection 34.2(1). Explanatory Notes, supra note 29, at the denition of eligible alignment income in subsection 34.2(1). Subparagraph (a)(ii) of the denition of eligible alignment income in subsection 34.2(1). Subsection 96(1); and Explanatory Notes, supra note 29, at subparagraph (a)(ii) of the denition of eligible alignment income in subsection 34.2(1). The description of element A of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1). The description of element B of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1). The same reasoning explains why ASPA included in QTI excludes deductible dividends. The description of element C of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1). This is consistent with the rules that govern the computation of QTI under subsection 34.2(15). A corporation must compute QTI on the basis that the partnership deducts the maximum amount of any expense, reserve, allowance, or other amount and has elected to include in income any amount of work in progress. The computation of EAI on this basis puts the corporation in the same position as it would be if the partnership were able to claim resource deductions and claimed the maximum amount in respect thereof. Shreeram and Jolly, supra note 9. Subparagraph (b)(i) of the denition of qualifying transitional income in subsection 34.2(1). Paragraph (a) of the denition of qualifying transitional income in subsection 34.2(1).
77 78 79
80 81 82 83
84 85 86
occur in the corporations rst or a subsequent taxation year ending after March 22, 2011.87 1.ASPA Included in QTI on a Multi-Tier Alignment There are two formulas for computing ASPA under a multi-tier alignment. Which formula applies depends on whether a scal period of the partnership ends in the corporations taxation year before or after an eligible scal period. An eligible scal period arises if a scal period of the partnership ends in the corporations taxation year and such year is the rst taxation year in which the scal period of the partnership is aligned with the scal period of one or more other partnerships under a multi-tier alignment.88 If a scal period of the partnership ends in the taxation year of the corporation before the eligible scal period, the partnership has two scal periods that end in the year. In that case, ASPA is the difference between formulaic accrual (computed on the basis of the corporations share of partnership income for the rst scal period of the partnership that ends in the corporations taxation year only, without reference to the partnerships eligible scal period) and the total of the corporations designation of QRE and its designation for the stub period.89 If the eligible scal period is the partnerships rst scal period that ends in the corporations taxation year, the partnership has only a single scal period that ends in the year. In that case, ASPA is the difference between formulaic accrual (computed on the basis of the corporations share of partnership income for the eligible scal period less EAI for the eligible scal period) and the total of EAI for the eligible scal period, the corporations designation for QRE, and its designation for the stub period. ASPA excludes the proration over the stub period of EAI for the eligible scal period to avoid double-counting of QTI.90 A corporation is not required to include in income ASPA that arises in a taxation year before the year of a multi-tier alignment.91 This coordinates the accrual of ASPA and the reserve for QTI on a multi-tier alignment, since QTI would not include ASPA for a taxation year that preceded the year of alignment.92
2. EAI Included in QTI on a Multi-Tier Alignment On a multi-tier alignment, EAI arises if an eligible scal period of the partnership ends in the taxation year of the corporation and the corporation is a member of the partnership at the end of the eligible scal period.93 An eligible scal period is the rst aligned scal period of the partnerships in the multi-tier structure. EAI represents the corporations direct or indirect share of income or loss of each of the partnerships in a multi-tier structure that is allocated to the corporation by the partnership as a result of the alignment. The corporation computes EAI in the same way for a multi-tier alignment as for a single-tier alignment, except that EAI specically excludes any amount that would have been included in the corporations income for the year without the multi-tier alignment.94 Example 2 illustrates the application of these rules. Example 2 C is a corporation with a calendar taxation year. P 1 is a partnership with a January 31 scal period. P 2 is a partnership with a February 28 scal period. C owns a signicant interest in P 1. P 1 owns an interest in P 2. A multi-tier alignment election is deemed by subsection 249.1(11) to have been made to end the scal periods of P 1 and P 2 on December 31, 2011. C has EAI in respect of P 1 because there is a multi-tier alignment of the scal periods of P 1 and P 2 on December 31, 2011 under a deemed multi-tier alignment election; P 1s December 31, 2011 scal period is an eligible scal period that ends in Cs calendar taxation year; and C is a member of P 1 at the end of the eligible scal period. EAI in respect of P 1 equals Cs share of P 1s income for the eligible scal period. This amount includes Cs indirect share of P 2s income for its February 28, 2011 and December 31, 2011 scal periods.
87 88 89 90
Explanatory Notes, supra note 29, at the denition of qualifying transitional income in subsection 34.2(1). Paragraph (b) of the denition of adjusted stub period accrual in subsection 34.2(1). The formula [(A B) C/D] (E + F) in subparagraph (b)(i) of the denition of adjusted stub period accrual in subsection 34.2(1). On a multi-tier alignment, QTI includes both ASPA for the corporations taxation year that contains the multi-tier alignment and EAI for the eligible scal period. Including EAI in ASPA would double-count EAI included in QTI. Subsection 34.2(9). Subparagraph (b)(i) of the denition of qualifying transitional income in subsection 34.2(1). Paragraph (b) of the denition of eligible alignment income in subsection 34.2(1). Subparagraph (ii) of the description of element A of the formula in paragraph (b) of the denition of eligible alignment income in subsection 34.2(1).
91 92 93 94
Partnership Income Computation A corporation computes the income of a partnership for a scal period for the purposes of determining its ASPA or EAI included in QTI on the basis that the partnership has 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.95 These rules seek to ensure that a corporation cannot manipulate the computation of QTI to maximize the amount eligible for deferral under the reserve. The 1995 amendments contained a parallel provision that did not require an individual to deduct the maximum amount of any expense in computing income from a business eligible for transitional relief.96 The individual could augment the reserve deduction if the business deferred or avoided deductible expenses. The different rule under paragraph 34.2(15)(a) of the 2011 amendments aims to address that mischief.
Deduction of Reserve for QTI

