On September 16, 2011, Tax Executives Institute submitted the following recommendations to the Canadian Department of Finance for revision of proposed legislation accelerating corporate partner income inclusions. TEI’s comments, which took the form of a letter from TEI President David M. Penney to Brian Ernewein, General Director and Senior Assistant Deputy Minister in the Canadian Department of Finance’s Tax Policy Branch, were prepared under the aegis of the Institute’s Canadian Income Tax Committee,
whose chair is Carmine A. Arcari of Royal Bank of Canada. Contributing substantially to the development of TEI’s comments were Lynn Moen of Walton International Group Inc. and Marvin E. Lamb of Imperial Oil Limited. Jeffery P. Rasmussen, TEI Senior Tax Counsel, is staff liaison to the Canadian Income Tax Committee and coordinated the preparation of the comments.
TEI's previous letter of June 21, 2011, relating to those budget proposals can be found here.
Original Submission
Magazine Article
On June 6, 2011, the government released a Budget message with legislative proposals to amend various provisions of the Income Tax Act, Canada (the Act) to accelerate income inclusions by corporate partners. Tax Executives Institute submitted comments on the proposals on June 21, a copy of which is attached to this letter. The Department of Finance released draft legislation to implement the proposals on August 16, 2011, commenced a consultation period, and issued Explanatory Notes on September 1 to clarify and explain the legislation. On behalf of Tax Executives Institute, I am writing to reiterate the Institute’s concerns about some aspects of the proposals, and to make recommendations to clarify the August 16 draft legislation.
Background on Tax Executives Institute
Tax Executives Institute is the preeminent international association of business tax executives. The Institute’s 7,000 professionals manage the tax affairs of 3,000 of the leading companies in North America, Europe, and Asia. Canadians constitute 10 percent of TEI’s membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions, and must contend daily with the planning and compliance aspects of Canada’s business tax laws. Many of our non-Canadian members (including those in Europe and Asia) work for companies with substantial activities in Canada. The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.
TEI concerns itself with important issues of tax policy and administration and is dedicated to working with government agencies to reduce the costs and burdens of tax compliance and administration to our common benefit. In furtherance of this goal, TEI supports efforts to improve the tax laws and their administration at all levels of government. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the issues raised by the August 16, 2011, draft legislation affecting corporate partner income inclusions.
Summary of June 21 Institute Recommendations
The following comments and recommendations from the Institute’s letter of June 21 in respect of the budget proposals remain apropos to the August 16 draft legislation and we urge their consideration during this consultation. The letter fully explains each recommendation.
- The transition period for the inclusion of qualifying transitional income (QTI) should be extended from five to ten years.
- Transitional relief should be available for all corporate partners that owned a partnership interest as of March 22, 2011. A corporate partner that does not have income allocated from the partnership’s first taxation year either because the partnership interest is purchased after the partnership’s year-end but before March 22, 2011 or because the corporation invested in a partnership formed before March 22, 2011, with a fiscal period ending after the corporate partner’s first taxation year ending after that budget date will not qualify for transitional relief.
- The “Under-Reported Stub Period Accrual” calculation should be modified or eliminated. Considering the uncertainty in determining income calculations, this provision will produce excessive interest charges.
- The one-time “Single-tier Alignment Election” that will permit a partnership to change its fiscal period is unnecessarily restrictive. There is no sound policy or administrative reason for making this a “one-time” election with a very narrow timeframe. We recommend either eliminating the time limit for making the election or expanding the window for making the election to a minimum of three years.
In addition, we have the following comments on the draft legislation released on August 16, 2010:
Losses
Subsection 34.2(2) of the draft legislation states that “a corporation shall include in computing its income for a taxation year its adjusted stub period accrual . . . .” This statement mirrors the preamble to section 12 of the Act, which refers solely to income inclusions. As a result, the Adjusted Stub Period Accrual (ASPA) calculation seemingly applies only when income is allocated from a partnership to a partner. Although this is the proper result for calculating ASPA for the Qualifying Transitional Income (QTI) amount, it seems to produce an incorrect result where the partnership incurs a loss in subsequent years within the transition period. In loss years during the transition period, there would seemingly be no ASPA so the loss would be allocated to the partner in a year subsequent to the year in which the loss was incurred. We believe it would be appropriate to permit subsequent year’s losses to be treated consistently with subsequent year’s income. Hence, we recommend that losses be included in the calculation of ASPA in tax years after QTI is established.
In addition, the draft legislation does not address situations where a partnership incurs a loss in its first tax year ending after March 22, 2011. The phase-in of the QTI relief over a five-year period thus seemingly applies only where a partnership earns income for the first taxation year ending after March 22, 2011; a corporate partner in a partnership that incurs a loss in that period would be precluded from transition relief notwithstanding that the partnership may earn income in subsequent years that causes more than one year’s partnership income to be included in a future tax year of a partner. Where more than one year’s income will be allocated from a partnership to a corporate partner, we believe it would be appropriate to afford the corporate taxpayer a transition of such income over the remaining balance of the QTI relief period. We recommend that the legislation be revised to permit QTI to be calculated on an annual basis for income earned during the phase-in period and permit the phased taxation of such income over the remaining transition period.
