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Corporate Tax PlanningCo-Editors: Derek G. Alty,* Brian R. Carr,** Michael R. Smith,*** and Christopher J. Steeves****

Limitation on Deferral of PartnershipIncome by a CorporationJeff Oldewening and Brian R. Carr*****

Recent amendments to the Canadian Income Tax Act limit the opportunity for acorporation to defer income through the use of a partnership with a scal period thatdiffers from the taxation year of the corporation. Under the new rules, where thecorporation owns a signicant interest in the partnership, the corporation mustinclude in income an amount in respect of its share of the partnerships income forthe portion of the partnerships scal period that falls within the corporations taxationyear. On the transition to the new regime, the corporation may be required to includein income an amount that represents more than one year of partnership income. Atransitional reserve apportions the incremental income over a ve-year period.

This article reviews the 2011 amendments in detail. The authors provide an overviewof the amendments and the underlying policy rationale; discuss the applicationof the new rules, using simple examples to illustrate the concepts; and commenton selected policy considerations. They then highlight several interpretive issuesarising from the technical language, and suggest a number of planning techniquesthat taxpayers may use to resolve some of the difculties presented by theamendments. The authors conclude that the policy of the provisions is sound but thatthe complexity of the new rules and the interpretive difculties they raise will resultin increased compliance costs and disputes between taxpayers and the CanadaRevenue Agency.

KEYWORDS: PARTNERSHIPS n CORPORATE TAXES n DEFERRED INCOMEn STATUTORY INTERPRETATIONn TAX ANALYSISn RESOURCES

ARTICLE REPRINTThis article was rst published in Canadian Tax Journal

* Of Ernst & Young LLP, Toronto.

** Of Moskowitz and Meredith LLP, Toronto.

*** Of Deloitte & Touche LLP, Calgary.

**** Of Fasken Mart ineau DuMoulin LLP, Toronto. ***** Of Moskowitz and Meredith LLP, Toronto. We thank Chris Sheridan, student-at-law, and Torran Jolly for comments on our article.


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Introduction ........................................................................................................................................ 4

Overview of the Provisions ................................................................................................................ 5

Detailed Review of the Provisions .....................................................................................................6

Accrual Obligation ........................................................................................................................ 6

Calculation of ASPA ...................................................................................................................... 7

Formulaic Accrual ..................................................................................................................... 7

Designation of QRE .................................................................................................................7

Designation for the Stub Period ................................................................................................ 8

Interest Charge for Underaccrued Partnership Income ............................................................. 9

Prohibition of Amendment or Revocation of Designations .................................................... 10

Special Rule for a New Corporate Partner of a Partnership ..................................................... 10

Deduction of ASPA and Apportioned Income ........................................................................... 10

Alignment Elections ................................................................................................................... 10

Single-Tier Alignment Election ................................................................................................11

Multi-Tier Alignment Election ..................................................................................................11

Transitional Reserve ................................................................................................................... 11

Computation of QTI ................................................................................................................11

Partnership Income Computation .......................................................................................... 14

True-Up of QTI ......................................................................................................................... 14

Deduction of Reserve for QTI ..................................................................................................... 14

Specied Percentage for the Year of QTI ................................................................................ 14

Prior-Year Reserve Limit ......................................................................................................... 14

Income Limit .......................................................................................................................... 14

CONTENTS

2 | Corporate Tax Planning


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Reserve Denial Rules ..................................................................................................................15Relieving and Anti-Avoidance Provisions ................................................................................. 15

Adjusted Cost Base Adjustments ..............................................................................................15

Character of ASPA, Partitioned Income, and Reserve for QTI .................................................. 16

Deemed Allowable Capital Loss ................................................................................................ 16

Exceptions .................................................................................................................................. 16

Joint Ventures ............................................................................................................................. 17

Issues and Tax-Planning Opportunities ........................................................................................... 18

Policy Considerations ................................................................................................................ 18

Signicant Interest Threshold ............................................................................................. 18

Specied Percentage of QTI .................................................................................................. 18

Deadline To Make an Alignment Election ................................................................................ 18

Multi-Tier Alignment Elections ............................................................................................... 18

Interpretive Issues ...................................................................................................................... 18

Meaning of Character ......................................................................................................... 18

Corporate Tax Attributes ......................................................................................................... 20Activities to Which the Reserve Relates.............................................................................. 21

Planning Opportunities .............................................................................................................. 22

Accrual of Partnership Losses ................................................................................................ 22

Revocation of an Alignment Election ......................................................................................23

ASPA on Reassessment ........................................................................................................23

No QTI ................................................................................................................................... 23

Deduction of Reserve for QTI in Short Taxation Years ............................................................. 24

Conclusion .........................................................................................................................................24

Corporate Tax Planning | 3


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INTRODUCTIONFor the purposes of the Canadian Income Tax Act, 1 a corporation

must include in income for a taxation year its share of theincome of a partnership for a scal period of the partnershipthat ends in the taxation year of the corporation. 2 Before theimplementation of the legislation 3 proposed in the 2011 federalbudget, 4 a corporation could defer recognition of partnershipincome if the corporations taxation year ended before theend of the partnerships scal period. The corporation couldcompound the deferral by using a tiered partnership structure.