A corporation may deduct for a taxation year a reserve for QTI in any amount up to the least of the following amounts: the specied percentage for the year of QTI;99 if a reserve was deductible in the prior year, the total of the prior years reserve deduction included in income for the year and the amount of any increase to QTI in the year under a true-up of QTI (the prior year reserve limit);100 and n the corporations income for the taxation year computed before the deduction of the reserve for QTI and of an offset or a reserve for income attributable to debt forgiveness101 (the income limit).102 Specied Percentage for the Year of QTI If QTI arises in 2011, the corporation may deduct a reserve of 100 percent of QTI for 2011, 85 percent for 2012, 65 percent for 2013, 45 percent for 2014, and 25 percent for 2015.103 If QTI arises in 2012 or 2013, the specied percentage of QTI adjusts to permit the corporation to deduct a reserve of 100 percent of QTI in 2012 or 85 percent of QTI in 2013, as the case may be, and the specied percentages for each subsequent year adjust accordingly.104 The specied percentage of QTI for each calendar year applies to all of the corporations taxation years that end in that calendar year.105 Prior-Year Reserve Limit Under the prior-year reserve limit, if a reserve for QTI was deductible by a corporation in the immediately preceding taxation year, the corporation may deduct a reserve for QTI in a taxation year to the extent of the total of the prior years reserve added back into income for the year and any increase to QTI in the year under the true-up of QTI. If QTI increases under the true-up, the prior-year reserve limit increases by that amount only in the particular taxation year in which QTI adjusts.106 Income Limit The income limit restricts the reserve for QTI to the corporations income for the taxation year from all sources computed before
True-Up of QTI
If QTI includes ASPA, QTI merely approximates partnership income for the stub period. After the stub period, QTI adjusts up or down as ASPA is recalculated based on the corporations share of the actual partnership income for the stub period but without reference to a designation for the stub period.97 The recalculation of ASPA takes into account a designation of QRE, so such a designation permanently reduces ASPA included in QTI. ASPA included in QTI adjusts if the corporations share of partnership income changes, if formulaic accrual differs from actual partnership income prorated backward over the stub period, or if the corporation has made a designation for the stub period. If QTI includes EAI only, QTI does not adjust since EAI constitutes actual partnership income for the eligible scal period and not a mere estimate. Normally, QTI adjusts in the corporations taxation year immediately following the taxation year in which QTI rst arose. QTI may adjust in a subsequent year if short taxation years of the corporation intervene before the end of the partnerships scal period that contains the stub period.98
95 96 97 98 99
Subsection 34.2(15). Former paragraph 34.2(2)(c). Subsection 34.2(17). Subsection 34.2(16). Paragraph 34.2(11)(a). Paragraph 34.2(11)(b).
100 101
Sections 61.3 and 61.4. Paragraph 34.2(11)(c). Paragraph (a) of the denition of specied percentage in subsection 34.2(1). Paragraphs (b) and (c) of the denition of specied percentage in subsection 34.2(1). Explanatory Notes, supra note 29, at subsection 34.2(11). Subparagraph 34.2(11)(b)(ii); and Explanatory Notes, supra note 29, at example 2 after section 34.2.
102 103 104 105 106
deduction of the reserve for QTI and an offset or a reserve for income attributable to debt forgiveness. The corporation cannot deduct a reserve for QTI to create a loss for a taxation year. The income limit refers to income, not taxable income. Deductions in computing taxable income, such as loss carryovers and dividends, do not reduce the income limit. If the income limit applies to restrict the reserve for QTI in a taxation year, the prior-year reserve limit generally applies to limit the reserve for QTI in the following year (and thereafter throughout the transitional period).107 The corporation does not face a cash ow constraint from additional tax payable that is attributable to the transition to the new regime if a loss absorbs QTI, so the corporations reserve is restricted by the income limit accordingly.
On a tax-deferred windup under subsection 88(1), paragraph 88(1)(e.2) deems the parent to be the same corporation as, and a continuation of, the wound-up subsidiary for the purposes of section 34.2. Similarly, on a tax-deferred amalgamation under subsection 87(1), paragraph 87(2)(j) deems the amalgamated corporation to be the same corporation as, and a continuation of, the predecessor corporations for the purposes of section 34.2. The parent or amalgamated corporation inherits the QTI of the subsidiary or the predecessor corporations, as the case may be. The reserve denial rules in paragraph 34.2(13)(a) and subparagraph 34.2(13)(c)(iii) do not apply in those cases. Another relieving rule in subsection 34.2(14) deems a corporation to be a member of a partnership at the end of a taxation year if the corporation has disposed of its partnership interest to a related or afliated corporation and the same or another related or afliated corporation owns the partnership interest at the end of the year. The provision facilitates internal reorganizations that would otherwise result in forfeiture of the reserve. An anti-avoidance rule in subsection 34.2(18) disallows the reserve if it is reasonable to conclude that one of the main reasons for the corporations membership in a partnership in a taxation year is to avoid the application of subsection 34.2(13). The provision targets a corporation that substantially withdraws from a partnership but retains a nominal partnership interest, not for a commercial purpose, but instead to qualify for the reserve.
Reserve Denial Rules

A corporation is not entitled to deduct a reserve for QTI in a taxation year if the corporation has not been a member of the partnership continuously since before March 22, 2011 until the end of that taxation year;108 at the end of the year or at any time in the following taxation year, the corporations income is exempt from tax, or the corporation is non-resident and the partnership does not carry on business through a permanent establishment in Canada;109 or
Adjusted Cost Base Adjustments

Neither ASPA nor apportioned income included in income for a corporations taxation year increases the adjusted cost base to a corporation of a partnership interest. If the corporation sells the partnership interest in the following taxation year before the end of the partnerships scal period, the corporation may realize a gain on the disposition attributable in part to partnership income for the stub period previously accrued. Double taxation will not arise, however, because the corporation may deduct in the year of disposition such prior years ASPA or apportioned income, as the case may be.
the corporations taxation year ends immediately before another taxation year in which the corporation becomes a bankrupt,110 in which the corporation is dissolved or wound up (other than pursuant to a tax-deferred windup under subsection 88(1)),111 or at the beginning of which the partnership no longer principally carries on the activities to which the reserve relates.112
Relieving and Anti-Avoidance Provisions