Designations
Under proposed subsection 34.2(10), a company may not amend or revoke the amount “designated” as its Adjusted Stub Period Accrual or qualified resource expenditures. This restriction seems unduly stringent, especially given the longstanding practice of affording taxpayers the opportunity to amend or correct items in their tax returns. Moreover, considering the practical constraint of differing return filing deadlines where the partnership and corporate partners have different fiscal periods, it will be challenging for the partnership to compute its actual taxable income for its most recent fiscal year prior to the date by which the corporate partner must “designate” an amount for its Adjusted Stub Period Accrual or qualified resource expenditures. As a result, the draft legislation practically compels use of the “formulaic approach,” which relies on the partnership’s prior year’s taxable income, rather than affording taxpayers an opportunity to elect the actual or formulaic approach. In addition, whether because of changes in discretionary claims, CRA audit adjustments (which may occur many years later), or computation or interpretation errors, there will often be changes to a partnership’s taxable income after the initial calculation and designation on the corporate partner’s tax return. Hence, we recommend that the draft legislation be revised to permit companies to amend their “designated” amounts.
Even though the draft legislation states that the corporation is to designate the amount of the Adjusted Stub Period Accrual on its return, there is neither a reference to a prescribed form on which to make the designation nor a description of the manner of making the designation. Also, there is no provision for making a late-filed designation. We recommend that the legislation describe the form or manner in which to make the designations and also permit late-filed designations.
Finally, in computing QTI, which includes the Adjusted Stub Period Accrual income, proposed subsection 34.2(15) requires that the income of the partnership be computed as though the maximum deductions for all expenses, reserves, allowances, and other amounts are taken. In many partnerships that report resource income, the partnership income includes both regular income and “successor” income amounts. In such cases, the corporate partner may claim amounts from successor pools at the corporate level in accordance with section 66.7, which permits a carryforward of excess deductions for regular expenditures. Since there are strict limitations on the use of successor pools, the taxpayer would strive to match the successor income from the partnership as much as possible against the deductions from such pools. Although proposed subsection 34.2(6) indicates that the amount designated in calculating the Adjusted Stub Period Accrual may not exceed the maximum amount otherwise allowed (implying that a lesser amount may be claimed), proposed subsection 34.2(15) states that, when calculating QTI, the maximum amount deductible must be claimed. We recommend that the draft legislation be revised to eliminate this inconsistency and to accord flexibility to taxpayers claiming resource deductions in the calculation of QTI.
Transitional Relief
Under proposed subparagraph 34.2(13)(c)(i), the transitional relief provisions will not apply if a partnership “no longer principally carries on the activities to which the reserves relate.” This vague statement will likely engender controversy, including litigation, about its scope and effect. As important, a decision to change the partnership’s business model should not affect a transitional amount that was determined prior to that business decision. We recommend deleting this limitation on transition relief from the draft legislation.
Adjusted Cost Base
The draft legislation amends subsection 53(2) to make adjustments to the adjusted cost base (ACB) of a partner’s interest in a partnership with respect to QTI that includes “eligible alignment income.” Thus, where reserves are deducted under subsection 34.2(11), the amendments reduce the ACB of the partnership interest by the amount of the reserve addition. The draft legislation, however, does not contemplate an adjustment to the ACB of the partnership interest for the Adjusted Stub Period Accrual income. Because such income will generally be taxed to a partner in a taxation year that is before the year-end of the partnership, the partner is paying tax on an income inclusion but the adjustment to the ACB in the partnership interest is not made until immediately after the partnership’s year-end. Hence, if a corporate partner sold its partnership interest after the corporation’s year-end but before the partnership’s, the partner would not receive an appropriate ACB adjustment for the previously taxed income.
We recommend that the proposed changes to section 53 be revised to afford an adjustment to the ACB of the partnership interest for amounts included in the partner’s income related to the net “adjusted stub period accrual” income and the corresponding reserve on that income so that the ACB of the partnership interest at any given time includes the income that has been included in the partner’s taxable income.
Changes in Partnership Interest Other than in a Complete Disposition
Subsection 34.2(14) of the draft legislation describes how the Adjusted Stub Period Accrual is redetermined where there is a complete disposition of partnership interests to a related party within a corporate group. The draft legislation, however, provides no guidance describing how the Adjusted Stub Period Accrual should be calculated or applied to transactions that produce a shift in partnership ownership interests within a corporate group but that fall short of a complete disposition. For example, a member of a corporate group may make a new (or disproportionate) capital contribution in return for an interest (or increased interest) in a partnership. In addition, partnerships may be dissolved or reorganized with other entities.
We recommend that the legislation clarify the treatment of the Adjusted Stub Period Accrual for transactions that produce a shift in the partnership ownership structure but do not result in a complete disposition of a partnership interest.
Clarify the Availability of Foreign Tax Credit Relief
Under the current Act, partnerships allocate foreign-source income and foreign tax credits at the end of the partnership’s year and the corporate partner reports the income and claims the related foreign tax credit relief in the fiscal year in which the partnership year ends. Under the proposed Adjusted Stub Period Accrual rules, the foreign-source income inclusion will be accelerated to an earlier tax year but there is no draft legislative provision correspondingly accelerating the related foreign tax credits for foreign taxes imposed on such income. Because of the foreign tax credit limitation, a mismatch between the foreign-source income inclusion and the foreign tax credit relief will, at a minimum, adversely affect corporate partners’ cash flows and may lead to a permanent increase in tax liabilities should the foreign tax credit expire unused.[1]
We recommend that the Department clarify the treatment of foreign source income (including the calculation and characterization of per-country amounts) and related foreign tax credits related to the Adjusted Stub Period Accrual income inclusion and QTI to ensure that income inclusions align with applicable foreign tax credit relief.
Conclusion
TEI’s comments were prepared under the aegis of the Institute’s Canadian Income Tax Committee, whose chair is Carmine A. Arcari. If you should have any questions about the recommendations, please do not hesitate to call Mr. Arcari at 416.955.7972 (or carmine.arcari@rbc.com) or David V. Daubaras, TEI’s Vice President for Canadian Affairs, at 905.858.5309 (or david.daubaras@ge.com).