Ottawa, October 31, 2006
2006-061
Related documents:
Backgrounder
PDF Version
Statement by the Honourable Jim Flaherty, Minister of Finance
The Honourable Jim Flaherty, Minister of Finance today
announced a Tax Fairness Plan for Canadians. The plan will restore balance
and fairness to the federal tax system by creating a level playing field
between income trusts and corporations.
"The measures I am bringing forward today are necessary
to restore balance and fairness to Canada's tax system, to ensure our
economy continues to grow and prosper and to bring Canada in line with other
jurisdictions," said Minister Flaherty. "Our plan is the result of
months of careful consideration and evaluation. Our actions are clear,
decisive and in the best interest of all Canadians."
For months there has been a growing trend toward corporate
tax avoidance. Top Canadian companies, operating within the current rules,
have announced their intention to convert to income trusts. They feel
compelled to seek more favourable tax treatment by capitalizing on an
available tax rule.
While these decisions offer corporations short-term tax
benefits, they are creating an economic distortion that is threatening
Canada's long-term economic growth and shifting any future tax burden onto
hardworking individuals and families. If left unchecked, these corporate
decisions would result in billions of dollars in less revenue for the
federal government to invest in the priorities of Canadians, including more
personal income tax relief. These decisions would also mean less revenue for
the provinces and territories.
Canada stands alone in its treatment of income trusts. The
structure being used in this country was shut down in the United States and
Australia.
"The landscape has changed dramatically in the short
time I have been Minister of Finance, and in fact, this year we have seen
nearly $70 billion in new trust announcements," said Minister Flaherty.
"The current situation is not right and is not fair. It is the
responsibility of the Government of Canada to set our nation's tax policy,
not corporate tax planners."
The measures in the Tax Fairness Plan include:
A Distribution Tax on distributions from publicly traded income trusts
and limited partnerships.
A reduction in the general corporate income tax rate of one-half
percentage point as of January 1, 2011.
An increase in the Age Credit Amount by $1000 from $4,066 to $5,066
effective January 1, 2006. This will benefit low and middle-income
seniors.
A major positive change in tax policy for pensioners. The government
will permit income splitting for pensioners beginning in 2007.
These measures represent a major tax reduction. Our Tax
Fairness Plan will deliver over one billion dollars of new tax relief
annually for Canadians.
For income trusts that begin trading after today, these
measures will apply beginning with their 2007 taxation year. For existing
income trusts and limited partnerships the government is proposing a
four-year transition period. They will not be subject to the new measures
until their 2011 taxation year.
"The time has come for Canada's New Government to
act," said Minister Flaherty. "By introducing our Tax Fairness
Plan today we are acting in the national interest, doing what's right for
all Canadians, and significantly enhancing the incentives to save and invest
for family retirement security."
The Tax Fairness Plan will build on the steps taken in
Budget 2006. In that document Canada's New Government delivered
significant tax relief for Canadians with 29 tax cuts amounting to $20
billion in tax relief over the next two years.
Additional details are available in the attached
backgrounder or on the Department of Finance web site.
___________________________________
For further information, media may contact:
Dan Miles
Director of Communications
Office of the Minister of Finance
613-996-7861
David Gamble
Media Relations
Department of Finance
613-996-8080
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Backgrounder
The rapid growth of "income trusts"
"Income trusts" or publicly-traded flow-through entities
(FTEs)[1] are an
increasingly significant presence in Canadian business. As Chart 1 shows,
these entities have grown dramatically over the past few years and now
represent over $200 billion in market capitalization.
Despite the actions taken by the Government in the 2006 Budget to help
address these issues, there is no indication that this trend will change: in
2006 alone, corporations representing almost $70 billion in market
capitalization have either converted themselves into FTEs or announced plans
to do so.
Chart 1: Market Capitalization of Publicly-Traded Canadian FTEs,
1995-2006 (as of October 20, 2006)
The cause: unbalanced tax treatment
A major reason for the proliferation of these entities and a major
reason for the concern they have generated is the unbalanced income tax
treatment that applies to them and their investors. In short, tax rules that
were designed essentially for non-commercial and portfolio investment trusts
(and for owner-operated partnership businesses) are being used by
large-scale business entities that are widely held and publicly-traded, and
the results are not appropriate.