A corporation cannot deduct a reserve for QTI for a taxation year if the corporation disposes of its partnership interest or winds up on a taxable basis.113
107 108 109 110
Explanatory Notes, supra note 29, at subsection 34.2(11). Paragraph 34.2(13)(a). Paragraph 34.2(13)(b).
Subparagraph 34.2(13)(c)(ii). As dened in subsection 248(1), bankrupt means a person who has made an assignment or against whom a bankruptcy order has been made, or the legal status of that person: Bankruptcy and Insolvency Act, RSC 1985, c. B-3, as amended, section 2.
111
Subparagraph 34.2(13)(c)(iii). Subparagraph 34.2(13)(c)(i). Paragraph 34.2(13)(a) and subparagraph 34.2(13)(c)(iii).
112 113
EAI constitutes actual income of the partnership for a completed scal period. EAI increases the adjusted cost base to a corporation of a partnership interest;114 however, a corporation may deduct a reserve for QTI that includes EAI. On a disposition by the corporation of the partnership interest, the corporation will not be subject to double taxation on the portion of any gain attributable to EAI. Therefore, the adjusted cost base of a partnership interest to a passive corporate partner is reduced to the amount that would have prevailed without the EAI.115
capital gain, that portion is deductible only against taxable capital gains of the corporation. If the corporation does not have sufcient actual taxable capital gains, or ASPA or added-back QTI that is deemed by paragraph 34.2(5)(a) to be taxable capital gains, in the year to absorb that portion of the deduction, the excess is deemed to be an allowable capital loss for the year.117 The deemed allowable capital loss prohibits the deduction of an overaccrued taxable capital gain against ordinary income. The deemed allowable capital loss is equal to the difference between118 1. the portion of the deduction of ASPA or partitioned income, as the case may be, that is deemed by paragraph 34.2(5)(a) to be a taxable capital gain; and the difference between 2. the total of a. taxable capital gains allocated to the corporation by the partnership for the taxation year; and b. accrued taxable capital gains for the current stub period (namely, the portion of ASPA and the add-back of QTI that is deemed by paragraph 34.2(5)(a) to be a taxable capital gain); and 3. allowable capital losses allocated to the corporation by the partnership for the taxation year that contains the stub period to the extent of the taxable capital gains included in the computation of the deemed allowable capital loss. Accrued taxable capital gains for the current stub period reduce the deemed allowable capital loss because the deduction of the prior years accrued taxable capital gains applies against them rst. Allowable capital losses are deductible only to the extent of actual and accrued taxable capital gains included in the computation so that actual allowable capital losses allocated to the corporation by the partnership are not duplicated in the deemed allowable capital loss calculated under the formula set out above.
Character of ASPA, Partitioned Income, and Reserve for QTI

ASPA, partitioned income, and QTI include all sources of partnership income. Sourcing rules in subsection 34.2(5) deem the accrual and the reserve to have the same character as the partnership income from which they derive so that the appropriate corporate tax rate applies to the amount. Partitioned income and the reserve for QTI are deemed to be income and taxable capital gains with the same character and in the same proportions as any income and taxable capital gains making up the constituent elements of the partnership income that is allocated to the corporation and used to compute the particular amount. Example 3 illustrates the effect of this provision. Example 3 Under the characterization rule, if a partnership allocates to a corporation $100,000 of partnership income composed of $40,000 of active business income, $30,000 of property income, and $30,000 of taxable capital gains, ASPA will be deemed to be 40 percent active business income, 30 percent property income, and 30 percent taxable capital gains.116 The corporate tax rate applicable to business income (including the small business deduction, if applicable) will apply to 40 percent of the ASPA, while the rate applicable to investment income (including refundable taxes, if applicable) will apply to the property income and taxable capital gains.
Deemed Allowable Capital Loss

Subsection 34.2(4) permits a corporation to deduct in a taxation year ASPA or partitioned income, as the case may be, previously included in income in the immediately preceding taxation year. If a portion of the deduction derives from amounts deemed by the characterization rule to be a taxable
Exceptions
Three situations are specically excluded from the application of the new regime.
114 115 116 117
Subparagraph 53(1)(e)(i). Subparagraph 53(2)(c)(i.4). The example is taken from the Explanatory Notes, supra note 29, at subsection 34.2(5). The formula A (B C) in paragraph 34.2(5)(b).
Paragraph 34.2(5)(b).
118
First, the accrual of ASPA and partitioned income does not apply in a taxation year in which the corporation becomes bankrupt.119 The accrual applies for all taxation years of the corporation that follow the year of bankruptcy.120 Second, the regime does not apply in computing foreign accrual property income (FAPI) in respect of a corporation.121 The exception avoids technical problems that would otherwise arise in computing FAPI.122 The exception does not extend to a Canadian-resident corporation that owns a partnership that in turn owns a foreign afliate that earns FAPI.123 This limitation forecloses deferral of FAPI by a Canadian-resident corporation through a transfer of shares of a foreign afliate to a partnership. Third, the regime does not apply in computing exempt surplus and taxable surplus of a foreign afliate, except to the extent that the context otherwise requires.124 This exception does not apply to hybrid surplus, which ought not to arise.125 The exception relieves the obligation on a foreign afliate to apply the regime in computing surplus where the afliate does not defer partnership income subject to Canadian tax. The context may require the afliate to compute surplus differently if the surplus is computed by reference to Canadian-source income of the afliate affected by the new regime.
Joint Ventures
As an administrative concession, the Canada Revenue Agency (CRA) formerly permitted a joint venture to adopt a scal period that could differ from that of its participants.126 If the joint ventures scal period ended before the taxation year of a participant, the participant deferred income from the joint venture until the participants following taxation year. The CRA has withdrawn its prior administrative position to conform to the policy of the 2011 amendments.127 A participant in a joint venture, whether a corporation, a trust, a partnership, or an individual, must include in income for a taxation year its share of income of a joint venture for the portion of the joint ventures scal period that falls within the participants taxation year. On an administrative basis, the CRA grants transitional relief that mimics the reserve for QTI and is subject to the same conditions. The CRA initially stated that, to claim transitional relief, a participant must elect in writing on or before the ling-due date for its rst taxation year that ends after March 22, 2011. The CRA subsequently extended the deadline for the election to September 22, 2012.128
119
Subsection 34.2(7). See the denition of bankrupt, supra note 110. The Department of Finance misstated this aspect of the exception in the Explanatory Notes, supra note 29, at subsection 34.2(7). Paragraph 34.2(8)(a). Paragraph 95(2)(f) requires a foreign afliate to compute FAPI under the provisions of the Act. Absent the exception, if a foreign afliate owned an interest in a partnership that earned passive property income, the foreign afliate would be required to include in income ASPA that would be deemed by paragraph 34.2(5)(a) to be property income. Although ASPA would be included in FAPI, it would bear no foreign tax, so the afliate would not be able to deduct foreign accrual tax in respect of the inclusion. Thus, the afliate would bear a higher effective Canadian tax rate on accrued FAPI than on actual FAPI. Further, the character of ASPA in a taxation year of the afliate could differ from the character of the partnership income allocated to the afliate in the following year. This might arise if, for example, the afliate met the investment business denition in subsection 95(1) in one year but not in the following year. The computation of FAPI would be distorted by the mismatch between the character of ASPA and actual partnership income allocated to the corporation by the partnership. Explanatory Notes, supra note 29, at paragraph 34.2(8)(a). Paragraph 34.2(8)(b). Hybrid surplus arises on a disposition by a foreign afliate of shares of another foreign afliate. The characterization rule in paragraph 34.2(5)(a) does not deem the afliate to have disposed of property, so hybrid surplus ought not to arise on accrual of partnership income for a stub period. The technical notes apply similar reasoning to conclude that ASPA deemed by paragraph 34.2(5)(a) to be a taxable capital gain, and an allowable capital loss deemed to arise under paragraph 34.2(5)(b), do not affect a corporations capital dividend account (CDA) because the characterization rule does not deem a disposition of capital property to have occurred: see Explanatory Notes, supra note 29, at subsection 34.2(5). Revenue Canada Round Table, in Report of Proceedings of the Forty-First Tax Conference, 1989 Conference Report (Toronto: Canadian Tax Foundation, 1990), 45:1-60, question 40, at 45:23-24. CRA document nos. 2011-0403081C6, June 6, 2011, and 2011-0429581E5, November 29, 2011. Letter to Ian Pryor of Cadesky and Associates from Gwen Moore of the CRA, Re: Revised Administrative Policy for Participants in Joint Ventures, dated January 10, 2012.
120 121 122
123 124 125
126
127 128
ISSUES AND TAX-PLANNING OPPORTUNITIES

