Department of Finance-TEI Liaison Meeting Agenda: December 3, 2003.

1. Supplement to Agenda Item Number 16

As background for item 16 in the 2003 Department of Finance-TEI Liaison Meeting Agenda, we submit Question 8 from the CCRA-TEI 2002 Liaison Meeting Agenda--Sale of a Partnership Interest, as well as CCRA's response.

TEI's Question:

The taxation year of a partnership is its fiscal period. Subsection 249.1(7) of the Income Tax Act (hereinafter "the Act") states that "no change in the time when a fiscal period ends may be made for the purposes of this Act without the concurrence of the Minister." On a sale of a partner's interest where the partnership carries on an active business, the partners generally prefer to terminate the partnership's fiscal period as of or immediately prior to the closing date. Closing the books and the fiscal period immediately prior to the sale ensures a proper allocation of income or loss to the continuing, terminating, and new partners for their respective periods of ownership of the partnership interest. It also ensures that various adjustments to the adjusted cost base of a partner's partnership interest are made.

Although the Minister will generally agree to a request for a change in a partnership's fiscal period, the partnership must specify a date certain in its request for a new fiscal period and taxation year. In the context of a sale of a partnership interest, however, the partners and partnership may be unable to specify an exact calendar date for the closing because of time needed to perform due diligence, obtain regulatory approvals, and satisfy conditions precedent that arise from the negotiations and the purchase and sale agreements. Once the various approvals are received and the conditions precedent satisfied, there is generally a rush to complete the purchase and close as soon as possible. Filing a request for a change in fiscal period with CCRA will delay the closing and is viewed as an unnecessary business and legal risk.

In lieu of the current requirement to specify a date certain in the request for a change in taxation period, would CCRA consider granting a request for a year-end change to the "date immediately prior to the acquisition of control"? In other words, will CCRA grant a change in the taxation year end that is "formula driven" rather than a specific date?

CCRA's Reply:

A departure of a partner from a partnership is governed by the relevant provincial law and terms of the Partnership Agreement, which Agreement normally dictates the fiscal year of the partnership. For income tax purposes, there is no deemed year end when a partner leaves a partnership. In fact, paragraph 98.1(1)(b) provides that when a person ceases to be a member of a partnership during a taxation year, the disposition will be deemed to take place at the end of the particular fiscal period. Therefore, even if the particular Partnership Agreement and provincial law permitted it, we are view of that it is contrary to paragraph 98.1(1)(b) to permit a change to a fiscal year end of a partnership solely due to the departure of a partner.

Furthermore, subsection 249.1(7) states that, "No change in the time when a fiscal period ends may be made for the purposes of this Act without the concurrence of the Minister". In assessing the merits of a request, paragraph 2 of Interpretation Bulletin IT 179R states, "Requests for changes in fiscal periods will be approved if they can be demonstrated to be prompted solely by sound business reasons other than obtaining tax benefits". The reasons provided above appear to be tax related (allocation of income and adjustments to the adjusted cost base) versus "sound business reasons". The determination of income of partners and the adjusted cost base of partnership interests are governed by the relevant provisions of the Income Tax Act and, in our view, not "sound business reasons" for changing a fiscal period of a partnership.

Should there be "sound business reasons" for a change in a fiscal period and should the terms of the Partnership Agreement and the relevant provincial law otherwise permit it, we note that "fiscal period" is defined in subsection 249.1(1) and refers to a period of time. Subsection 249.1(3) states "Where a fiscal period of a business or a property of a person or partnership ends at any time, the subsequent fiscal period, if any, of the business or property of the person or partnership is deemed to begin immediately after that time."

In order to assist in understanding the computation of time indicated in the Income Tax Act, the Interpretation Act, subsection 27(3) provides, "Where a time is expressed to begin or end at, on or to continue to or until a specified day, the time includes that day." We therefore are of the opinion that the legislation requires that a specific day should accompany the request for a change in the fiscal period.

2. Follow Up on Question 21 from the 2002 Department of Finance-TEI Liaison Meeting Agenda

To supplement item 33 of the current year's agenda, we include question 21 from the 2002 Department of Finance-TEI Liaison Meeting Agenda in respect of partnership foreign tax credits.

