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Protecting The Integrity Of The Tax System


In his speech to Parliament on 22 March 2011, the Minister of Finance emphasised the need for a stable government, while delivering a plethora of targeted tax incentives for families. Although Budget 2011 provides limited tax relief for businesses in certain sectors, the main theme of the business tax measures is protecting the integrity of the tax system. Taxand Canada analyses the various measures that are to be introduced i.e. new stop-loss rules on the disposition of shares, elimination of tax deferral obtained from the use of partnerships, curtailing donations of publicly listed flow-through shares, amongst other measures.

Accelerated Recognition of Partnership Income
Eliminating the deferral of income has the potential to accelerate significant amounts of income, thereby accelerating the payment of tax. Budget 2011 proposes complex new rules to accelerate the recognition of partnership income by corporate partners. As a result, a $2.8 billion increase in tax revenue over the next 5 years is forecast. Aside from accelerating the payment of tax, these rules will be the source of increased cost and administrative inconvenience for the corporations affected.

Income Accrual
Effective for taxation years ending after 22 March 2011, corporate partners affected by the new rules will be required to accrue partnership income for the portion of the partnership's fiscal period that falls within the corporation's taxation year (a Stub Period). The effect is to accelerate the recognition of partnership income for the Stub Period.

Election to Change Partnership's Fiscal Period
To address the administrative inconvenience resulting from these proposed measures, a single-tier partnership may make a one-time election to change its fiscal period providing a number of conditions are met.

Stop-Loss Rules on Redemption of Shares
Existing rules allow a Canadian corporation in some cases to deduct the amount of a dividend received from another Canadian corporation. The tax policy behind such "tax-free" inter-corporate dividends is to ensure that dividends are taxed only once as they are paid through a corporate chain and ultimately to individual shareholders.

To prevent abuse, these rules are complemented by certain "stop-loss rules" which, in certain circumstances, reduce the amount of loss otherwise realised by a corporation on a disposition of shares by the amount of previous tax-free dividends received. According to the Government, however, these carve-outs have been exploited by some taxpayers, and the perceived loss of tax revenue was considered significant enough that Budget 2011 will curtail the carve-outs and extend the stop-loss rules.

To counter the perceived tax avoidance, Budget 2011 proposes to extend the application of the stop-loss rules to any dividend deemed to be received on the redemption of shares held by a corporation, except only dividends deemed to be received on the redemption of shares of the capital stock of one private corporation that are held by another private corporation (other than a financial institution).

Mineral Exploration Tax Credit Extended Once Again
The mineral exploration tax credit, commonly known as a "super flow-through", is an added advantage in flow-through share offerings. Qualifying mineral exploration expenditures incurred and renounced by a principal-business corporation pursuant to a flow-through share agreement may be eligible for a 15% federal tax credit, in addition to the deduction from income which the subscriber obtains from the renunciation. Currently, the super flow-through is scheduled to expire at the end of March 2011.

Budget 2011 extends the availability of the super flow-through for one more year, to include flow-through share agreements entered into before 31 March 2012. Under the "look back" rule, funds raised and renounced in one year can be spent on qualifying expenditures in the following year. Because of the "look-back" rule, the effect of this extension is to support qualifying exploration expenditures until the end of 2013. This extension is becoming a perennial feature of federal budgets.

Taxand's Take

If passed into law, these tax measures will have a broad impact. However, with this Budget, more than most, questions are already being raised as to whether the Government will fall and hence whether the Budget proposals will be enacted. No doubt the weeks ahead will be filled with intense political debate, as well as uncertainty regarding the proposed tax changes.

Read the full article on the Canadian Budget Review 2011 here

Also featured in the Globe and Mail on 5 June 2011

Your Taxand contact for further queries is:
Sharon Bennett
T. +1 519 569 4563

Taxand's Take Author