The budget contained a measure 5 to limit the deferral ofpartnership income by a corporation that owns a signicantinterest 6 in the partnership. The measure provided that wherethe partnerships scal period ends after the corporationstaxation year, the corporation must include in income anamount, referred to as adjusted stub period accrual (ASPA), 7 in respect of the portion of the partnerships scal period thatfalls within the corporations taxation year (the stub period).The initial accrual could cause a corporation to include inincome an amount that represented the corporations share

of partnership income for up to two scal periods of thepartnership. Accordingly, the measure provided transitionalrelief to apportion the initial accrual over a ve-year period.

Sections 34.2, 34.3, and 249.1 enacted by Bill C-13implemented the budget measure, 8 with minor modicationsin response to comments from the tax community. 9 Theprovisions are based on amendments introduced in 1995that limit a similar deferral opportunity for an individual or aprofessional corporation that earns income from a businesswith an off-calendar scal period or through a partnership. 10

The budget disclosed that the government acted to limit thedeferral opportunity in the corporate context for two reasons:

1. Deferral of corporate tax through the use of partnerships,whether or not intentional, is inequitable. 11 The government

intended to harmonize the treatment of partnership incomeearned by corporations with the treatment of businessincome earned by individuals, and to bring Canadian taxlaw into line with that of other countries such as the UnitedStates, the United Kingdom, and Australia.

1 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as the Act). Unless otherwise noted, statutory references in this article are tothe Act.

2 Subsection 96(1).3 Bill C-13, Keeping Canadas Economy and Jobs Growing Act; SC 2011, c. 24; royal assent December 15, 2012 (herein referred to as the 2011

amendments).4 The 2011 federal budget was initial ly delivered by the Conservative minority government on March 22, 2011; however, the government fell

before it could enact the budget measures. After re-election with a majori ty, the government reintroduced the budget, with only minorchanges, on June 6, 2011: see Canada, Department of Finance, 2011 Budget, Budget Plan, June 6, 2011 (herein referred to as the budget).

5 Resolution (41) of the Notice of Ways and Means Motion To Amend the Income Tax Act and the Income Tax Regulations, Budget Plan, supranote 4, annex 3, at 367.

6 Dened in subsection 34.2(1) and discussed below in the text accompanying note 24.7 Dened in subsection 34.2(1) and discussed below in the text accompanying note 25 and following.8 Sections 34.2 and 34.3 apply to taxation years of a corporation ending after March 22, 2011, the date of the rst budget: see Bill C-13, supra

note 3, at section 3(2). Section 249.1 applies to the 2011 and subsequent scal periods of a partnership: ibid., at section 73(2).9 See, in particular, Tax Executives Institute , Re: June 6, 2011, Budget Proposals: PartnershipsDeferral of Corporate Tax, June 21, 2011,

submission to the Honourable James M. Flaherty, Minister of Finance (www.tei.org/news/Documents/Budget_2011_Partnership_Proposals.pdf); and Tax Executives Institute, Re: August 16th Draft Legislation: Corporate Partner Income Inclusions, September 16, 2011, submissionto Brian Ernewein, general director and senior assist ant deputy minister, Tax Policy Branch, Department of Finance (www.tei.org/news/

Documents/Corporate%20Partner%20Income%20Inclusion%20August%2016%20Prop %20Legislation.pdf). In addition, the JointCommittee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants (the joint committee)provided oral comments on the budget measure at a meeting with Finance ofcials in Ottawa on June 20, 2011. For additional comments onthe provisions, see Lee-Lynn Gan, Roque Hsieh, and Tony Tse, Ending the Year Ending After the End of the Year, in 2011 British ColumbiaTax Conference (Toronto: Canadian Tax Foundation, 2011), 12:1-31; Samuel Tyler and Steven Hurowitz, Partnerships Update, PowerPointpresentation in 2011 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2011), t ab 9; Alycia Calvert and Thomas Copeland, RecentDevelopments Regarding Partnerships, PowerPoint presentation at the 2011 annual tax conference of the Canadian Tax Foundation,November 28, 2011; Brian R. Carr and Penny Woolford, Partnership Proposals: 2011 Federal Budget (2011) 17:2 Corporate Finance 1969-75;Andrea Shreeram and Torran Jolly, The Proposed Partnership Accrual Rules: Issues and Opportunities for the Resource Industry(forthcoming article to be published by Federated Press); and Bruce Ball and Darcy Moch, Bill C-13Corporate Tax Deferral Rules in Sections34.2, 34.3 and 249.1 of the Income Tax Act (Canada), November 14, 2011, letter to Brian Ernewein (www.cica.ca/about-the-profession/cica/ government-relations/submissions/2011-submissions/item54306.pdf) (herein referred to as the joint committee submission) at 18.