Non-residents and tax-exempts continue to benefit
Publicly-traded FTEs are in many respects not very different from
business corporations. Their tax treatment, though, can be radically
different. In particular, FTEs and their investors have enjoyed
substantially lower combined income tax rates than large corporations and
their shareholders. Until recently, this was the case where an FTE's
investors were taxable Canadian-resident individuals. The combination of
corporate income tax and the shareholder's tax on the dividend was
significantly greater than the tax an otherwise identical investor would pay
on income distributed by an FTE.
In its 2006 Budget the Government resolved this difference for those
investors, by reducing the rate of federal tax on dividends from large
Canadian corporations. Table 1 shows the result: with the 2006 change,
taxable Canadian individuals face a total tax rate on FTE income that is the
same as the rate on dividends from large Canadian corporations. This has
eliminated much of the impetus for taxable Canadian residents to prefer FTE
investments to investments in Canadian public companies.
However, Table 1 also indicates that non-residents (represented here by a
taxable United States investor) and tax-exempt entities can obtain a sizable
tax advantage if they invest in an FTE rather than a corporation.
Table 1: Simplified Comparison of Investor Tax
Rates (current system)
Investor
FTE
(Income)
Large Corporation (Dividend)
Taxable Canadian (*)
46%
46%
Canadian tax-exempt
0%
32%
Taxable U.S. investor (**)
15%
42%
(*) All rates in the table are as of
2011, include both entity- and investor-level tax (as applicable) and
reflect already-announced rate reductions. Rates for "taxable
Canadian" assume that top personal income tax rates apply and
that provincial governments increase their dividend tax credit for
dividends of large corporations.
(**) Canadian taxes only. U.S. tax will in most cases also apply.
As noted above, the pace of conversions of corporations into FTEs, in
particular business trusts, has not abated. Since the Government has
resolved the issue for Canadian-resident individuals, it can be concluded
that the tax advantages still enjoyed by non-resident and tax-exempt
investors in FTEs are now a driving force behind these conversions.
Provincial implications
In addition to delivering a federal tax advantage to certain investors,
FTEs create two serious difficulties for Canada's provinces. First, to the
extent they have non-Canadian investors, FTEs deplete overall provincial tax
revenues even more significantly than they deplete federal revenue. This is
because although federal non-resident tax applies to income that a
foreign-resident investor earns through an FTE, that income is not subject
to tax in any province. (In contrast, the dividends that a foreign-resident
shareholder of a Canadian corporation receives are paid out of income that
has already been taxed both federally and provincially.)
Second, to the extent an FTE's Canadian investors reside in provinces
other than where the FTE itself operates, tax revenue is shifted between
provinces. A corporation's home province ordinarily expects to be able to
tax the corporation's earnings. But if the corporation becomes an FTE,
that province may lose a large portion of the associated tax revenue;
instead the provinces where the investor resides will get the tax, if any,
on the distribution. Several provinces have expressed concerns about the
impact this has on their economies and their tax revenues. For example, in
its last Budget, the Province of Alberta estimated its net revenue loss as a
result of income trusts to be about $400 million per year. The Government
recognizes that it has a unique role in the federal-provincial tax
environment, and has the responsibility to deal with these issues.
Other countries' experiences
Canada is not the only country that has faced issues around the tax
treatment of FTEs and similar entities. Australia and the United States, for
example, have tax systems broadly comparable to Canada's, and both have
had to deal with the distortions that FTEs can cause. Although the
particulars of the Australian and U.S. rules are necessarily unique, both
have foreclosed the kind of inappropriate avoidance of entity-level tax that
Canada's FTEs now exploit.
The Government's solution: continuing the Tax Fairness commitment
Given the difficulties FTEs cause, and faced with their accelerating
growth, the Government has concluded that it must act. The Government will
not address the tax issues around FTEs in isolation. Rather, it is proposing
a package that continues its commitment to tax fairness for all Canadians.
With that commitment in mind, the Government plans a four-fold approach
that combines a measured response to the tax imbalance created by FTEs while
also providing meaningful tax relief to Canadian pensioners and seniors and
businesses in Canada. The elements of this approach are as follows:
1. Changes to the tax treatment of FTEs and their investors
A more appropriate tax regime will be introduced for FTEs. Under this
regime their tax treatment will be more like that of corporations, and their
investors will be treated more like shareholders.
Specifically, certain distributions of FTEs' income will be subject to
tax at corporate income tax rates. Those distributions will like the
dividends that corporations pay not be deductible by an FTE that is a
trust, and will be taxed in the hands of an FTE that is a partnership. The
investors in the FTE will be taxed as though the distributions were
dividends.
