2016 Issue No. 41 20 September 2016 Tax Alert Canada Finance releases draft income tax technical amendments EY Tax Alerts cover significant tax news, developments and changes in legislation that affect Canadian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor or EY Law advisor. On 16 September 2016, the Department of Finance released a new package of draft legislative proposals relating to technical amendments to the Income Tax Act and Income Tax Regulations, and the accompanying explanatory notes. Many of the technical amendments included in this release respond to issues raised by taxpayers and their representatives, or are part of an ongoing effort by the Department of Finance to improve the accuracy and consistency of the income tax legislation and regulations. Interested parties are invited to submit comments on the legislative proposals by 15 November 2016. In addition, the Department of Finance released a backgrounder describing proposed changes to the 2016 federal budget measures relating to sales of linked notes. These new proposals will modify the draft legislative proposals on linked notes that were previously released on 29 July 2016. Proposed changes relating to sales of linked notes In the 16 September 2016 backgrounder on sales of linked notes, the Department of Finance announced the following changes: Change to application date The proposed measures will apply to sales of linked notes that occur after 2016, instead of after September 2016 as originally proposed in the 2016 federal budget and in the 29 July 2016 draft legislative proposals. Amendment to calculation of deemed interest The formula to determine the amount of deemed interest on the sale of a linked note will be modified. Specifically, the portion of the formula that would apply where a portion of the return on a linked note is based on a fixed rate of interest will be removed. The Department of Finance indicated that the proposed change will simplify the deemed interest calculation and the associated reporting requirements.
For more information on the original proposals related to linked notes, please see EY Tax Alert 2016 Issue No. 37, Finance releases draft proposals on taxation of switch funds and linked notes and EY Tax Alert 2016 Issue No. 14, Federal budget 2016-17. New draft legislative proposals The 16 September 2016 package of draft legislative proposals includes various minor technical amendments, as well as a number of more significant technical amendments and new rules. In total, there are more than 125 new or amended provisions included in the package. The following is a summary of some of the more significant proposed amendments. International tax measures Foreign mergers Introduction of new rules that allow (on an elective basis) for a disposition of taxable Canadian property that is a share of a Canadian-resident corporation to occur on a taxdeferred (rollover) basis where the disposition occurs as a result of a foreign merger and certain other conditions are met. These new rules apply to foreign mergers that occur on or after 16 September 2016. Upstream loan rules Various amendments to the upstream loan rules, which address a number of issues raised by the CPA-CBA Joint Committee on Taxation in a letter dated 7 August 2013 and an issue raised in a 10 March 2015 comfort letter issued by the Department of Finance. The amendments include: Foreign exchange gains and losses Amendments to expand the transitional set-off relieving rule in subsection 39(2.1) of the Act and its companion rule in paragraph 95(2)(g.04). These amendments apply to portions of loans received and indebtedness incurred on or before 19 August 2011 that remain outstanding on that date and that are repaid, in whole or in part, on or before 19 August 2016. Back-to-back loans Amendments to ensure that the back-to-back loan rules apply for purposes of the transitional set-off relieving rules in subsections 39(2.1) and (2.2) and paragraph 95(2)(g.04). These amendments apply to loans received and indebtedness incurred after 19 August 2011, and any portion of a particular loan received or indebtedness incurred on or before 19 August 2011 that remains outstanding on 19 August 2014. Continuity rules Introduction of new upstream loan continuity rules (and certain related temporary relieving rules) where there has been a reorganization of a corporation or partnership. These new rules apply to transactions and events that occur on or after 16 September 2016; however, a taxpayer may elect before 2017 to have the rules apply as of 20 August 2011. Reserve for previously-taxed FAPI Amendments to include previously-taxed foreign accrual property income (FAPI) in the subsection 90(9) deduction, where the specified debtor is either the Canadian-resident taxpayer, a person resident in Canada that does not deal at arm s length with the taxpayer, or a partnership no member of which is a non-resident person that does not deal at arm s length with the taxpayer. This amendment applies to loans received and indebtedness incurred after 19 August 2011, and any portion of a particular loan received or a particular indebtedness incurred on or before 19 August 2011 that remains outstanding on 19 August 2014, subject to a transitional rule for loans received and indebtedness incurred before 16 September 2016. Specified debtor The definition of a specified debtor for purposes of the upstream loan rules is amended to include a new exception for non-resident corporations that are non-arm s length Finance releases draft income tax technical amendments 2