10 Section 34.1, section 34.2 prior to the 2011 amendments, paragraph 249.1(1)(b), and subsection 249.1(4). These provisions (herein referred toas the 1995 amendments) were enacted in nal form by SC 1996, c. 21.

11 Budget Plan, supra note 4, at 315.



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2. Such deferral provides an incentive to corporations toestablish captive partnerships for little purpose otherthan to defer income, a strategy that is not economicallyproductive. 12 It is common in some industries 13 for relatedcorporations to carry on business through a partnership andto choose a scal period for the partnership that ends afterthe taxation years of the corporations within the group inorder to defer income.

This deferral opportunity has existed for a very long time.Why the government acted only now, 16 years after the1995 amendments relating to individuals and professionalcorporations, to limit the deferral opportunity remains amystery. A conuence of factors may have prompted thegovernment to change the law. These factors include a desireto raise revenue and recent litigation that may have caused the

government to consider the general anti-avoidance rule (GAAR)inadequate to combat multi-year deferral of income through atiered partnership structure.

With respect to the rst of these possible motivations, thebudget indicated that the measure would raise an estimated$2.85 billion from 2012 to 2016. 14 This makes it one of thelargest revenue-generating items in the budget. We infer thatthe government intended to raise such additional revenue toreduce projected federal budgetary decits.

As regards recent GAAR litigation, one Tax Court judgment anda recent appeal have specically addressed the issue of deferralthrough the use of tiered partnership structures: In Fredette v. The Queen ,15 individual taxpayers used a tiered

partnership structure to effect a two-year deferral of income.The taxpayers transferred rental property to a partnershipwith a scal period that ended after the calendar year. Thetaxpayers then transferred their partnership interest to asecond partnership with a scal period that ended after thatof the rst partnership. The Tax Court found that a one-yeardeferral of income, which resulted from the selection ofthe scal period of the rst partnership, did not constituteabusive tax avoidance. The court held, however, that GAARapplied to deny the second year of deferral achieved throughthe use of the second partnership.

In a recent appeal, Vitalaire Canada Inc. v. The Queen ,16 the minister reassessed the taxpayer under GAAR to denya 21-month deferral of income achieved through a tieredpartnership structure. In its notice of appeal, the taxpayeroutlined valid business reasons for the use of the tieredpartnership structure and the choice of the scal periodsfor the partnerships. The minister led a reply but thenconsented to judgment on the factual basis that there was noavoidance transaction to which GAAR could apply. 17

The settlement in Vitalaire Canada may indicate that theminister thought that the courts may allow multi-year deferralof income where a taxpayer establishes a tiered partnershipstructure primarily for bona de purposes other than to deferincome. Some speculate that Finance may have acted torestrict the deferral of partnership income in response to the

outcome in this case. 18

OVERVIEW OF THE PROVISIONSA corporation that owns a signicant interest in a partnershipmust include in income for taxation years ending after March22, 2011 its ASPA in respect of the partnership for a stub period.ASPA is determined by a mathematical formula that dependson the partnerships income for its scal periods that end in thecorporations taxation year and the number of days in the stubperiod. A corporate partner may reduce ASPA by making twodiscretionary designations.

The rst designation is relevant only to resource industries.

A corporate partner of a partnership that incurs qualiedresource expenses 19 (QRE) may make a designation to reduceASPA in recognition of such QRE. The designated amount islimited by the actual amount of resource expenses incurredby the partnership in the stub period that are identied by thepartnership for the purposes of the corporations designation ofQRE. Resource expenses receive special treatment becausea partnership does not deduct such expenses in computingits income. Instead, resource expenses of a partnership areallocated to the partners, which include their share of thoseexpenses in their resource accounts.

12 Ibid.13 Examples include the real estate and resource industries.14 Budget Plan, supra note 4, annex 3, at 263, table A3.1.15 2001 DTC 621 (TCC).16 Docket no. 2009-1976(IT)G (TCC).17 See Notice of Appeal of Vitalaire Canada Inc., June 5, 2009 and the Reply to the Notice of Appeal of Her Majesty the Queen,

October 29, 2009.18 Shreeram and Jolly, supra note 9.19 Dened in subsection 34.2(1) and discussed below in the text accompanying note 35 and following.



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The second designation allows a corporate partner toreduce ASPA to an amount not less than nil in order toreect the corporate partners expectation or knowledge ofthe partnerships actual income for the stub period. If theASPA resulting from the designation is less than a particularbenchmark, 20 however, the corporate partner must include inincome an interest charge to compensate the government forthe corporations underaccrual of partnership income for thestub period caused by the excessive designation.

Under existing law that continues to apply (subsection96(1)), the corporation must include in income for a taxationyear its share of partnership income for a scal period ofthe partnership that ends in the corporations taxation year.Because the corporation previously accrued all or a portion ofsuch amount as ASPA in a prior taxation year, the corporation

may deduct the ASPA previously included in income to avoiddouble-counting of income.