Question 21--Partnership Foreign Tax Credit

For purposes of the Act, a partnership is not a taxpayer. Rather, the income or loss of the partnership is taxed in the hands of the partners. Where the fiscal year of the partnership and the tax year of a partner do not coincide, the partner's pro-rata share of the partnership's income for a particular year is included in the partner's income for his taxation year in which the partnership's fiscal year ends. These rules can lead to situations where the taxes paid by a foreign partnership relate to a year that differs from the year in which a Canadian partner is required to include in income his share of the foreign partnership's income.

In response to a taxpayer letter (Document number 2000-0029575, December 14, 2000), CCRA indicated that:

   [i]n interpreting the term <<for the year>> as it is
   used in subsections 126(1) and 126(2), as well as in
   the definitions of <<business income-tax>> and <<non
   business-income tax>> in subsection 126(7) of the
   Act, that term relates to the year for which the
   foreign income or profit tax is exigible (i.e., liable to
   be paid). In other words, it relates to the year for
   which the taxpayer is liable to pay tax to the foreign
   jurisdiction for the income which is considered to
   have been earned under the tax law of the foreign
   jurisdiction (the <<taxable year>>).

   The CCRA letter continues, stating that

   subject to the relevant carryover provisions for business-income
   tax, such tax is eligible to be claimed
   as a foreign tax credit, for Canadian tax purposes,
   for a taxation year if such taxation year for which
   the person is making the claim coincides with the
   taxable year.

Given the anomalous result that CCRA's interpretation creates, would the Department of Finance indicate whether this result is intended? If CCRA's interpretation is correct, would the Department amend the applicable provisions to clarify that in the circumstances described above the foreign income or profit tax may be claimed as a foreign tax credit in the taxation year in which the Canadian resident includes the foreign income in his income?

(1) See Interpretation Bulletin IT-126R2, paragraph 4.

(2) See Interpretation Bulletin IT-126R2, paragraph 5.

(3) See Technical Interpretation, Document 2001-0067105, March 19, 2001.

(4) See Round Table on Federal Taxation, APFF-2001 Conference, Question 27, Document 2001-0093395.

(5) Specifically, a taxpayer might first use the losses of a liquidated subsidiary in the parent corporation on the basis that the wind up of the subsidiary had commenced. Then, in a later year after the subsidiary is subsequently revived, the taxpayer would use the same losses in the subsidiary corporation. Since the tax years of the parent corporation during which the subsidiary's losses were used were statute-barred, the CCRA was unable to reassess the parent corporation and the same losses were used twice by different corporations.

(6) We recognize that under either approach exceptions will be necessary to take account of consequential assessments arising from audits conducted by the provinces or foreign tax authorities.

(7) See the Explanation of draft paragraph 96(1.01)(a) in the Technical Notes to the Draft Technical Bill issued December 20, 2002. The full draft of subsection 96(1.01) is, as follows:

(1.01) Income allocation to former member

If, at any time in a fiscal period of a partnership, a taxpayer ceases to be a member of the partnership

(a) for the purposes of subsection (1) and sections 34.1, 34.2, 101,103 and 249.1, and notwithstanding paragraph 98.1(1)(d), the taxpayer is deemed to be a member of the partnership at the end of the fiscal period; and

(b) for the purposes of the application of paragraph (2.1)(b) and subparagraphs 53(1)(e)(i) and 53(2)(c)(i) to the taxpayer, the fiscal period of the partnership is deemed to end

(i) immediately before the time at which the taxpayer is deemed by subsection 70(5) to have disposed of the interest in the partnership, where the taxpayer ceased to be a member of the partnership because of the taxpayer's death, and

(ii) immediately before the taxpayer ceased to be a member of the partnership, in any other case.

(8) CCH Windows Document No. 2002-0117125.

(9) See item number one in the Appendix for CCRA's response to Question 8 from the 2002 TEI-CCRA Liaison Meeting.

(10) Indeed, paragraph 7(3)(a) precludes the application of other sections in the Act.

(11) Question 7.C. from the 2001 TEI Liaison Meeting with the Department explains, as follows:

   Under subsection 190.1(3), a financial institution may reduce
   its Part VI tax payable by the total of its Part I tax liability
   for the year, plus such amount as it claims of its unused Part I
   tax credits and unused surtax credits. As a result of the
   legislated corporate tax rate reductions, the taxpayer's ability
   to offset Part VI tax against Part I tax has been diminished and
   the time required to recover the credits lengthened. TEI
   recommends that the tax payable rate prescribed under subsection
   190.1(1) (currently 1.25 percent) be reduced proportionately with
   the reduction in the general corporate tax rate under Part I.