Manufacturing and Processing Sector: Accelerated Capital Cost Allowance
As part of its plan to continue to stimulate the Canadian manufacturing sector, the Federal Government proposes to extend certain incentives related to the acquisition of machinery and equipment. Currently, machinery and equipment acquired by a taxpayer, after March 18, 2007 and before 2012, primarily for use in Canada for the manufacturing or processing of goods for sale or lease is eligible for a temporary accelerated capital cost allowance (“CCA”) at a rate of 50% on a straight line basis (subject to the application of the “half-year rule”) under Class 29. The Budget proposes to extend this temporary incentive for two years to eligible machinery and equipment acquired before 2014.
Machinery and equipment acquired by a taxpayer after 2013, primarily for use in Canada for the manufacturing or processing of goods for sale or lease will be required to be included in Class 43 for which a 30% declining balance CCA rate applies.
Clean Energy Generation Equipment: Accelerated Capital Cost Allowance
In order to promote the use of clean energy, the Budget includes a proposal to accelerate CCA on certain clean energy generation equipment. Under the current CCA regime, Class 43.2 provides accelerated CCA (50% per year on a declining balance basis) for specified clean energy generation and conservation equipment. This class incorporates, by reference, a detailed list of eligible equipment that generates or conserves energy by: (i) using a renewable energy source (e.g., wind, solar, small hydro); (ii) using fuels from waste (e.g., landfill gas, wood waste manure); or (iii) making efficient use of fossil fuels (e.g., high efficiency cogeneration systems, which simultaneously produce electricity and useful heat). This constitutes an exception to the general practice of setting CCA rates based on the useful life of assets.
The Budget goes one step further in order to encourage productive use of otherwise wasted energy by expanding the list of equipment that falls into Class 43.2 to include equipment that generates electricity using waste heat. In particular, it is proposed that Class 43.2 be amended to include equipment that is used by the taxpayer, or by a lessee of the taxpayer, to generate electrical energy in a process in which all or substantially all of the energy input is from waste heat.
Eligible equipment will include electrical generating equipment, control, feedwater and condensate systems, and other ancillary equipment, but not buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), transmission equipment or distribution equipment. Systems will not be eligible if they use chlorofluorocarbons or hydrochlorofluorocarbons due to their negative environmental impacts.
This measure will encourage investment in equipment that uses thermal energy that would otherwise be wasted in order to generate electricity.
This measure will apply to eligible equipment acquired on or after March 22, 2011 (“Budget Day”) that has not been used or acquired for use before that date.
Qualifying Environmental Trusts
The Income Tax Act (the “Tax Act”) currently includes special rules for a qualifying environmental trust (“QET”), introduced in relation to the regulatory regimes under which the operator of a mine, quarry or waste disposal site was required to pre-fund, by means of a trust, the costs of reclaiming or restoring the site.
Currently, the QET pays 28% tax on its investment income. The complex rules applying to the operator that funded the QET generally do not result in additional tax for the operator, provided the funds withdrawn from the QET are spent on eligible expenses.
The Budget proposes to expand the range of trusts eligible for QET treatment to include trusts that are required to be established for pipeline abandonment. The existing condition that a trust be mandated under the terms of a contract entered into with the federal or provincial Crown under legislation will be modified to include trusts that are created after 2011 and mandated by order of a tribunal constituted by a law of Canada or a province (such as the National Energy Board). These changes will apply to the 2012 and subsequent taxation years for trusts created after 2011.
Eligible Investments and Prohibited Investments
To qualify for tax treatment as a QET, a trust’s holdings must be limited to certain eligible investments. The Budget proposes to expand the range of eligible investments for QETs to include certain debt instruments and securities.
The Budget proposes that a QET not be permitted to invest in “prohibited investments”. For this purpose, prohibited investments will generally include: (i) an interest in an equity or debt security issued by a contributor to or beneficiary of the trust (and certain related persons or affiliated partnerships to the contributor or beneficiary); or (ii) a person or partnership in which a contributor to or a beneficiary under the trust has a “significant interest” (generally 10% or more).
These changes will apply to the 2012 and subsequent taxation years for trusts created after 2011. A trust created before 2012 can have these changes apply to it for all taxation years that end after 2011, if the trust and the relevant government regulatory authority jointly elect for such application.