There are a number of policy considerations, interpretive issues, and planning opportunities that arise out of the 2011 amendments.
Policy Considerations
Signicant InterestThreshold The budget stated that the government introduced the 2011 amendments in part to address a corporations opportunity to defer income through the use of captive partnerships for little purpose other than tax savings. However, the provisions extend beyond captive partnerships, applying to all corporations that own a signicant interest in a partnership. The 10 percent threshold for a signicant interest may have been selected by Finance to balance the mischief of deferral against the cost of compliance.129 In this regard, most partnerships that have partners with an ownership interest below the threshold are publicly traded. Publicly traded partnerships invariably have individual partners and thus must have a calendar scal period,130 which limits deferral opportunities. Private operating partnerships seldom have partners that do not have a signicant interest as dened in subsection 34.2(1). It is doubtful that the signicant interest threshold will exempt many corporate partners. Specied Percentage of QTI By virtue of the denition of specied percentage of QTI in subsection 34.2(1), transitional relief applies over a ve-year period. The parallel rule under the 1995 amendments permitted transitional relief over a 10-year period. Finance has not explained the policy behind the shorter transition period in the corporate context.131 The explanation may lie in the underlying policy of the provisions to raise revenue. Deadline To Make an Alignment Election Prior to nalization of the 2011 amendments, a procedural rule required some corporate partners to le an alignment election
under paragraph 249.1(10)(a) as early as September 23, 2011 on the basis of proposed legislation without the benet of a prescribed form. Commentators criticized the short deadline as unnecessarily restrictive.132 There is no obvious policy or administrative reason to impose such a short deadline. It could be that Finance simply wished to match the language of the ling deadlines imposed under the 1995 amendments governing an individuals election of an off-calendar scal period for a business.133 On December 16, 2011, Finance announced an intention to introduce further legislation to treat late alignment elections as having been led on time if the election is led on or before January 31, 2012.134 The amendment will provide only limited relief. Multi-Tier Alignment Elections Each partnership in a multi-tier partnership structure formed after March 22, 2012 must align to a calendar scal period, without the ability to make a multi-tier alignment election to adopt an off-calendar scal period.135 Commentators have criticized a mandatory calendar scal period for each partnership in a multi-tier partnership structure on the basis that commercial considerations may favour an off-calendar scal period, and corporate partners may have off-calendar taxation years that do not coincide with the partnerships calendar scal period.136
Interpretive Issues
Meaning of Character Paragraph 34.2(5)(a) deems the inclusion and deduction of ASPA and apportioned income to be income or taxable capital gains of the same character and in the same proportion as the income or taxable capital gains that make up the constituent elements of the partnership income that is allocated to the corporation and used to compute the particular amount. The deeming rule serves a function similar to paragraph 96(1)(f).
129
At a meeting between the joint committee and the Department of Finance in the summer of 2011 (supra note 9), the joint committee criticized the 10 percent threshold as too low. It submitted that accrual ought to apply only if the corporation controls the choice of the partnerships scal period. In answer to the criticism, Finance responded that accrual is supposed to apply whether or not deferral of income achieved by a corporation through the use of a partnership is intentional. Subsection 249.1(1). For criticism of the difference, see the submissions of the Tax Executives Institute dated June 21, 2011, supra note 9, at 2-3, and September 16, 2011, ibid., at 2. Ibid., the submission of June 21, 2011, at 4, and the submission of September 16, 2011, at 2. Subsection 249.1(4). Canada, Department of Finance, Minister of Finance Announces Extension of Time To File Corporate Partnership Alignment Elections, News Release 2011-138, December 16, 2011. Paragraph 249.1(1)(c). See the joint committee submission, supra note 9, at 17 .
130 131
132 133 134
135 136
The term character is unusual for Canadian tax purposes. In the few provisions of the Act that refer to the character of a payment,137 the term refers to characteristics, source, and purpose.138 Elsewhere in the Act, the term composition accompanies the term character. 139 Character connotes the collective qualities, features, traits, or peculiarities that distinguish a thing.140 In the context of the Act, at a minimum, character refers to the source of an amount as income or capital earned or realized in a particular place. Yet character connotes a more general concept than source, so ASPA, partitioned income, and the reserve for QTI ought to acquire all of the traits of the partnership income from which they derive. A number of technical issues result from this deeming provision. Capital Dividend Account Finance states that the portion of ASPA deemed by paragraph 34.2(5)(a) to be a taxable capital gain does not affect the corporations capital dividend account (CDA).141 The reason is that paragraph 34.2(5)(a) does not deem the corporation to have disposed of capital property, and so there is no addition to CDA.142 Commentators have questioned the merit of Finances technical position.143 The issue is that character connotes a broad concept, including not only the source of income but also every other quality, feature, trait, or peculiarity that distinguishes income. The event that gives rise to income may qualify as a quality, feature, trait, or peculiarity that distinguishes the income and thus may form part of its character. Further, if paragraph 34.2(5) (a) creates a legal ction and does not merely declare the law, the consequences and incidents that inevitably and logically accompany the deeming of ASPA as a taxable capital gain ought to be deemed to arise as well.144 As a corollary, the ASPA deemed to be a taxable capital gain may thus be deemed to have derived from a disposition of a capital property. Therefore,
paragraph 34.2(5)(a) may imbue ASPA with the disposition of capital property, giving rise to an underlying taxable capital gain realized by the partnership from which the ASPA derives. If so, the ASPA could be included in a corporations CDA. An alternative interpretation of paragraph 34.2(5)(a), which arrives at the same conclusion as Finance, is that the deeming rule applies only for the limited purpose of computing the income of a corporation for a taxation year. The corporation referred to in that phrase is the corporation subject to section 34.2. The computation of CDA does not pertain to the computation of the income of that corporation. Although the denition of capital dividend account145 and the rules relating to the payment of capital dividends146 are both contained in division B of part I of the Act, which concerns the computation of income, it is the income of the shareholder and not the income of the corporation that is affected by the payment of a capital dividend. While the corporation is liable to a tax under subsection 184(2) for the declaration of a capital dividend in excess of the balance of its CDA, subsection 184(2) does not affect the computation of the corporations income. Therefore, the deeming rule in paragraph 34.2(5)(a) should not apply for the purposes of computing the CDA of the corporation. From a policy perspective, we consider that ASPA should not be included in a corporations CDA. ASPA is purely notional. While the corporation initially bears tax payable on the ASPA, it recovers the tax in the following year once the ASPA is deducted. The inclusion of ASPA in the CDA cannot be justied on that basis. Foreign Tax Credits If ASPA derives from partnership income that consists of, for example, interest earned in a foreign country, paragraph 34.2(5) (a) should deem ASPA to be interest earned in that foreign country. The corporation does not bear foreign tax on ASPA. Thus, the corporation cannot claim a foreign tax credit for ASPA deemed to be interest earned in the foreign country.
137