The FTEs that will be subject to these new rules will be fully defined in
the legislation to implement these measures. As a practical matter, however,
it can be assumed that the rules will apply to any publicly-traded
"income trust" (or publicly-traded partnership), other than one
that only holds passive real estate investments.
These changes will generally take effect beginning with the 2007 taxation
year for trusts that begin to be publicly-traded after October 2006, but
will only apply beginning with the 2011 taxation year for those FTEs that
are already publicly-traded.
The measures will be effective in rebalancing the income tax treatment of
FTEs. As a result, the legal form a given business takes whether as a
corporation, a trust or a partnership will come to depend less on the
peculiarities of the tax law, and more on the substantive business
attributes of each of those structures.
The attached Technical Annex provides further detail on the new tax rules
for trusts and partnerships.
Table 2 summarizes the effects of these changes.
Table 2: Simplified Comparison of Investor
Tax Rates in 2011
Current System
New System
Investor
FTE
(Income)
Large Corporation (Dividend)
FTE
(Non-Portfolio Earnings)
Large Corporation (Dividend)
Taxable Canadian (*)
46%
46%
45.5%
45.5%
Canadian tax-exempt
0%
32%
31.5%
31.5%
Taxable U.S. investor (**)
15%
42%
41.5%
41.5%
(*) All rates in the table are
as of 2011, include both entity- and investor-level tax (as
applicable) and reflect already-announced rate reductions and the
additional .5% corporate rate reduction described below. Rates for
"taxable Canadian" assume that top personal income tax rates
apply and that provincial governments increase their dividend tax
credit for dividends of large corporations.
(**) Canadian taxes only. U.S. tax will in most cases also apply.
2. Corporate income tax reduction
The 2006 Budget announced that the general corporate income tax rate
would be reduced from 21% to 19% by 2010. The Government will reduce the
rate by a further one-half percentage point, to 18.5%, beginning in 2011.
Table 3 sets out the general corporate income tax rates for 2007 to 2011,
taking into account this change.
This will further enhance the competitiveness of Canada's corporate
income tax system.
Table 3: Federal Corporate Income Tax Rates,
2007-2011
2007
2008
2009
2010
2011
(percent)
General corporate income tax rate
21.0
20.5
20.0
19.0
19.0
Proposed rates
21.0
20.5
20.0
19.0
18.5
3. Age credit enhancement
The age credit, a special federal income tax credit for Canadians 65
years of age and older, will be significantly enhanced, with the increase
taking effect retroactively to January 1, 2006.
The age credit is calculated by multiplying the lowest personal income
tax rate by an amount that is indexed to inflation; for 2006, this amount is
$4,066. The credit is subject to an income test that targets the assistance
to seniors who need it most. The unused portion of the credit may be
transferred to a spouse or common-law partner.
For 2006, the age credit amount begins to be phased out when net
income reaches $30,270. The phase-out rate is 15%, which means that the
credit is fully phased out when net income reaches $57,377.
The amount on which the age credit is computed will be increased by
$1,000 to $5,066, effective January 1, 2006. This increase will help low-
and middle-income seniors by providing up to $155 ($152.50 for 2006) of
federal income tax relief each year for those eligible to receive the
credit.
With this enhancement, the age credit will be fully phased out when
net income reaches $64,043.
4. Pension income splitting
Canada's income tax system generally requires each individual taxpayer
to report and pay tax on all of the income they earn. This is the case even
if the individual, like many Canadians, actually uses much of their income
to support other family members. The current system gives some limited
relief for taxpayers in this situation, for example through tax credits for
the support of a spouse or common-law partner or dependent children, but it
still attributes the income itself exclusively to the person who earns it.
Recognizing the special challenges of planning and managing retirement
income, and to provide targeted assistance to pensioners, this package
includes a new mechanism for pension income splitting. The measure will
allow any Canadian resident who receives income that qualifies for the
existing pension income tax credit to allocate to their resident spouse (or
common-law partner) up to one-half of that income. This measure will
significantly increase the incentive to save and invest for family
retirement security.
For individuals aged 65 years and over, eligible pension income includes
lifetime annuity payments under a registered pension plan, a registered
retirement savings plan or a deferred profit-sharing plan and payments out
of or under a registered retirement income fund. For individuals under 65
years of age, eligible pension income includes lifetime annuity payments
under a registered pension plan and certain other payments received as a
result of the death of the individual's spouse or common-law partner.