The provisions are designed to limit the ability of a corporationto defer partnership income. To completely eliminate thedeferral opportunity, Finance could have forced each partnerand the partnership to have the same scal period. Inrecognition that arms-length corporations may operate inpartnership, the provisions preserve the discretion afforded tocorporations and partnerships to choose any scal period. Torelieve the compliance burden of the provisions, an election isavailable to change the partnerships scal period to align withthe taxation year of one or more of the corporations.

Each partnership in a tiered partnership structure is requiredto adopt a calendar scal period where a corporation owns asignicant interest in one or more of the partnerships, unlessan election is made to choose an off-calendar scal period forall of the partnerships. If an election is not made, an election isdeemed to have been made to adopt a calendar scal period foreach partnership.

On the transition to the new regime, a corporation may berequired to include in income an amount that representsmore than one year of partnership income. This results from

the corporations obligation to include in income its share ofpartnership income for the partnerships scal period ending inthe corporations taxation year pursuant to the existing rules insubsection 96(1) and each of the following amounts: the corporations ASPA in respect of the partnership for the

stub period; and if an election to change the partnerships scal period is

made, the corporations share of partnership income for thepartnerships scal period that ended within the corporationstaxation year because of the election that otherwise wouldhave been deferred by the corporation (referred to as eligiblealignment income [EAI]). 21

To mitigate hardship that might result from tax payable on theincremental income, a corporation may claim transitional relief

in the form of a reserve. The reserve allows the corporation totreat the total of such ASPA and EAI as qualifying transitionalincome 22 (QTI), which may be included in income over a ve-year transitional period.

DETAILED REVIEW OF THE PROVISIONSAccrual ObligationSubsection 34.2(2) requires a corporation 23 to include in incomefor a taxation year ASPA in respect of a partnership where the corporation has a signicant interest in the partnership

at the end of the partnerships last scal period that ends inthe corporations taxation year;

another scal period of the partnership begins in the year andends after the year; and

at the end of the year, the corporation is entitled to a share ofan income, loss, taxable capital gain, or allowable capital lossof the partnership for that other scal period.

A signicant interest 24 is a partnership interest of acorporation that, alone or together with related or afliatedpersons or partnerships, is entitled to more than 10 percentof the income or loss of the partnership or the assets (net ofliabilities) of the partnership on dissolution.

20 Discussed below in the text accompanying note 45 and following.21 Dened in subsection 34.2(1) and discussed below in the text accompanying note 75 and following.22 Dened in subsection 34.2(1) and discussed below in the text accompanying note 70 and following.23 The provisions do not apply to a professional corporation. A professional corporation may be subject to accrual under section 34.1.24 Dened in subsection 34.2(1).



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Calculation of ASPAASPA estimates a corporations share of partnership incomefor a stub period and approximates the partnership incomethat the corporation would otherwise defer. For a single-tierpartnership, 25 ASPA equals the difference between

1. a formulaic accrual of partnership income for the stubperiod 26 and

the total of the following designations made by thecorporation in its return of income:

2. a designation of QRE 27 and

3. a designation for the stub period. 28

Formulaic AccrualFormulaic accrual prorates forward over the stub period

the corporations share of a partnerships net income froma business or property and net taxable capital gains for thepartnerships scal periods that fall within the corporationstaxation year. 29 Consistent with the scheme of the Act, incomputing formulaic accrual, allowable capital losses aredeductible only against taxable capital gains. 30 Formulaicaccrual excludes deductible dividends to prohibit a doublededuction by the corporation for the portion of ASPAattributable to dividends. 31

Formulaic accrual reduces but does not eliminate deferralof partnership income. If partnership income rises fromyear to year, ASPA underestimates the actual income of thepartnership for the stub period. ASPA permits the corporationto defer some partnership income for the stub period until thefollowing year.

Designation of QREA partnership is not permitted to deduct resource expenses; 32 instead, such expenses incurred by the partnership areallocated to the partners at the end of each scal period. Thepartners then add those resource expenses to their resourceaccounts. 33 A partner may claim a deduction in respect of aresource account in computing its income for a taxation year.

Formulaic accrual does not take into account a corporatepartners deductions in respect of its resource accounts thatrelate to resource expenses incurred by the part-nershipin the stub period. 34 The omission leads to overaccrual bythe corporation of partnership income for the stub period.Therefore, as a relieving measure, the cor-poration maydesignate QRE 35 in its return for a taxation year to reduce itsASPA.36

25 ASPA is computed differently on a multi-tier alignment. A multi-tier alignment (as dened in subsection 34.2(1)) occurs on an actual ordeemed multi-tier alignment election to match the scal periods of partnerships in a tiered partnership structure. ASPA under a multi-tieralignment is a special case that applies only for the rst taxation year of the corporation in which the alignment occurs.