Proposed subsection 260(5.1) refers to character in the marginal notes: Canada, Department of Finance, Legislative Proposals To Amend the Income Tax Act and Related Legislation To Effect Technical Changes and To Provide for Bijural Expression in That Act (Ottawa: Department of Finance, July 16, 2010). Proposed paragraph 260(8)(b) also refers to character, as does proposed paragraph 143.4(3)(b) in Canada, Department of Finance, Legislative Proposals Relating to Income Tax (Ottawa: Department of Finance, March 16, 2011). Explanatory Notes, supra note 29, at subsection 260(5.1). See proposed paragraph 260(8)(b) in the July 16, 2010 draft legislation, supra note 137 . See the denition of character in The Concise Oxford English Dictionary, 8th ed.; and Kennedy v. William C. Cavell Enterprises Ltd. (1987), 23 OAC 349 (Div. Ct.), cited in the denition of character in The Dictionary of Canadian Law, 2d ed. Explanatory Notes, supra note 29, at paragraphs 34.2(5)(a) and (b). Clause (a)(i)(A) in the denition of capital dividend account in subsection 89(1). Joint committee submission, supra note 9, at 21. East End Dwellings Co. Ltd. v. Finsbury Borough Council, [1952] AC 109, at 132 (HL). Subsection 89(1). Section 83.
138 139 140
141 142 143 144 145 146
As a result, the corporation bears a higher effective Canadian tax rate on the accrual than on the actual income. The mismatch between the obligation to accrue unearned foreign-source income and the inability to deduct an offsetting foreign tax credit impinges on cash ows. Commentators have criticized this result.147 Successor Rules The successor rules in section 66.7 permit a corporation that acquires all or substantially all of the Canadian or foreign resource properties of another person to be treated as a successor entitled to resource expenses incurred by the previous owner of such properties. The rules also apply on an acquisition of control of a corporation to treat the corporation as a successor of itself. Where the successor rules apply, a successor corporation may deduct an amount in respect of resource expenses incurred by the previous owner of the resource property. However, the deduction is limited to income from, and proceeds from the disposition of, the particular resource property owned by the original owner at the time of the event that gave rise to the application of the successor rules. A corporate partner of a partnership that owns resource properties is not the owner of the partnerships property by virtue of its interest in the partnership.148 However, the partnership cannot deduct any resource expenses that it incurs, but instead allocates those expenses to the partners at the end of the scal year of the partnership. But for specic relieving provisions in the successor rules, a corporation could not apply any of its resource expenses existing immediately before an acquisition of control against income from, and proceeds from the disposition of, resource properties owned by a partnership in which the corporation had an interest immediately before the acquisition of control. Paragraph 66.7(10)(j) treats the corporation as having owned, immediately before the acquisition of control, a portion of the resource property owned by the partnership at the time of the acquisition of control equal to the corporations percentage share of the aggregate of amounts that would be paid to all partners of the partnership if the partnership were wound up. In addition, for taxation years ending after the acquisition of control, a partners share of the income of the partnership is deemed to be income of the corporation for the year
attributable to production from the property. The corporate partners share of income of the partnership for such purposes is the lesser of its share otherwise determined and the amount that would be its share of the income of the partnership if that share were determined on the basis of the corporate partners percentage entitlement to the property of the partnership on a windup of the partnership. A similar issue arises where there is an amalgamation of corporations that are not subsidiary wholly owned corporations of a person and one of the corporations is a partner of a partnership. In that case, the relieving provision extends to the amalgamated corporation.149 One issue that arises is whether the 2011 amendments permit a corporation that is a successor to itself by virtue of an acquisition of control of the corporation, or that is formed on an amalgamation of predecessor corporations that are not subsidiary wholly owned corporations, to deduct the successored resource expenses against income of a partnership in computing its ASPA. The concern arises because subsection 34.2(5) refers to character but not to the source of income. We consider that character is a concept that subsumes all aspects or dimensions of income, including source. Therefore, production income from, and proceeds from the disposition of, successored resource property should form part of the character of ASPA, and successored resource expense accounts should be deductible against ASPA. There is no policy reason to exclude production income and proceeds from the disposition of resource property held by a partnership from the character of ASPA, and thereby preclude the deduction of resource expenses from ASPA pursuant to the successor rules. Corporate Tax Attributes Anomalies arise when APSA is relevant in computing refundable dividend tax on hand (RDTOH)150 and safe income under the new regime. RDTOH Commentators have noted that RDTOH may become trapped in the corporation if ASPA derives from an unusually high amount of property income allocated to the corporation by a partnership.151 The characterization rule will deem ASPA to be property income included in the corporations aggregate
147
See the September 16, 2011 submission of the Tax Executives Institute, supra note 9, at 5. The same issue may have prompted Finance to introduce paragraph 34.2(8)(a) to make section 34.2 inapplicable in computing FAPI of a foreign afliate in respect of a Canadian-resident corporation. Paragraph (g) of the denition of Canadian resource property in subsection 66(15). See proposed paragraph 66.7(10)(j) in the July 16, 2010 draft legislation, supra note 137 . Dened in subsection 129(3). Joint committee submission, supra note 9, at 22.
148 149 150 151
investment income. 152 High corporate tax rates applicable to property income will apply to ASPA included in the corporations income for its taxation year, and the corporation will realize RDTOH. In the following taxation year, the corporation will deduct the prior years ASPA. The characterization rule in paragraph 34.2(5)(a) will deem the deduction to be a property loss. If the partnership allocates to the corporation business income earned by the partnership in its scal period that falls within the same taxation year of the corporation in an amount that exceeds the ASPA deduction, the corporation will not realize a non-capital loss because the business income offsets the property loss.153 Therefore, the corporation will be unable to carry back a loss to its prior taxation year to reduce aggregate investment income and thus RDTOH in that prior year. Effectively, in this scenario, ASPA anticipates that the partnership will earn property income for the stub period, but instead the partnership earns business income. As a result, the corporation will pay high-rate tax on ASPA, since the accrual is deemed to be property income, whereas it ought to pay lowrate tax, since the actual partnership income for the stub period is business income. The incremental tax cannot be recovered except by payment of a taxable dividend to release the trapped RDTOH as a dividend refund.154 If the corporation has corporate shareholders, however, part IV applies to that taxable dividend. The result shows that, while paragraph 34.2(5)(a) is intended to cause the proper corporate tax rate to apply to ASPA, the regime does not work perfectly.
Safe Income Subsection 55(2) deters the conversion of a capital gain on a disposition of shares of a Canadian-resident corporation into a deductible intercorporate dividend. Subsection 55(2) applies if the hypothetical gain realized on the disposition could reasonably be considered to be attributable to anything other than safe income of the corporation. Safe income includes income earned or realized by a corporation as computed under the rules of the Act.156 Consequently, safe income includes a corporations ASPA in respect of a partnership before the disposition. As an administrative concession, the CRA currently permits safe income computed at the relevant safe-income determination time to include the corporations share of actual partnership income earned to that time.157 We expect that the CRA will revise its administrative position so as to ensure that there is no double-counting of safe income. Activities to Which the Reserve Relates Under the 1995 amendments, an individual was not entitled to a transitional reserve if a business was not carried on principally by either the individual or the members of a partnership of which the individual was a member.158 In this context, the term business included another business substituted for the particular business or for which the particular business was substituted.159 The 2011 amendments contain a parallel provision that denies the corporation a reserve for QTI if the partnership no longer principally carries on the activities to which the reserve relates.160 Since the reserve for QTI pertains to all sources of income, the provision refers to activities rather than merely a business. Activities does not have a technical meaning. In the ordinary sense, activity means a particular occupation or pursuit. 161 The term covers a broad range of conduct undertaken in pursuit of prot. This implies that a partnership carries on the activities to which the reserve relates if the partnership carries on (or holds) the same or a similar business (property) as, or a business (property) substituted for, the business carried on (or
