Partnerships – Deferral of corporation tax
Under subsection 96(1) of the Income Tax Act, income earned by a corporation as a member of a partnership is included in the corporation’s income for the corporation’s tax year in which the fiscal period of the partnership ends. If the partnership has a fiscal period that ends after the end of the corporation’s tax year, taxation of the partnership earnings can be deferred by up to one year.
The rules in new sections 34.2, 34.3, and amended section 249.1 were introduced to limit the deferral of tax that arises because of this misalignment.
The two main aspects of section 34.2 are the rules related to:
These rules do not affect a corporation’s capital dividend account which is to be determined without reference to section 34.2.
Adjusted stub period accrual (ASPA)
For tax years of a corporation that end after March 22, 2011, some corporations may have to accrue additional income in respect of the partnership (other than dividends for which a deduction is available under section 112 or 113), when the fiscal period of the partnership begins in the tax year and ends in a following tax year.
The corporation will be required to accrue income (ASPA) for the portion of the partnership’s fiscal period that falls in the corporation’s tax year (the stub period). As the ASPA income inclusion in a tax year is an estimate of the stub period income, the corporation is entitled to claim that same amount in the immediately following tax year.
Both the ASPA income inclusion and the treatment of that same amount in the following year are subject to the characterization rules under subsection 34.2(5). As such, the claim in the immediately following tax year may be a deduction or a deemed allowable capital loss, whichever applies. A corporation may have ASPA in respect of more than one partnership and, in such cases, the ASPA rules apply to the corporation on a partnership-by-partnership basis.
In general, a corporation (other than a professional corporation) has to include in its income for a tax year its ASPA in respect of a partnership if:
- the corporation has a significant interest in the partnership at the end of the last fiscal period of the partnership that ends in the tax year;
- another fiscal period of the partnership begins in the tax year and ends after the tax year of the corporation;
- at the end of the tax year, the corporation is entitled to a share of an income, loss, taxable capital gain, or allowable capital loss of the partnership for the fiscal period referred to in the preceding bullet.
A corporation has a significant interest in a partnership if the corporation, or the corporation together with affiliated or related parties, is entitled to more than 10% of the partnership’s income or loss (or assets, net of liabilities, if the partnership were to cease to exist).
These rules apply to any corporation (as described above), that is a member of a partnership, even if the partnership has as a member an individual or a professional corporation that is subject to the 1995 rules limiting deferral for unincorporated businesses.
The definition of adjusted stub period accrual in subsection 34.2(1) gives the formulas for calculating a corporation’s ASPA in respect of a partnership. The ASPA formula allows the corporation to designate two reductions:
- the first designation concerns qualified resource expenses incurred by the partnership during the corporation’s stub period;
- the second allows a corporate partner to make a discretionary designation to reduce its ASPA to reflect its knowledge of the actual partnership income for the stub period.
Once filed, the designations cannot be amended or revoked. If the amount of the discretionary designation is too high, creating an income shortfall, the corporation may be subject to an additional income inclusion. The additional income inclusion may increase if the shortfall is above a 25% threshold.
If the corporation is a member of a partnership subject to a multi-tier alignment, the ASPA inclusion does not apply to the corporation in respect of the partnership for tax years before the tax year that includes the end of the first fiscal period of the partnership that is aligned under the multi-tier alignment.
Under certain conditions, a corporation (other than a professional corporation) that becomes a member of a partnership in a tax year may make a designation to apportion its income from the partnership between two tax years – the tax year in which the fiscal period of the partnership began and the tax year in which the fiscal period of the partnership ends.
The ASPA rules generally apply to tax years of a corporation that end after March 22, 2011. In many cases, these rules could result in an income inclusion of a significant incremental amount of partnership income for a corporation’s first tax year ending after March 22, 2011.
The rules providing transitional relief will generally result in no additional taxes being payable for that first tax year. Instead, the additional income will generally be brought into the corporation’s income over the five following tax years.