26 The expression [( A B ) C / D ] in the formula in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).27 The description of E in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).28 The description of F in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).29 More than one scal period of a partnership may fall within the corporations taxation year as a result of a 53-week taxation year of the

corporation pursuant to paragraph 249.1(1)(a) or a single-tier alignment election: see Canada, Department of Finance, Explanatory NotesRelating to the Income Tax Act and Related Regulations (Ottawa: Department of Finance, October 2011), at the description of A in paragraph(a) of the denition of adjusted stub period accrual in subsection 34.2(1).

30 The description of B in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).31 Dividends are deductible by a corporation but not by a partnership. If ASPA included deductible dividends, paragraph 34.2(5)(a) would deem

that portion of ASPA to be a dividend. The corporation could deduct under section 112 or 113 such portion of ASPA as a dividend in the yearand deduct under subsection 34.2(4) the same amount as the prior years ASPA in the following year.

32 Paragraph 96(1)(d).33 Resource accounts consist of cumulative Canadian exploration expenses (CCEE) as dened in subsection 66.1(6), cumulative Canadian

development expenses (CCDE) as dened in subsection 66.2(5), adjusted cumulative foreign resource expenses in respect of a country(ACFRE) as dened in subsection 66.21(1), and cumulative Canadian oil and gas property expenses (CCOGPE) as dened in subsection66.4(5).

34 A corporation may deduct up to 100 percent in respect of its CCEE account under subsection 66.1(2); 30 percent and 10 percent annually ona declining balance basis in respect of its CCDE and CCOGPE accounts, respectively, under subsections 66.2(2) and 66.4(2); and 10 percentannually on a declining basis in respect of an ACFRE account in respect of a country and an additional 20 percent annually on a decliningbalance basis against income from the resource property in that country under subsection 66.21(4).

35 Subsection 34.2(1) denes qualied resource expenses as Canadian exploration expenses (CEE), Canadian development expenses (CDE),foreign resource expenses (FRE), and Canadian oil and gas property expenses (COGPE) incurred by the partnership in the stub period.

36 The description of E in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).



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QRE consist of resource expenses incurred by the partnershipin a stub period. A corporation may designate QRE only if thecorporation obtains from the partnership information in writingidentifying the QRE within six months after the end of thecorporations taxation year. 37 The corporations share of suchidentied QRE is based on its share of resource expenses ofthe partnership for the partnerships last scal period that fallswithin the corporations taxation year, because the QRE aredetermined as if they had been incurred by the partnership inits last scal period that ended in the corporations taxationyear. 38 The corporations share of the actual resource expensesincurred by the partnership in the stub period is not relevant indetermining the corporations QRE.

The corporations designation of QRE cannot exceed themaximum amount of the QRE identied by the partnership that

would be deductible in computing the corporations income forthe taxation year determined as if 39

the only resource expenses of the corporation for thetaxation year were those identied by the partnership;

the partnerships scal period that includes the stub periodwere to end co-incidentally with the corporations taxationyear; and

the corporations share of QRE incurred by the partnership inthe stub period were deemed 40 to have been incurred by thecorporation.

The designation of QRE does not affect the computation ofthe corporations resource expense accounts. Similarly, thecomputation of the corporations resource expenses does notaffect the designation of QRE.

Proceeds from the disposition of resource properties realizedby the partnership in the stub period do not reduce QRE eligiblefor designation. The proceeds of disposition are not incomeof the partnership but rather reduce the resource accountsof its corporate partners when allocated to them at the end

of the partnerships scal period. 41 A corporation may deferpartnership income for a stub period through a designationof QRE to reduce ASPA notwithstanding that the proceedsfrom the dis-position of resource properties realized by thepartnership in the stub period reduce or eliminate the netamount added to the resource accounts as a result of thepartnership incurring QRE in the stub period. 42

Example 1 illustrates the application of these rules.

Example 1Corporation A has a signicant interest in partnership B.Corporation As taxation year-end is November 30. Partnership Bhas a scal period ending January 31.

As of November 30, corporation A has CCEE, CCDE, andCCOGPE accounts of $100, $500, and $2,000, respectively.

Partnership B identies as corporation As QRE for the stubperiod CEE of $10, CDE of $30, and COGPE of $150 inrespect of corporation A as of November 30. The designationof QRE that corporation A may claim is determined as if itsCCEE, CCDE, and CCOGPE accounts were $10, $30, and$150, respectively, so that the maximum designation is $34,consisting of deductions of $10, $9, and $15 in respect of itsnotional CCEE, CCDE, and CCOGPE accounts.

The maximum deduction that corporation A may claim at theend of its taxation year in respect of its resource expense is$450, consisting of deductions of $100 (100 percent), $150(30 percent), and $200 (10 percent) in respect of its CCEE,

CCDE, and CCOGPE accounts actually existing at the end ofthat taxation year.

Designation for the Stub PeriodThe corporation may make a designation for the stub period inits return to reduce ASPA to an amount not less than nil. 43 Thecorporation may wish to do so if formulaic accrual would resultin overaccrual of partnership income for a stub period.