The issue would not arise if ASPA included in the corporations income for its taxation year were deemed by paragraph 34.2(5)(a) to be a taxable capital gain. In the corporations following taxation year, paragraph 34.2(5)(b) would deem the corporations deduction of ASPA to be an allowable capital loss. The corporation would carry back the allowable capital loss under paragraph 111(1)(b) to be deducted in computing aggregate investment income in the prior year.155 The loss carryback would eliminate the RDTOH attributable to ASPA deemed by paragraph 34.2(5)(a) to be a taxable capital gain, which the partnership ultimately did not realize in the partnerships scal period that contained the stub period.
152 153 154 155 156 157
Dened in subsection 129(4). See the denition of non-capital loss in subsection 111(8). Subsection 129(1). Subparagraph (a)(iii) of the denition of aggregate investment income in subsection 129(4). Subsection 55(5). CRA document nos. 9237115, July 23, 1993; 9907157 , June 7 , 1999; and 2007-0243151C6, October 5, 2005. The CRAs current administrative position extends the jurisprudential principles in Canada v. VIH Logging Inc., 2005 FCA 36. Former subparagraph 34.2(6)(c)(i). Former subsection 34.2(3). Subparagraph 34.2(13)(c)(i). As dened in The Concise Oxford English Dictionary, 8th ed.
158 159 160 161
the property held) by the partnership that generated the QTI to which the reserve relates. The breadth of activities may explain why the 2011 amendments do not contain a special provision to extend its ordinary meaning. The reserve denial rule in subparagraph 34.2(13)(c)(i) differs from the 1995 precedent on which it is patterned. The difference imports ambiguity. The test could reasonably focus on either of the following:162 whether the partnerships current principal activities are different from its historical activities to which the reserve relates; or whether the historical activities to which the reserve relates are carried on principally by the partnership. The rst formulation of the test requires a review of all of the current activities of the partnership. The second asks only whether the partnership is carrying on the activities that gave rise to QTI eligible for the reserve. Because the test bears more than one reasonable meaning on a textual analysis, a purposive analysis and a contextual analysis play a greater role in the interpretive process.163 On a purposive analysis, the reserve for QTI is intended to mitigate a cash ow constraint imposed by the additional tax payable on the inaugural accrual of partnership income for a stub period. Only the partnerships historical activities that produced QTI ought to be relevant. Requiring a partnership to limit its principal activities to the very same activities that produced QTI would create a disincentive to innovate in order to adapt to market changes. On a contextual analysis, to conform with the thrust of the parallel rule under the 1995 amendments, the reserve denial rule ought to focus on whether the historical activities that produced QTI are carried on principally by the partnership.164 Therefore, in our view, subparagraph 34.2(13)(c)(i) requires a determination of whether the historical activities to which the reserve relates are no longer carried on principally by the partnership. Examples 4 through 6 illustrate the ambiguity in the existing provision.165 Example 4 A partnership grows. The partnership carries on the business that produced QTI and another business that is now its principal activity. In our view, the historical activities to which the
reserve relates are carried on principally by the partnership. Subparagraph 34.2(13)(c)(i) should not apply to deny the reserve for QTI. Example 5 A partnerships activities evolve. The partnership ceases to carry on the business that produced QTI but instead carries on a similar business. Although the partnerships business is not the same as the one to which the reserve relates, on the basis of the ordinary meaning of the term activities, the historical activities to which the reserve relates may be considered to be carried on principally by the partnership. If so, subparagraph 34.2(13)(c)(i) should not apply to deny the reserve for QTI. The facts will be crucial in making the determination. Example 6 QTI derives from a one-time taxable capital gain realized by a partnership on a disposition of capital property outside the ordinary course of business. Throughout the transitional period, the partnership no longer principally carries on the activities to which the reserve relates because the disposition was a one-time event. Subparagraph 34.2(13)(c)(i) should apply to deny the reserve for QTI. This outcome is defensible where, for instance, the taxable capital gains relevant in computing QTI arose from an internal reorganization. On the other hand, the result is questionable from a policy perspective if QTI relates to an arms-length disposition of capital property.
Planning Opportunities
Accrual of Partnership Losses A corporation does not have negative ASPA in respect of an unprotable partnership. If the formula to compute ASPA produces a negative result, section 257 deems the amount to be nil. Therefore, the corporation cannot accrue partnership losses for a stub period. Further, ASPA is a partnership-by-partnership computation. If the corporation owns a signicant interest in more than one partnership, the corporation cannot net the income and losses of the partnerships in computing ASPA. Commentators have criticized the result as inconsistent with automatic netting of income shortfall adjustments in computing interest on underaccrued partnership income.166 A corporation may engage in self-help to net such ASPA. The corporation may make a designation for the stub period to reduce ASPA for the protable partnership by the amount of the
162 163 164
See the September 16, 2011 submission of the Tax Executives Institute, supra note 9, at 4; and the joint committee submission, ibid., at 14. Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, at paragraph 10. Former subparagraph 34.2(6)(b)(i) denied a reserve for December 31, 1995 income where the business is not carried on principally by the individual. The examples are taken from the joint committee submission, supra note 9, at 13-14. See the September 16, 2011 submission of the Tax Executives Institute, supra note 9, at 2-3; and the joint committee submission, ibid., at 6.
165 166
loss for the stub period of the unprotable partnership. Interest on underaccrued partnership income will not apply unless the lesser of the ASPA computed without the designation for the stub period and actual stub period accrual for the protable partnership exceeds the actual stub period accrual for the unprotable partnership.167 If the corporation does not know the actual stub period accrual for the partnerships at the time of ling its return in which the designation for the stub period is made, it may designate a smaller amount to leave a margin for variance in the expected income and loss of the partnerships, and thus avoid the interest charge. Revocation of an Alignment Election Section 249.1 does not contain a provision that expressly permits an alignment election to be revoked.168 However, Finance interprets paragraph 249.1(10)(d) as invalidating all elections that are led if more than one election has been led and they contain contradictory elected dates. The policy appears to be that an election should not be capable of amendment for the purposes of retroactive tax planning. One might interpret paragraph 249.1(10)(d) differently, as invalidating only the second and subsequent elections that are led without affecting the validity of the rst, on the basis that the test in paragraph 249(10)(d) applies to each purported election at the time it is led. If Finances interpretation prevails, however, it may be possible to revoke an election by ling a second, otherwise valid election that species a different elected date. On the basis of Finances interpretation, until the deadline to elect expires, corporate partners may revoke an election by ling another one that meets all of the substantive and procedural requirements other than paragraph 249.1(10)(d). For example, the corporation ling the second election will require authority to act for all the members of the partnership and must le the election on time. Once the deadline expires, however, such a second ling will not be a valid election and, thus, paragraph 249.1(10)(d) should not apply to invalidate the initial election. ASPA on Reassessment A reassessment to increase a corporations share of partnership income for a scal period of the partnership that falls in the corporations taxation year will prompt a consequential adjustment of additional ASPA in the year. If the minister issues the reassessment near the end of the normal reassessment period, the consequential adjustment will arise even though the corporation knows that it could have made a designation for