For income tax purposes, the amount allocated will be deducted in
computing the income of the transferor (the person who actually received the
pension income) and included in computing the income of the transferee (the
person to whom some or all of the pension income is allocated). Since it
will in many cases increase the transferee's tax payable, both persons
must agree to the allocation in their tax returns for the year in question.
The pension income splitting allocation will be available for the 2007
and subsequent taxation years, and must be made one year at a time.
This Plan will provide over $1 billion of new tax relief annually for
Canadians.
Table 4 summarizes the impact of the proposed measures.
Table 4: Impact of Proposed Measures
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
Total
(millions of dollars)
Tax Relief
- Increase of the Age Credit
405
345
355
360
380
400
2,245
- Pension Income Splitting
165
675
710
745
780
820
3,895
- 0.5% General Corporate Tax Rate
Reduction
0
0
0
0
180
725
905
Total
570
1,020
1,065
1,105
1,340
1,945
7,045
Revenue from Publicly-traded
Flow-through Entities
0
0
0
0
-100
-400
-500
Total
570
1,020
1,065
1,105
1,240
1,545
6,545
Technical Annex
Current system: Taxation of flow-through entities
When a corporation pays a dividend to its shareholders, it usually does
so using money that has already borne tax. The dividend will also be subject
to tax in the hands of the shareholder. If the shareholder is an individual
and is resident in Canada, the income tax system relieves the potential
double taxation through the dividend "gross-up" and dividend tax
credit mechanism.
In contrast to corporations, both trusts (optionally) and partnerships
(automatically) are able to operate in such a way that they are not
ordinarily subject to tax on the income they earn. For a trust, a
distribution of income to the trust beneficiaries is required to remove the
tax liability from the trust. For a partnership this effect is automatic:
the members of the partnership, not the entity itself, are considered to
earn the partnership income. In both cases, however, the existing income tax
rules allow the entities themselves not to bear any tax liability, instead
shifting to other persons all of the income tax burden associated with their
operations along, of course, with the income itself.
This tax difference between corporations on the one hand, and FTEs (both
trusts and partnerships) on the other hand, stems from the different roles
each structure has historically played. In particular, most sizable
businesses in Canada especially those that have raised capital through
public markets have traditionally been organized as corporations, while
partnerships were generally smaller, owner-operated businesses and trusts
served a variety of mostly non-commercial and portfolio investment
functions.
These conditions have changed: trusts and partnerships now operate in
many business sectors, and investments in them can be publicly traded. Where
this is the case, the role of the typical member or beneficiary is
essentially the same as the role of a typical shareholder of a public
corporation: that person is a passive investor.
In principle, the tax that an FTE does not pay is paid instead by those
public investors, and there should be no tax reason for an investor to
prefer FTE income to corporate dividends. This is indeed the case for
taxable Canadian-resident individuals. In the past, the rates set under the
dividend gross-up and dividend tax credit system meant that these
individuals may have preferred FTE income. The 2006 Budget addressed that
possibility by reducing the personal income tax rate payable on dividends of
large corporations. This largely equalized the tax treatment of taxable
Canadian investors' income from FTEs and their income from corporations.
However, the tax system still includes a bias in favour of investments in
FTEs for two important categories of investors tax-exempt investors and
non-residents. The tax advantages for these investors is often a major
consideration in a business's decision whether to organize (or reorganize)
itself as an FTE, rather than as a corporation.
Canadian tax-exempt investors, such as Canadian pensions and RRSPs, are
subject to tax neither on FTE income nor on dividend income. However,
because dividends are paid out of income that in most cases has been taxed,
the dividend income received by these tax-exempt investors has in effect
borne tax, at a combined federal-provincial tax rate that will be about 32%
after already-announced corporate rate reductions have fully taken effect.
The absence of an equivalent tax on the earnings of an FTE means that these
investors will generally prefer those earnings to dividends.
Non-resident investors also benefit from a lower rate of tax on income
received from Canadian FTEs compared with the dividends of taxable Canadian
corporations. For example, U.S. investors are subject to total Canadian tax
of 15% on income received from Canadian publicly listed income trusts,
compared with a combined tax rate of around 42% on dividends from large
Canadian corporations.[2]
Table 5 shows the tax rates these investors pay on income from an FTE and
dividend income
Table 5: Investor Tax Rates in 2011 (under the
current system)
Investor
FTE
(Income)
Large Corporation
(Dividend)
Taxable Canadian (*)
46%
46%
Canadian tax-exempt
0%
32%
U.S. investor (**)
15%
42%
(*) Assumes the top personal income tax
rate and that provincial governments increase their dividend tax
credit for dividends of large corporations.