37 Paragraph 34.2(6)(a), the denition of ling-due date in subsection 248(1), and paragraph 150(1)(a).38 Subparagraphs 34.2(6)(a)(i) through (iv).39 Paragraph 34.2(6)(b).40 Subsection 66(18).41 A corporation must include the proceeds of disposition in income for a taxation year i f they produce a negative CCDE account or negative

cumulative foreign resource expense (CFRE) account. See subsections 66.2(1) and 66.21(3).42 Shreeram and Jolly, supra note 9.43 The description of F in paragraph (a) of the denition of adjusted stub period accrual in subsection 34.2(1).



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If a corporation makes a designation for a stub period, theresulting ASPA of a qualifying partnership 44 is tested againsta benchmark in a subsequent taxation year of the corporationto verify that the corporation adequately accrued partnershipincome for the stub period. 45 The concept of a qualifyingpartnership identies all of the partnerships subject to thenew regime whose scal periods end in the corporationssubsequent taxation year in order to x the timing ofverication. Verication normally occurs in the corporationstaxation year that follows the year of the designation, butcould occur in a subsequent year if short taxation years of thecorporation intervene before the end of the partnerships scalperiod that contains the stub period. 46

The benchmark is the lesser of formulaic accrual (less anydesignation of qualied resource expenses) and actual stub

period accrual. 47 Actual stub period accrual recalculates theASPA without reference to the designation for the stub periodto produce a positive or negative amount based on actualpartnership income for the partnerships scal period thatcontains the stub period. Actual stub period accrual is not purelya partnership-by-partnership computation. In computing actualstub period accrual, allowable capital losses of a qualifyingpartnership are deductible to the extent of the differencebetween the total of all taxable capital gains of all otherqualifying partnerships and all allowable capital losses of allother qualifying partnerships. 48

If the benchmark exceeds ASPA, the difference represents

the corporations under-accrued partnership income for thestub period of a qualifying partnership. 49 The corporation mustinclude in income the underaccrued partnership income for the

taxation year in which verication occurs. 50 The corporation alsomay be required to include in income for the year an interestcharge to compensate the government for the deferral ofincome, as discussed below. 51

Interest Charge for Underaccrued Partnership IncomeThe interest charge consists of regular and penaltycomponents.

The regular component consists of the total of a corporationsincome shortfall adjustment 52 for each qualifying partnershipfor a taxation year. 53 An income shortfall adjustment is a positiveor negative amount that represents interest on underaccrued oroveraccrued partnership income for a stub period of a qualifyingpartnership. The income shortfall adjustment is computed atthe average prescribed rate applicable to underpayments oftax 54 for the period from the end of the corporations taxationyear in which the corporation made the designation for the stubperiod to the end of the corporations taxation year in which thecorporation included the underaccrued partnership income incomputing its income.

The penalty component of the interest charge applies ifunderaccrued partnership income for the stub period exceeds25 percent of the benchmark. More specically, the penaltycomponent applies if the total of income shortfall adjustmentsfor all qualifying partnerships exceeds 25 percent of theamount that would be the income shortfall adjustments if noASPA were included in income for the prior year. The amount ofthe penalty component of the interest charge is 50 percent ofthe excess. 55

44 Subsection 34.3(1) denes a qualifying partnership as a partnership whose scal period began in a preceding taxation year of thecorporation and ends in the particular t axation year of the corporation, and in respect of which the corporation was required to calculate ASPAfor the preceding taxation year.

45 Paragraph 34.3(2)(a).46 Paragraph 34.3(2)(b) provides that, where the corporation has QTI (qualifying transitional income), verication does not occur in the

corporations rst t axation year to which subsection 34.2(17) applies. Verication is not necessary in that year because the corporation did notdefer partnership income under the designation for the stub period. While the designation reduced ASPA, the designated amount would havebeen deductible by the corporation under the reserve for QTI. Under subsection 34.2(17), the ASPA included in QTI is recalculated in the yearwithout reference to the corporations designation for the stub period.

47 Dened in subsection 34.3(1).48 The description of B in the denition of actual stub period accrual in subsection 34.3(1).49 Conversely, if ASPA exceeds the benchmark, the difference represents the corporations overaccrued partnership income for the stub period

of a qualifying partnership.50 The partnerships income for the scal period that contains the stub period is allocated to the corporation by the partnership under subsection

96(1), and the corporation may deduct under subsection 34.2(4) ASPA in respect of the partnership for the stub period that was previouslyincluded in income for a prior t axation year.

51 Subsection 34.3(3).52 Dened in subsection 34.3(1).53 Element A of the formula in subsection 34.3(3).54 Regulation 4301(a).55 The expression 0.50 ( A B ) in the formula in subsection 34.3(3).



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The corporation aggregates income shortfall adjustments ofqualifying partnerships. The interest charge does not applyin the event of a full offset of underaccrued and overaccruedpartnership income for the stub period of all qualifyingpartnerships.