Qualifying transitional income
Whether a corporate partner is eligible for transitional relief depends initially on whether the corporation is a member of the partnership on March 22, 2011, and whether it has qualifying transitional income (QTI) in respect of the partnership. A corporation’s qualifying transitional relief in respect of a partnership could be made up of:
- ASPA arising in the corporation’s first tax year ending after March 22, 2011;
- eligible alignment income, which can result from a single-tier alignment or a multi-tier alignment of the fiscal period of a partnership; or
- both ASPA and eligible alignment income (in other words, the fiscal period of a partnership may be aligned, but that alignment may not coincide with the tax year end of all its corporate members).
Alignment elections and eligible alignment income
Under certain conditions, a single-tier partnership was allowed a one time election to change its fiscal period, for example to align with the tax year of one or more corporate partners. For partnerships in a multi-tier partnership structure that would otherwise be forced to have a December 31 fiscal period end, a one time election allowed them to align to a common fiscal period if certain conditions were met. The eligible period to make an election has ended.
A corporate partner may have additional income as a result of single-tier or multi-tier alignment election that may represent eligible alignment income, which qualifies for transitional relief. Unlike adjusted stub period accrual, a corporation may have eligible alignment income in respect of a partnership even though its interest in the partnership is not a significant interest.
Generally, corporations will have up to five calendar years to report the QTI following the tax year in which the QTI initially arose. For example, if the first tax year in which the QTI arose ended in 2011, the effective QTI inclusion is: 0% in 2011, 15% in 2012, 20% in each of 2013, 2014 and 2015, and 25% in 2016.
This is done by claiming an amount, as a reserve, for a declining specified percentage of the QTI each year (subject to certain limits). Like other reserves, the amount claimed in a tax year is brought into income in the following tax year. Both of these amounts are subject to the characterization rules under subsection 34.2(5). The QTI amount that is initially calculated may be required to be adjusted in the second or subsequent tax year to accurately prorate the income for the stub period.
There is no adjustment to QTI if it includes only eligible alignment income. If the QTI is adjusted, it is a one time adjustment. Although this adjustment to QTI does not affect a corporation’s reserve for the first tax year (or the amount included in its income for the following tax year in respect of the reserve), it does change the QTI in respect of the partnership for the purpose of claiming a specified percentage of that QTI for the year in which it is adjusted and each following tax year in which a reserve is claimed in respect of QTI.
The first tax year the transitional reserve can be claimed may end in 2011, 2012, or 2013. The first tax year in which the QTI arises may be 2013 only if a multi-tier alignment occurs and the corporation’s first tax year that includes the aligned fiscal period of the partnerships ends in 2013. Then the corporation has only up to four calendar years to report the QTI following the tax year in which the QTI initially arose.
This transitional relief applies on a partnership by partnership basis if a corporation is a member of two or more partnerships.
The availability of transitional relief depends on certain conditions being met. For example, a corporation generally must be a member of a partnership for which the corporation has QTI continuously since before March 22, 2011 until the end of the tax year in which the corporation is claiming a reserve in respect of QTI. A continuation rule is provided for cases where a corporation transfers its partnership interest to, and which is held by, another corporation that is related to, or affiliated with, the corporation.
Generally, the ASPA and related amounts are deemed to have the same character and be in the same proportions as the partnership income that they relate to.
Reporting requirements for corporations
To calculate the income inclusion under 34.2 and, if applicable, the income shortfall adjustment and additional amount under 34.3, use Schedule 71, Income Inclusion for Corporations that are Members of Single-Tier Partnerships, or Schedule 72, Income Inclusion for Corporations that are Members of Multi-Tier Partnerships. These are worksheets and you do not have to file them with your return.
To report the amounts, file a completed Schedule 73, Income Inclusion Summary for Corporations that are Members of Partnerships, with your return.
Joint ventures – Elimination of fiscal period
Joint ventures no longer have a fiscal period. Therefore, participant taxpayers who entered into joint venture arrangements are no longer eligible to compute income as if the joint venture had a separate fiscal period. For more information, see Joint ventures – Elimination of fiscal period.
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