(**) Canadian taxes only. U.S. tax will in most cases also apply.
Proposal: Taxation of "specified investment flow-through"
(SIFT) distributions
"Specified investment flow-through"
The proposed new rules are meant to apply to a clearly defined set of
FTEs, to be known as "specified investment flow-throughs" or SIFTs.
As a practical matter it can be assumed that all of the entities
conventionally known as "income trusts" are SIFTs, as are any
publicly-traded partnerships that hold significant investments in Canadian
properties. The following description reflects the details that are expected
to be included in the new statutory definition of "specified investment
flow-through".
A trust (other than a real estate investment trust see below) will be
a SIFT throughout a taxation year if, at any time in the year, it satisfies
all of the following conditions:
The trust is resident in Canada;
Units of, or other investments in, the trust are listed on a stock
exchange or other public market; and
The trust holds one or more "non-portfolio properties".
A partnership will be a SIFT throughout a taxation year if, at any time
in the year, it satisfies these conditions:
The partnership meets one or more of the following residence-like
criteria: it is a "Canadian partnership" (an existing
defined term that describes a partnership all of the members of which
are resident in Canada); its central management and control is located
in Canada; it was formed under the law of Canada or a province; or it
would, if it were a corporation, be resident in Canada;
Units of, or other investments in, the partnership are listed on a
stock exchange or other public market[3];
and
The partnership holds one or more "non-portfolio
properties".
Non-portfolio properties will include certain investments in a
"subject entity", Canadian resource properties, timber resource
properties and real properties situated in Canada.
The main kinds of subject entity will be corporations resident in Canada,
trusts resident in Canada, and partnerships that meet one or more of the
residence-like criteria listed above. Non-resident corporations and trusts,
and partnerships that otherwise would not meet this definition, may also be
subject entities if their principal source of income is in Canada.
An investment in a subject entity will be a non-portfolio property if it
meets either (or both) of the following tests:
The investor holds a significant portion of the subject entity's
value: The investor holds securities of the entity that have a
total fair market value that is greater than 10 percent of the entity's
"equity value". For this purpose an entity's equity value is
the fair market value of all of the issued and outstanding shares or
interests in the entity.
Most of the investor's value is attributable to the subject entity:
The investor holds securities of the entity that, together with all
of the securities that the investor holds of entities affiliated with
the entity, have a total fair market value that is greater than 50
percent of the equity value of the investor itself.
Securities of an entity are to be viewed very broadly. They can be
expected to include not only equity investments in the entity (shares,
units, etc.) but also debts and other liabilities owing by the entity,
rights to revenue or income, and options to acquire anything that would be a
security of the entity. Provided adequate safeguards against abuse can be
implemented, an exception may be made for liabilities and other obligations
that arise in the normal course of the entity's business, such as trade
payables.
An investor's Canadian resource properties, timber resource properties
and real properties situated in Canada will be non-portfolio properties of
the investor if the total fair market value of all such properties held by
the investor is greater than 50 percent of the equity value of the investor
itself. For this purpose, any property the value of which is derived
principally from Canadian resource properties, timber resource properties or
real properties situated in Canada will be treated as being itself a
property of that type.
Lastly, any other property owned by the investor will be a non-portfolio
property if the investor (or a person or partnership with which it does not
deal at arm's length) uses the property in carrying on a business in
Canada.
Real estate investment trusts
Certain trusts that would otherwise be SIFTs will be excluded from the
SIFT definition. These are trusts (commonly known as real estate investment
trusts or REITs) that meet a series of conditions relating to the nature of
their income and investments. Those conditions are similar to the conditions
that the United States applies to US real estate investment trusts, and like
the US rules this exception from the SIFT measures recognizes the unique
history and role of collective real estate investment vehicles.