Prohibition of Amendment or Revocation of DesignationsA corporation cannot amend or revoke a designation ofQRE or a designation for the stub period. 56 Otherwise, acorporation might, for example, alter a designation for thestub period with the benet of hindsight to avoid an interestcharge for underaccrued partnership income. The prohibitionhas signicant consequences because the minister cannotwaive or cancel an income inclusion under the taxpayer reliefprovisions. 57

Special Rule for a New Corporate Partner of a PartnershipA corporation may acquire a signicant interest in a partnershipafter the last scal period of the partnership that falls withinthe corporations taxation year. In these circumstances, ASPAfor the partnership would be nil, since no scal period ofthe partnership would fall within the corporations taxationyear. However, the corporation may include in income for thetaxation year of acquisition a designated amount of partnershipincome if 58

the corporation acquires a partnership interest during a scalperiod of the partnership (the particular period);

the particular period spans the end of the corporations

taxation year in which the corporation acquired thepartnership interest; the particular period ends within six months after the end of

the corporations taxation year; 59 and

at the end of the particular period, the corporation hasa signicant interest in the partnership as dened insubsection 34.2(1).

The corporation apportions partnership income for a particularperiod in the taxation year in which the corporation acquiredthe partnership interest by making a designation in its returnfor the year in any amount up to a maximum determined byformula. 60 The maximum amount is determined by proratingbackward over the stub period the corporations share of theactual income of the partnership from all sources (other thandeductible dividends) for the particular period.

A corporation may wish to apportion partnership incomefor a particular period in a taxation year in order to usenon-capital losses that would otherwise expire. Alternatively,a corporation may decline apportionment in order to deferpartnership income for the particular period without risk ofinterest on underaccrued partnership income in a subsequenttaxation year. 61

Deduction of ASPA and Apportioned IncomeSubsection 96(1) requires a corporation to include in incomefor a taxation year its share of partnership income for a scalperiod of the partnership that ends in that taxation year. Toavoid double taxation on an earlier accrual of such partnershipincome, a corporation may deduct for a taxation year ASPA orapportioned income, as the case may be, included in incomefor its prior taxation year. 62

Alignment ElectionsTo relieve the accrual obligation, the corporate members ofa partnership may elect to change the scal period of thepartnership to coincide with the taxation year of one or more

56 Subsection 34.2(10).57 Subsection 220(3.1).58 Subsection 34.2(3).59 The denition of ling-due date in subsection 248(1) and paragraph 150(1)(a).60 The formula A B / C in paragraph 34.2(3)(b).61 The 1995 amendments contain a parallel rule in subsection 34.1(2). The progressive rate structure for individuals provides an incentive for

an individual to apportion business income between calendar t axation years straddled by an off-calendar scal period of the business. If theindividual includes all of the income for the scal period of the business in the second calendar taxation year, a higher marginal tax rate mayapply to the business income. The same incentive does not arise in the corporate context because corporate tax rates are at.

62 Subsection 34.2(4).



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of its corporate partners. Separate rules apply depending onwhether the partnership structure is single-tier or multi-tier. 63 If corporate partners have different taxation years, the electionwill be available to align the partnerships scal period to thetaxation year of only one of the corporations. 64

Single-Tier Alignment ElectionA single-tier alignment election enables the corporatemembers of a partnership in a single-tier structure to elect tochange the scal period of the partnership where at least oneof those members has a signicant interest in the partnership.Certain substantive and procedural elements must be met tomake the election. The elements are restrictive.

Subsection 249.1(8) contains the substantive elements. Sincean election may result in income included in QTI eligible for thereserve, the substantive elements serve to restrict access to,and income that qualies for, such transitional relief.

Subsection 249.1(10) contains the procedural elements. Theprocedural elements prescribe the method to be used to makean election and serve to ensure that all corporate partners arebound thereby. Among other things, the election must be ledin prescribed form on or before the earliest ling-due date of anycorporate partner for its rst taxation year ending after March22, 2011. 65 Further, the election must be made by a corporationwith authority to act for the members of the partnership, 66 and no other election may have been led that species acontradictory date for the partnerships scal period. 67

Multi-Tier Alignment ElectionIf a corporation owns a signicant interest in a partnershipin a multi-tier partnership structure, each partnership in thestructure must adopt a calendar scal period unless a multi-tier alignment election is made to adopt an off-calendar scal

period for all of the partnerships. 68 The obligation arises even ifthe nexus between the partnerships is negligible. An election isavailable if the substantive elements in subsection 249.1(9) andthe procedural elements in subsection 249.1(10) are met.