foreign affiliates of the taxpayer (other than controlled foreign affiliates for which there is already an existing exception) and that satisfy certain share ownership conditions. This amendment applies to loans received and indebtedness incurred after 19 August 2011, and any portion of a particular loan received or indebtedness incurred on or before 19 August 2011 that remained outstanding on 19 August 2014. Foreign affiliates In addition to the upstream loan related amendments mentioned above, various other amendments related to the foreign affiliate rules, including: Stub period FAPI - Introduction of new rules to ensure that stub period FAPI is included in the taxpayer s income for the taxation year in which the taxpayer disposes of, or reduces, its interest in a foreign affiliate. A different version of these rules was previously included in the 12 July 2013 package of draft legislative proposals. These amendments will apply as of 12 July 2013, subject to certain transitional rules. Hybrid entity exception Amendments to extend the hybrid entity exception related to the foreign accrual tax denial rule (in respect of FAPI), so that the denial will not apply solely because a hybrid entity is part of a foreign affiliate ownership chain. Specifically, it is proposed that the exception, which currently applies where a specified owner is a hybrid entity, also applies where a pertinent person or partnership is a hybrid entity. A similar change will be made to the rules for determining the underlying foreign tax of a foreign affiliate. These changes generally apply for taxation years that end after 24 October 2012. These amendments address an issue raised by the CPA-CBA Joint Committee on Taxation in a letter dated 7 August 2013, and respond to a 1 March 2016 comfort letter issued by the Department of Finance. Income from the sale of property Amendment to the safe harbour exception related to the inclusion in FAPI of an affiliate s income from the sale of property. Specifically, the amendment excludes the affiliate s revenues from securities transactions that qualify for the exception in subsection 95(2.31) in determining whether an affiliate meets the 90% safe harbour test (in paragraph 95(2)(a.1)). This amendment applies to taxation years of a foreign affiliate of a taxpayer that end after October 2012. Foreign currency exchange rate Amendments consequential to the reduced frequency in the publishing of exchange rates by the Bank of Canada and to allow an acceptable rate where the Bank of Canada will no longer publish an exchange rate for the relevant currency. Beginning 1 March 2017, the Bank of Canada will only publish a single currency rate each day at 4:30 p.m. ET. These amendments apply as of 1 March 2017. Foreign exchange gains and losses determination Amendments to expand the use of a foreign affiliate s calculating currency, in determining the foreign exchange gains and losses contemplated by subsection 39(2), to certain agreements entered into to reduce currency risk with respect to certain debt, where the agreement was entered into by a foreign affiliate of the taxpayer, or a partnership of which the foreign affiliate is a member. This amendment applies to taxation years of a foreign affiliate that begin after 2 October 2007. Foreign affiliate dumping rules Amendments to ensure the foreign affiliate dumping rules apply to an investment by a corporation resident in Canada (the CRIC) in a non-resident corporation that is not a foreign affiliate of the CRIC, but is a foreign affiliate of another corporation resident in Canada that deals at non-arm s length with the CRIC. These amendments apply in respect of transactions and events that occur on or after 16 September 2016, and in certain circumstances, in respect of the portion of a particular amount owing to a CRIC by, or debt obligation of, a subject corporation that became owing prior to 16 September Finance releases draft income tax technical amendments 3
2016 and remains outstanding on 1 January 2017. In addition, a new rule is introduced to restore the option for taxpayers to elect out of the paid-up capital (PUC) offset rules (in subsection 212.3(7)) for certain transactions occurring between 28 March 2012 and 16 August 2013. An election under this new rule must be filed with the minister before 2017. Foreign spin-offs and shareholder benefit rules Amendments to ensure that the shareholder benefit rules do not apply on the division of a non-resident corporation (the original corporation) in circumstances where all the shares of a new corporation are received (as part of the foreign spinoff) by the shareholders of one or more classes of shares of the original corporation on a pro rata basis (applicable to divisions of non-resident corporations that occur after 23 October 2012). These amendments address issues raised by the CPA-CBA Joint Committee on Taxation in a letter dated 7 August 2013. Negative adjusted cost base (ACB) rules Technical amendments to clarify that where the negative ACB rules result in a deemed gain on taxable Canadian property owned by a non-resident taxpayer, the non-resident taxpayer is deemed to have disposed of the property for purposes of the section 116 compliance requirements and for purposes of determining the