The Budget also proposes to set the tax rate payable by a QET on its investment income to the corporate income tax rate generally applicable for the 2012 and later taxation years (to be reduced from 28%), applicable to the 2012 and subsequent taxation years.
Intangible Capital Expenses in Oil Sands Projects
Oil Sands Properties
The Budget proposes that the cost of oil sands leases and other oil sands resource property be treated as a Canadian oil and gas property expense (“COGPE”) deductible at a rate of 10% per year, instead of its current treatment as a Canadian development expense (“CDE”) deductible at a rate of 30% per year (both on a declining balance basis). This change will align the oil sands sector with the conventional oil and gas sector, and will be effective for acquisitions made on or after Budget Day.
Proceeds from the disposition on or after Budget Day of a taxpayer’s oil sands resource property will be applied to reduce the taxpayer’s cumulative CDE, or cumulative COGPE, based on the treatment by the taxpayer when the particular property was acquired. These changes will also apply to oil shale property, which is treated in a manner similar to oil sands resource property.
Pre-Production Development Expenses of Oil Sands Mines
The Budget proposes that development expenses incurred for the purpose of bringing a new oil sands or oil shale mine into production in reasonable commercial quantities be treated as CDE, deductible at a rate of 30% per year instead of its current treatment as a Canadian exploration expense (CEE), which is fully deductible in the year incurred. This will align the deduction rates for pre-production development costs in oil sands or oil shale mines with the rates applicable to in situ oil sands projects and the conventional oil and gas sector.
The Budget provides certain transitional relief for pre-production mining projects in recognition of the long time frames involved in developing oil sands and oil shale mining projects. The current CEE treatment will be maintained for expenses incurred before Budget Day, and for expenses incurred before 2015 for new mines on which major construction began (under prescribed rules) before Budget Day. Otherwise, the CDE treatment will be phased in on a gradual basis.
Stop-Loss Rules on the Redemption of a Share
In order to eliminate multiple levels of corporate tax on dividends paid out of corporate income, a corporation is allowed, subject to certain exceptions, a deduction in computing its taxable income for dividends received from taxable Canadian corporations. This deduction is available for dividends actually received and for dividends deemed by the Tax Act to have been received on a redemption or purchase for cancellation of shares and in certain other circumstances.
Where a corporation disposes of a share on which it has received tax-free inter-corporate dividends, “stop-loss rules” in the Tax Act will, in certain cases, reduce the amount of the loss that would otherwise be realized by the corporation. The loss is reduced by the amount of tax-free inter-corporate dividends received, or deemed to have been received, on the share.
These stop-loss rules are subject to certain exceptions that apply depending on whether the corporate shareholder holds the share as capital property, an income property or a mark-to-market property. There are some minor differences in these exceptions but, in general, a tax-free inter-corporate dividend received on a share will not reduce a loss on the share if: (i) the share is held by the shareholder for 365 days or more; and (ii) the dividend was received when the shareholder and persons not dealing at arm’s length with the shareholder owned 5% or less of any class of shares of the corporation from which the dividend was received.
The Budget proposes to extend the stop loss rules due to a concern that some corporations have been entering into tax avoidance arrangements in relation to losses that arise on the redemption of shares.
The stop-loss rules will be extended to any dividend deemed by subsection 84(3) of the Tax Act to be received by a corporate shareholder where shares held directly, or indirectly through a partnership or trust, are redeemed, purchased for cancellation or otherwise acquired by the issuing corporation. The only exception is for deemed dividends arising on a redemption, purchase for cancellation or acquisition of shares of a private corporation that are held directly by another private corporation (other than a financial institution) or that are held by another private corporation indirectly through a partnership or trust (other than a partnership or trust that is a financial institution).
This tax measure will apply to redemptions, purchases for cancellation or other acquisitions of shares by the issuing corporation that occur on or after Budget Day.
Partnerships – Deferral of Corporate Tax
The Budget proposes substantial and complex changes to the taxation of corporate partners with significant interests in partnerships to limit what the Federal Government perceives as inequitable tax deferral.