167
the stub period to reduce the resulting ASPA without exposure to an interest charge under subsection 34.3(3). In effect, the corporations recognition of partnership income is accelerated unfairly by reason of a reassessment of partnership income that affects the computation of ASPA. Under subsection 34.2(10), a corporation cannot amend or revoke a designation for the stub period. The provision does not expressly prohibit a late-led designation. Subsections 220(3.2) and (3.21) of the taxpayer relief provisions do not confer authority on the minister to accept a late-led designation for the stub period to reduce ASPA that arises on a reassessment as a consequential adjustment. In The Queen v. Nassau Walnut Investments Inc.,169 the Federal Court of Appeal permitted a taxpayer to make a lateled designation of safe income under paragraph 55(5)(f) in an objection to a reassessment. On the basis of Nassau Walnut, if a corporation did not make a designation for the stub period in its return of income, the corporation might try to late-le a designation for the stub period in an objection to the reassessment in order to eliminate incremental ASPA arising as a consequential adjustment. On the other hand, if the corporation has already made a designation for the stub period, subsection 34.2(10) prohibits amendment or revocation of the designation. Thus, a consequential adjustment to increase ASPA for a corporations taxation year could prompt a further reassessment for a subsequent taxation year of the corporation to include in its income an interest charge for underaccrued partnership income where ASPA (computed without the designation for the stub period) previously was less than the actual stub period accrual.170 The result is unfair. The threat of an interest charge from an unanticipated audit adjustment may deter a corporation from making a designation for the stub period altogether in those circumstances.171 No QTI QTI does not arise if the corporation acquires a signicant interest in the partnership during the partnerships scal period and before March 22, 2011 but the corporations taxation year ends before the partnerships scal period. In that case, the corporation must include in income for its second taxation year that ends after March 22, 2011 an amount that represents more than 12 months of partnership income without any transitional relief. Paragraph 34.2(16)(a) is not met, since the partnership does not have a scal period that ends in the corporations rst
See the joint committee submission, ibid., at 6. The analysis assumes that the protable and unprotable partnerships have the same scal period. Otherwise, the income shortfall adjustment for each partnership would not match since the stub periods would have different lengths. Under the 1995 amendments, subsection 249.1(6) permits a revocation of an election to adopt an off-calendar scal period for a business. 97 DTC 5051 (FCA).
168 169 170 171
See the September 16, 2011 submission of the Tax Executives Institute, supra note 9, at 3. Ibid.
taxation year ending after March 22, 2011. Thus, subsection 34.2(17) does not apply to true-up QTI in a subsequent taxation year. From a policy perspective, the corporation ought to be afforded the reserve for QTI because it owned its partnership interest when the minister of nance rst announced the measure in the budget.172 To resolve the problem, the corporation might try to make a single-tier alignment election. The elements of the election do not require that the elected date align the partnerships scal period to the taxation year of any corporate partner.173 The election may specify an elected day shortly after March 22, 2011 but before the end of the corporations taxation year. Under the election, the partnership would have a scal period that ends in the corporations rst taxation year ending after March 22, 2011. The corporation would realize ASPA (but not EAI) included in QTI. ASPA would arise because the partnership has a scal period that ends in the corporations rst taxation year ending after March 22, 2011 by reason of the election. EAI would not arise since there is no aligned scal period of the partnership and thus no eligible scal period. However, the potential application of GAAR to the single-tier alignment election in the particular circumstances should be considered.174 Deduction of Reserve for QTI in Short Taxation Years A short taxation year of the corporation may affect its deduction of a reserve for QTI. If the partnership does not allocate to the corporation any income for the short taxation year, the income limit may severely restrict the corporations reserve in the year. The prior-year reserve limit will restrict the corporations reserve for QTI in each subsequent taxation year that remains in the transitional period.175
To avoid the result, the corporation may undertake a transaction to increase its income for the short taxation year. For example, the corporation might cause subsidiaries to pay dividends or the corporation could sell property to realize taxable capital gains.176 The corporations deduction of dividend income in computing taxable income would not affect the income limit.
CONCLUSION
The policy to limit deferral of partnership income by a corporation is sound. From a tax policy perspective, the 2011 amendments promote equity and neutrality, but at the cost of high complexity. The provisions are fair because they treat corporations and individuals similarly, and harmonize Canadian tax law with that of other jurisdictions. They reduce economic distortions by limiting a tax incentive to carry on an incorporated business through a partnership. The provisions do not penalize the partnership form, since a partnership need not prepare nancial statements for a stub period. However, they increase administration and compliance costs, and will prompt disputes over ambiguities in the language. Some of the difculties arise because the provisions stem from a precedent designed for a different purpose. The 2011 amendments are necessarily more complex than the 1995 amendments because they apply to all sources of partnership income, which are subject to different corporate tax rates. We consider that, from a broad perspective, the provisions generally work well. They achieve the policy objective of limiting deferral of income by a corporation through the use of a partnership, and will raise revenue for the government. However, the provisions contain both technical deciencies and ambiguities. A corporation may use tax planning to resolve some of the problems.
172
Joint committee submission, supra note 9, at 8; and Tax Executives Institute, supra note 9, the submission of June 21, 2011, at 3, and the submission of September 16, 2011, at 2. Subsections 249.1(8) and (10).
173 174
The most recent decision on GAAR is Copthorne Holdings Ltd. v. Canada, 2011 SCC 63. Joint committee submission, supra note 9, at 11. Calvert and Copeland, supra note 9, at slide 26.
175 176
Contact us Brian R. Carr Partner, Corporate and Resource Tax Moskowitz & Meredith LLP T: +416-861-0846 E: briancarr@mmtaxlaw.ca kpmg.ca Jeff Oldewening Associate, Taxation Moskowitz & Meredith LLP T: +416-861-0505 E: jeffoldewening@mmtaxlaw.ca
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor 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 on such information without appropriate professional advice after a thorough examination of the particular situation. 2012 KPMG LLP , a Canadian limited liability partnership and a member rm of the KPMG network of independent member rms afliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. 6481 The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.