To benefit from this exception (i.e. to be a REIT) for a given taxation
year, a trust must:
At no time in the year hold any non-portfolio property other than
real properties situated in Canada;
Have as not less than 95% of its income for the year income from
properties (whether in Canada or abroad, and including dividends,
interest, rents, etc. and taxable capital gains from dispositions of
real properties);
Have as not less than 75% of its income for the year income that is
directly or indirectly attributable to rents from, mortgages on, or
gains from the disposition of, real properties situated in Canada; and
Hold throughout the year real properties situated in Canada, cash,
and debt or other obligations of Governments in Canada (including
Crown corporations, etc.) with a total fair market value that is not less than 75% of its equity value.
For these purposes, "real property situated in Canada" will
include securities issued by any entity that itself satisfies the above
conditions. A REIT can thus hold its Canadian real properties either
directly or through intermediary entities. "Real property situated in
Canada" will not, however, include any depreciable property the capital
cost allowance rate for which is greater than 5%.
Effects of being a SIFT trust
Under these proposals, a trust that is a SIFT (a "SIFT trust")
will not be permitted to deduct, in computing its income for tax purposes,
certain amounts that would otherwise be deductible. However, the trust will
not pay tax on those amounts at the full tax rate that normally applies to
undistributed trust income. Instead a special rate, based on the
federal-provincial corporate income tax rate, will apply to the SIFT trust
to the extent of its non-deductible distributions. As well, those amounts
will be treated in the hands of the SIFT trust's beneficiaries as taxable
dividends paid by a taxable Canadian corporation.
Non-deductibility
Under the existing law a trust can generally deduct in computing its
income for a taxation year any amount of that income that it pays to a
beneficiary in the year. The beneficiaries of a SIFT trust are ordinarily
the investors in the trust, and since SIFT trusts are usually unit trusts,
their investors are also unitholders. A SIFT trust can thus deduct its
distributions of income and taxable capital gains to its unitholders.
This will be modified to prevent a SIFT trust from deducting any part of
its distributions that is attributable either to a business it carries on in
Canada or to income from or capital gains on non-portfolio
properties. These amounts are referred to here as a SIFT trust's
"non-portfolio earnings". The only exceptions in respect of
non-portfolio earnings will be any taxable dividend that the trust could, if
it were a corporation, deduct under the Income Tax Act.
More specifically, there will be excluded, from the amount that a SIFT
trust can deduct, the total of:
income from businesses it carries on in Canada;
income (other than the dividends mentioned above) from its
non-portfolio properties; and
taxable capital gains from its dispositions of non-portfolio
properties.
It is important to note that some SIFT trusts may distribute to their
unitholders, either in addition to or instead of income, capital amounts. A
"return of capital" is not deductible by the trust, and it is not
included directly in the income of the unitholder. Instead, it reduces the
unitholder's cost of their investment. These effects do not change under
the proposed measures.
Reduced Tax Rate on Distributed SIFT Trust Earnings
Trusts are ordinarily taxed at the highest personal income tax rate of
29% federally, plus applicable provincial tax. This tax rate will be
reduced, for non-portfolio earnings that a SIFT trust distributes to its
beneficiaries (unitholders), to a rate that is equivalent to the federal
general corporate tax rate, plus 13% on account of provincial tax. With the
reductions already announced in the federal rate, and the further reduction
that accompanies these measures, the tax rate for distributed non-portfolio
earnings will be as shown in Table 6.
Table 6: SIFT Tax Rates: Distributed
Non-Portfolio Earnings, 2007-2011
2007
2008
2009
2010
2011
(percent)
Basic rate (federal)
21.0
20.5
20.0
19.0
18.5
Additional rate
(in lieu of provincial tax)
13.0
13.0
13.0
13.0
13.0
Total
34.0
33.5
33.0
32.0
31.5
The distributed non-portfolio earnings of a SIFT trust will be excluded
from the inter-provincial income allocation formula, meaning that provincial
tax will not apply. However, the 13% portion applied on account of
provincial tax will be collected and held for distribution to provinces
based on a reasonable allocation, which the Government intends to work with
the provinces to develop.
It should be emphasized that this special treatment both the lower
federal tax rate and the additional tax in lieu of provincial tax will
apply only in respect of those non-portfolio earnings that are distributed
to a SIFT trust's beneficiaries. Amounts that are retained by the SIFT
trust will continue to be taxed at the ordinary federal and provincial rates
that apply to the taxable income of a trust. The retention of this existing
difference between the taxation of trusts and the taxation of corporations
is deliberate, and is consistent with leaving in place other differences
such as the different treatment of returns of capital.