A partnership generally computes its income or loss for tax purposes as if it were a separate person. The partnership’s income or loss is then allocated among its partners. A partner’s share of the partnership’s income or loss for a particular fiscal year of the partnership is included in the computation of the partner’s income for the partner’s taxation year in which the partnership fiscal year ends.
For example, where ABC Inc. has a September 30 year end and is a partner in a partnership with an October 31 year end, ABC Inc.’s share of the partnership’s income for the partnership year ended October 31, 2011 is included in ABC Inc.’s income for ABC Inc.’s September 30, 2012 taxation year. In years where the partnership has income, this results in approximately a one year deferral for ABC Inc. of the tax payable on its share of partnership income. In years where the partnership has losses, this results in the deferral of a deduction, i.e., the reverse of a tax deferral.
The deferral of tax or tax deductions may extend for longer than one year in the case of multiple tiers of partnerships with different year ends.
The Federal Government expresses concern about an apparently increasing use by corporations of partnerships with misaligned fiscal periods for the primary purpose of deferring taxes. Notwithstanding the fact that different year ends for partnerships and their partners may, as the government acknowledges, have no tax deferral purpose and despite the availability of the general anti-avoidance rule to deal with abusive situations, new rules are proposed which will govern the recognition by a corporation of income from a partnership.
Limitation on Deferral: Income Accrual
The new rules will apply to a corporation (other than a professional corporation) for a taxation year of the corporation if:
- the corporation is a member of a partnership at the end of the corporation’s taxation year;
- the last fiscal period of the partnership that began in that taxation year of the corporation ends after the corporation’s year end; and
- the corporation (together with affiliated and related parties) was entitled to more than 10% of the partnership’s income (or assets in the case of wind-up) at the end of the last fiscal period of the partnership that ended in the corporation’s taxation year.
In computing a corporation’s income for a taxation year where the new rules apply, the corporation must effectively accrue income from the partnership for a portion of the partnership’s fiscal period that begins in that taxation year of the corporation and ends in the corporation’s next taxation year. The accrual is for the period from the beginning of the partnership’s fiscal period to the end of the corporation’s taxation year (the “Stub Period”).
The accrual of income for the Stub Period eliminates the perceived tax deferral. The proposed changes don’t appear to allow for accrual of partnership losses for the Stub Period. Any such losses would then be recognized in the following corporation taxation year as they are under the current rules.
The requirement to accrue partnership income for the Stub Period does not affect the requirement under the current rules for a corporation to include in its income its share of partnership income or loss for partnership fiscal periods ending in each taxation year of the corporation. Thus, a corporation will include in its income for a taxation year:
- its share of partnership income or loss for partnership fiscal periods ending in that taxation year, and
- an accrual amount in respect of the Stub Period.
A deduction for the prior year’s Stub Period income inclusion prevents double taxation of the Stub Period income.
This tax measure will apply to taxation years of a corporation that end after Budget Day.
Calculating the Accrual Amount
Unless the corporate partner makes a designation, the accrued income will generally be a pro-rated portion of the partner’s income from the partnership for the fiscal periods of the partnership that end in the corporation’s taxation year. The pro-rated amount is calculated by reference to the number of days in the Stub Period and is called the “Adjusted Stub Period Accrual”.
The Adjusted Stub Period Accrual income for a particular year is deducted in computing the corporation’s income for the next year. This deduction is allowed because the corporation will include an amount for the Stub Period in its income in the next year as part of, according to normal practice, its share of partnership income or loss for the partnership year ending in that next year of the corporation.
A corporation may designate a lower amount to be included in its income in respect of the Stub Period. The ability to designate a lower amount will be attractive where a corporation expects that its income from the partnership for the partnership fiscal period that includes the Stub Period will be less than its share of partnership income for the previous year. However, if the designated amount is less than the lesser of the corporation’s actual pro-rated income from the partnership for the Stub Period (determined by reference to the allocation for the partnership’s year ending in the corporation’s immediately following year) and the Adjusted Stub Period Accrual amount, then the corporate partner will be subject to an increased income inclusion for the following taxation year that will effectively charge the corporation for the deferral. If the designated amount is short by more than 25% of the lesser of the actual pro-rated income for the Stub Period and the Adjusted Stub Period Accrual amount (the amount over 25% being the “Excessive Shortfall”), there is a punitive result. In this case, the corporation must include 50% of the Excessive Shortfall in its income for the following year.