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ARTICLE REPRINT This article was rst published in Canadian Tax Journal

Corporate Tax Planning

Limitation on Deferral of Partnership Income by a Corporation

2 | Corporate Tax Planning

Corporate Tax Planning | 3

4 | Corporate Tax Planning

Budget Plan, supra note 4, at 315.

Corporate Tax Planning | 5

OVERVIEW OF THE PROVISIONS

6 | Corporate Tax Planning

DETAILED REVIEW OF THE PROVISIONS

Corporate Tax Planning | 7

8 | Corporate Tax Planning

Corporate Tax Planning | 9

Interest Charge for Underaccrued Partnership Income

10 | Corporate Tax Planning

Prohibition of Amendment or Revocation of Designations

Special Rule for a New Corporate Partner of a Partnership

Deduction of ASPA and Apportioned Income

Corporate Tax Planning | 11

12 | Corporate Tax Planning

Corporate Tax Planning | 13

14 | Corporate Tax Planning

Deduction of Reserve for QTI

102 103 104 105 106

Corporate Tax Planning | 15

Reserve Denial Rules

Adjusted Cost Base Adjustments

Relieving and Anti-Avoidance Provisions

107 108 109 110

Subparagraph 34.2(13)(c)(iii). Subparagraph 34.2(13)(c)(i). Paragraph 34.2(13)(a) and subparagraph 34.2(13)(c)(iii).

16 | Corporate Tax Planning

Character of ASPA, Partitioned Income, and Reserve for QTI

Deemed Allowable Capital Loss

114 115 116 117

Corporate Tax Planning | 17

120 121 122

123 124 125

18 | Corporate Tax Planning

ISSUES AND TAX-PLANNING OPPORTUNITIES

132 133 134

Corporate Tax Planning | 19

138 139 140

141 142 143 144 145 146

20 | Corporate Tax Planning

148 149 150 151

Corporate Tax Planning | 21

152 153 154 155 156 157

158 159 160 161

22 | Corporate Tax Planning

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Corporate Tax Planning | 23

168 169 170 171

24 | Corporate Tax Planning

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