non-resident s liability for tax in Canada and requirement to file a Canadian income tax return. These amendments, which address an issue raised in CRA documents 2011-0421481E5 and 2011-0417492E5, apply to gains from dispositions that occur on or after 16 September 2016. Business tax measures Fiscal period for multi-tiered partnership structures Introduction of new rules that permit partnerships in a tiered-partnership structure that have made a multi-tiered alignment election to retain their common non-calendar fiscal period in certain cases where a new partnership is added to the multi-tiered-partnership structure. Provided certain conditions are met, the new rules ensure that the original multi-tier alignment election remains operative despite the structure having a new partnership. This amendment responds to a 10 June 2014 comfort letter issued by the Department of Finance, and applies to fiscal periods of partnerships ending after March 2014. Acquisition of control rules Extension of the types of reverse takeover transactions to which the acquisition of control rules apply. Specifically, the rules will now also apply to certain reverse takeover transactions that involve an ordinary trust or partnership (without regard to whether the target entity is a specified investment flow-through trust or partnership, or a real estate investment trust). The expanded rules apply generally to transactions completed on or after 16 September 2016. Wind-up and parked debt obligations - Expansion of the rules that deem a parent corporation to be a continuation of its subsidiary following a wind-up to permit the deduction of a payment made against a parked debt of the former subsidiary corporation (effective for taxation years ending after 2001). This amendment responds to a 6 March 2003 comfort letter issued by the Department of Finance. Character conversion rules Amendments to ensure that certain currency forward purchase or sale agreements related to the purchase or sale of capital property are excluded from the application of the character conversion rules (effective retroactively to 21 March 2013), and to ensure that the income inclusion and deduction rules apply only to the derivative-based portion of the income return or loss (i.e., that is not attributable to the excluded underlying interests) of a derivative forward agreement (effective for acquisitions and dispositions of property that occur on Finance releases draft income tax technical amendments 4
or after 16 September 2016). These amendments address issues raised by the CPA-CBA Joint Committee on Taxation in a letter dated 15 October 2013. SR&ED rules Various technical amendments to the scientific research and experimental development (SR&ED) rules, namely, an amendment to the wording of the English version of the Act to restrict the potential broader scope of current expenditures that may be claimed under the proxy method for SR&ED performed on behalf of a taxpayer (effective for expenditures incurred after 16 September 2016), as well as amendments to clarify the SR&ED filing requirements and related consequences for failing to provide the required information (effective on royal assent), and to reduce the SR&ED investment tax credit rate from 20% to 15% for any repayment of government or non-government assistance or contract payments (assistance) that reduced qualified expenditures incurred after 2014 (effective for repayments of assistance made after 16 September 2016). Restrictive covenant rules Amendments to clarify the conditions that must be met to prevent an income inclusion under the restrictive covenant rules in the context of a restrictive covenant granted in conjunction with a realization of goodwill, and to clarify the persons that are required to jointly file the related election. These amendments apply to restrictive covenants granted on or after 16 September 2016. Capital dividend account (CDA) Amendment to the calculation of a private corporation s CDA to ensure that the non-taxable portions of capital gains distributed to the private corporation from a trust (which are added to the corporation s CDA) are reduced by the non-allowable portion of the corporation s realized capital losses. This amendment applies to trust distributions made on or after 16 September 2016. Bump rules where a partnership ceases to exist Introduction of a new rule that deems a leasehold interest in a depreciable property and an option to acquire a depreciable property to be depreciable properties that are not eligible for the bump rules that apply when a partnership ceases to exist. This new rule is applicable in respect of partnerships that cease to exist on or after 16 September 2016. Cost of an interest in a partnership Introduction of new rules for purposes of computing the cost to a taxpayer of an interest in a partnership that is property, other than capital property, of the taxpayer. These rules are intended to prevent taxpayers from circumventing the dividend stoploss rules by holding shares through a partnership, instead of holding the shares directly. In addition, an amendment is made to ensure that certain partnership losses that were subject to certain dividend stop-loss rules are included in computing the adjusted cost base of a partnership interest that is capital property of the taxpayer. These amendments apply as of 16 September 2016. Credit unions: Provincial income allocation Introduction of new rules for determining the amount of a federal credit union s taxable income earned in a province for purposes of the 10% federal tax abatement. The new rules are intended to mirror the special provincial allocation rules for banks, and apply as of 16 September 2016. Bond premiums relating to the reopening of a bond issue New reserve and related income inclusion rules for the unamortized amount at the end of the year of a premium received on the reopening of a bond issue. This change applies retroactively to bonds issued after 2000, and is in response to a 24 October 2001 comfort letter issued by the Department of Finance. Finance releases draft income tax technical amendments 5