Resource expenses incurred by a partnership, such as Canadian exploration expenses, Canadian development expenses, Canadian oil and gas property expenses, and foreign resource expenses, are generally not included in the calculation of the partnership income or loss that is allocated among the partners. Instead, these expenses are generally allocated separately to the partners. The new rules will allow Stub Period resource expenses to be accounted for in the same taxation year as the Stub Period accrual for partnership income if the partnership provides the necessary information on such expenses.
Other than for purposes of computing accrued Stub Period income from a partnership, the actual allocation of these resource expenses and other amounts affecting resource expense pools will continue to be made at the end of the partnership’s fiscal period.
For some corporations, the proposed change in recognition of partnership income will result in the inclusion of significant additional partnership income for a corporation’s first taxation year that ends after Budget Day. To mitigate the potential impact on cash-flow, transitional relief is provided that will generally result in no additional taxes being payable for that first corporate taxation year. The additional partnership income will generally be brought into the corporation’s income over the following five taxation years as follows:
Inclusion rate for transitional income Corporate Taxation Year Inclusion Rate 2011 0% 2012 15% 2013 20% 2014 20% 2015 20% 2016 25%
If the corporation’s first year end after Budget Day ends in 2012, no inclusion of transitional income is required for the 2012 year and the 5 year phased inclusion begins with the corporation’s 2013 taxation year.
To be eligible for continued transitional relief for a particular taxation year as described above, certain conditions must be met. The corporation must be a partner at the partnership’s last fiscal period end before Budget Day and continue as a partner until the end of the corporation’s taxation year for which continued transitional relief is claimed. There are other conditions relating, among other things, to the continuity of the partnership business that gave rise to the transitional income and the corporation not ceasing to be a Canadian resident, not going bankrupt or winding up.
Election to Change a Partnership’s Fiscal Period
The proposed new rules will allow a partnership to change its fiscal period to align, for example, with the taxation year of one or more corporate partners by way of a one-time election (a “Single-tier Alignment Election”), if the following conditions are met:
- the last day of the new fiscal period must be after Budget Day, and no later than the latest day that is the last day of the first taxation year that ends after Budget Day, of a corporate partner that has been a member of the partnership continuously since before Budget Day;
- the election must be in writing and filed with the Minister of National Revenue on behalf of the partnership on or before the earliest of all filing-due dates for the return of income of any corporate partner for the taxation year in which the new fiscal period ends;
- at least one of the corporate partners would, in the absence of the election, have Adjusted Stub Period Accrual income greater than nil in its first taxation year ending after Budget Day; and
- all members of the partnership are corporations other than professional corporations.
If a partnership changes its fiscal year end by way of a Single-tier Alignment Election, a corporate partner may have income from two partnership fiscal periods ending in the corporation’s first taxation year ending after Budget Day. The corporation’s share of partnership income for the second such partnership fiscal period will be eligible for transitional relief as described above such that this income is brought in over five years.
The Federal Government expressed particular concern that the partnership tax deferral can be multiplied through the use of a tiered structure (which could be several layers deep) where the partnership is itself a member of another partnership with a different fiscal period. The Budget therefore proposes that partnerships in a tiered partnership structure will all be required to have the same fiscal period.
Partnerships that are not required under existing rules to have a December 31 fiscal period will be allowed, on a one-time basis, to choose a common fiscal period by filing an election in writing with the Minister of National Revenue (referred to as a “Multi-tier Alignment Election”). The elected fiscal period must end before March 22, 2012 and must not exceed 12 months. The election must be filed on behalf of the partnerships on or before the earliest of all filing-due dates for the return of income of any corporate partner of any of the partnerships for the corporate taxation year in which the new fiscal period ends. If a Multi-tier Alignment Election is not filed, the common fiscal period of the partnerships will end on December 31.
The change of partnership year ends for multi-tier partnerships could result in additional partnership income for the first taxation year to which these new rules apply. This additional income will also be eligible for the transitional relief described above.