Dividend treatment
Any amount that becomes payable by a SIFT trust to a beneficiary of the
trust, and that the trust is, as a result of these measures, prevented from
deducting in computing its income, will be taxed in the hands of the
beneficiary (the unitholder) as though it were a taxable dividend from a
taxable Canadian corporation. (This deemed dividend will also be deemed to
be an "eligible dividend" for purposes of the new enhanced
dividend tax credit, if it is paid to a person resident in Canada.) The
effects of this treatment will vary depending on who the unitholder is. In
general terms, for example:
An individual who is resident in Canada and is taxable on the
distribution will apply the eligible dividend "gross-up" to
the distributed amount, and may claim the eligible dividend tax credit
to reduce the amount of personal tax the individual would otherwise
have paid.
A corporation resident in Canada may deduct the amount of the
distribution from its income.
A registered pension plan, a registered retirement savings plan (RRSP)
or registered retirement income fund (RRIF) will not be taxed on the
distribution. (For these unitholders the treatment of the distribution
as a dividend has no direct effect).
A unitholder who is non-resident will be taxed on the distribution
at the non-resident "withholding tax" rate for dividends,
taking into account any rate reduction provided, under an applicable
tax treaty, for cross-border dividends. For instance, a United States
pension or other retirement arrangement (such as an IRA) will, under
the Canada-US Income Tax Convention, be exempt from the Canadian tax
that would otherwise apply to the distribution, just as it would be if
it received a dividend.
Effects of being a SIFT partnership
Under the existing tax law, partnerships are not subject to income tax.
Rather, the income earned and losses incurred by a partnership are
calculated at the partnership level and allocated to the members of the
partnership in accordance with their respective interests.
Under these proposals, a partnership that is a SIFT will be required to
pay a tax on the total of its:
income from businesses it carries on in Canada;
income from its non-portfolio properties (other than dividends that
would, if it were a corporation, be deductible in computing its
taxable income); and
taxable capital gains from its dispositions of non-portfolio
properties.
As with SIFT trusts, the tax rate will be set at a rate equal to the
federal corporate tax rate, plus 13% on account of provincial tax. The
amount collected on account of provincial tax will be held for distribution
to provinces based on a reasonable allocation, which the Government intends
to work with the provinces to develop.
Dividend treatment
Partnership income that is subject to the new tax will be treated as
dividends. Specifically, partnership allocations, up to the amount that is
subject to the tax at the partnership level, may be recharacterized, in the
hands of the members of the partnership and in the same proportion as their
allocations of incomes and losses otherwise determined, as taxable dividends
from a taxable Canadian corporation. (This deemed dividend will also be
deemed to be an "eligible dividend" for purposes of the new
enhanced dividend tax credit if it is paid to a person resident in Canada.)
Anti-avoidance
The details outlined in this document reflect the present intentions of
the Government. These details are, however, subject to change in order to
ensure that they meet the policy objectives that underlie them. In
particular, if there should emerge structures or transactions that are
clearly devised to frustrate those policy objectives, any aspect of these
measures may be changed accordingly and with immediate effect.
Effective Date
The changes announced today will not apply to SIFTs that began to be
publicly traded before November 2006 or their investors for taxation
years that end before 2011. This transitional delay in implementing the new
rules is subject to the possible need to foreclose inappropriate new
avoidance techniques. For example, while there is now no intention to
prevent existing SIFTs from normal growth during that transitional period,
any undue expansion of an existing SIFT (such as might be attempted through
the insertion of a disproportionately large amount of additional capital)
could cause this to be revisited.
For SIFTs that begin to be publicly traded after October 2006, the
changes announced today will apply for the later of their 2007 taxation year
and the taxation year in which they begin to be traded.
Notes:
1. It is because they can flow income and the
associated tax liabilities to their investors that trusts and
partnerships are referred to as "flow-through entities" (FTEs).
Many publicly-traded FTEs are business income trusts, and the term
"income trusts" is sometimes used to refer to publicly-traded FTEs
in general. [Return]
2. All rates are as of 2011. [Return]
3. Two points should be noted about this
element. First, the concept of a public market is broader than just those
stock exchanges that are prescribed for purposes of the Income Tax Act,
and broader than even all stock exchanges. For example, an organized
quotation system that supports over-the-counter trading is considered a
public market for this purpose. Second, investments in the trust will for
this purpose include securities of other issuers, if those securities derive
all or substantially all of their value from securities issued by the trust.
[Return]