Functional currency rules Amendments to the definition of relevant spot rate consequential to the reduced frequency in the publishing of exchange rates by the Bank of Canada (beginning in March 2017) and the reduced number of currencies for which it will then provide exchange rates. (Similar amendments are also made to the definition of exchange rate in subsection 111(8) regarding capital gains and losses resulting from foreign currency fluctuations on foreign currency denominated liabilities.) These amendments apply as of 1 March 2017. Capital cost allowance Amendment to extend the application of the accelerated capital cost allowance for Class 43.1 (30%) and Class 43.2 (50%) to heat recovery equipment where the primary purpose of the equipment is extracting heat for sale. This amendment is applicable to heat recovery equipment acquired after 3 March 2010. Personal tax measures and measures relating to trusts Non-resident trust rules Amendment to ensure that for purposes of computing a foreign tax deduction (under subsection 20(12)) or a foreign tax credit, the trust s income from sources in Canada are excluded from the pooling of income to the foreign country in which the trust is resident (at the specified time). The amendment applies to taxation years that end on or after 16 September 2016. This amendment addresses an interpretation issue raised in CRA document 2013-0476381I7. Trust attribution Amendment to ensure the subsection 75(2) trust attribution rule does not apply to Canada Child Tax Benefit, the Universal Child Care Benefit and the Canada Child Benefit amounts held in trust for a child. This amendment is applicable to taxation years that end on or after 16 September 2016. Security option deduction Amendments to permit the paragraph 110(1)(d) deduction in computing the taxable income of a deceased taxpayer who is deemed to have received a security option benefit in the taxation year in which he or she died (provided certain conditions are met). This amendment applies to acquisitions of securities and transfers or dispositions of rights occurring after 4:00 p.m. ET on 4 March 2010. This amendment addresses situations currently covered by CRA s administrative position described in CRA document 2013-0484181E5. In addition, the prescribed share requirements in Regulation 6204(b) (re. the expected period without share redemptions, paid-up capital reductions, etc.) are amended to add a new exception to ensure a share is not precluded from being a prescribed share in certain situations where a subsection 51(1) or 86(1) tax-deferred exchange or disposition occurs. This amendment, which responds to a 29 November 2012 comfort letter issued by the Department of Finance, applies to the 2012 and subsequent taxation years. Pension income - Amendments to treat retirement income security benefit amounts received under Part 2 of the Canadian Forces Members and Veterans Re-establishment and Compensation Act as eligible pension income for purposes of the pension credit, and to allow these benefit amounts to qualify for the pension income splitting rules (subject to a specified cap). These amendments apply for 2015 and subsequent years. Life insurance policies Various technical amendments related to the rules for determining the income tax consequences on a disposition of an interest in a life insurance policy (effective on royal assent). Alternative minimum tax (AMT) and limited partnership losses Amendment to the application provisions (in Bill C-4 (2013), Economic Action Plan 2013 Act, No. 2) that related to changes Finance releases draft income tax technical amendments 6
made concerning the treatment of limited partnership losses for AMT purposes. Specifically, the relief available for taxpayers that filed an election to have the 2013 amendment apply to the 2006 to 2011 taxation years is extended retroactively so that it also applies to the taxpayer s 2003 to 2005 taxation years, where the taxpayer filed the required election with the minister before 12 March 2014. This change responds to a 6 January 2016 comfort letter issued by the Department of Finance. Registered plans Various technical amendments related to the rules for pooled registered pension plans (PRPP), Saskatchewan pension plans (SPP), registered disability savings plans (RDSP) and registered pension plans (RPP), with various effective dates. Qualified disability trusts Amendments to the formula for computing the recovery tax applicable to a trust that elected in an earlier taxation year to be qualified disability trust (effective for taxation years that end on or after 16 September 2016). Finance releases draft income tax technical amendments 7
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