If a multi-tier alignment election is not made to adopt anoff-calendar scal period for all of the partnerships in a multi-tier partnership structure, subsection 249.1(11) deems themembers of each of the partnerships to have made a multi-tieralignment election to end the scal period of the partnershipon December 31, 2011. The deemed election causes incomeallocated to a corporation by a partnership by reason of thepartnerships forced adoption of a calendar scal period toqualify as QTI eligible for the transitional reserve. Financehas stated that GAAR could apply where it is reasonable toconclude that the primary reason for a multi-tier partnership

structure created after March 22, 2011 is to produce QTIarticially under the deemed election. 69

Transitional ReserveComputation of QTIA corporation may deduct a reserve for QTI to providerelief from additional tax payable on the inaugural accrualof partnership income for the stub period and partnershipincome allocated to the corporation on an alignment election. 70 The corporation must include in income for a taxation yearthe reserve deducted by the corporation for its immediatelypreceding taxation year. 71

QTI arises only if a corporation is a member of a partnershipon March 22, 2011. 72 A corporation that joins an existingpartnership after March 22, 2011, or forms a new partnershipafter March 22, 2011, will not have QTI. QTI is computeddifferently depending on whether the partnership structure issingle-tier or multi-tier. 73

63 Subsections 249.1(8) and (9), respectively.64 If the requirements for an election cannot be met, a corporation or a partnership may apply to the minister under subsection 249.1(7) for leave

to change the scal period of the corporation or the partnership, respectively. The minister may grant leave if sound business reasons otherthan obtaining tax benets prompted the request: see Interpretation Bulletin IT-179R (Archived), Change of Fiscal Period, May 28, 1993.Alignment of a scal period of a partnership with a t axation year of a corporation ought to be a sound business reason unless manipulationof the computation of QTI eligible for the transitional reserve prompted the request. Alignment with leave does not produce QTI because EAIincluded in QTI consists of partnership income allocated to the corporation by the partnership by reason of an alignment election only: see thedenitions of eligible alignment income, single-tier alignment, and multi- tier alignment in subsection 34.2(1).

65 Paragraph 249.1(10)(a).66 Paragraph 249.1(10)(c).67 Paragraph 249.1(10)(d).68 Paragraph 249.1(1)(c) and subsections 249.1(9) and (10).69 Explanatory Notes , supra note 29, at subsection 34.2(13).70 Subsection 34.2(11).71 Subsection 34.2(12).72 Preamble of the denition of qualifying transitional income in subsection 34.2(1).73 See the denitions of qualifying transitional income, eligible alignment income, and adjusted stub period accrual in subsection 34.2(1).



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Computation of QTI for a Single-Tier Partnership For a single-tier partnership, QTI includes ASPA for thecorporations rst taxation year ending after March 22, 2011 74 and EAI (eligible alignment income) that arises on a single-tieralignment election. 75 Partnership income for a particular periodapportioned by the corporation for a taxation year under the specialrule that applies to new corporate partners does not qualify.

1.EAI Included in QTI on a Single-Tier Alignment On a single-tier alignment election, EAI may arise if there isan eligible scal period of the partnership that ends in thecorporations taxation year and the corporation is a memberof the partnership at the end of the eligible scal period. Aneligible scal period is the rst aligned scal period of thepartnership that ends in the rst taxation year of the corporationending after March 22, 2011. 76 The undened phrase aligned

scal period refers to the rst scal period of the partnershipthat aligns with the taxation year of a corporate partner underthe election. 77

If the eligible scal period is the partnerships rst scal periodthat ends in the corporations rst taxation year ending afterMarch 22, 2011, EAI is nil. 78 QTI excludes such partnershipincome because without the election, the corporation wouldhave been required to include the amount in income for itstaxation year. 79

If, however, the eligible scal period follows another scalperiod of the partnership that ends in the corporations rsttaxation year that ends after March 22, 2011, and the corporationis a member of the partnership at the end of the eligible scalperiod, EAI arises in recognition that the corporation mustinclude in income additional partnership income as a result

of the election. EAI includes the corporations share of thepartnerships income (other than deductible dividends) andtaxable capital gains. 80 Deducted from this amount is thecorporations share of the partnerships losses and allowablecapital lossesbut only to the extent of such taxablecapital gains 81for the eligible scal period. EAI excludesdeductible dividends so that the corporation does not deferthe partnerships dividend income as a reserve for QTI whilededucting the dividends immediately in the year of allocation. 82

EAI is computed on the basis that the corporation deductsunder any of sections 66.1, 66.2, 66.21, and 66.4 the maximumamount in respect of resource expenses of the partnershipincurred in the stub period that would be allocated to thepartner if the scal period of the partnership ended at the timeof the alignment election. 83 This limitation on EAI included

in QTI deters an election in the resource sector, since acorporation will prefer to compute QTI on the basis of ASPAwithout a designation of QRE. 84 The reason is that ASPAincluded in QTI is not reduced in a similar fashion unless thecorporation designates QRE. In computing ASPA included inQTI, the corporation ought to forgo a designation of QRE.

Computation of QTI for a Partnership in a Multi-TierStructure On a multi-tier alignment, QTI includes the corporations ASPAin respect of the part-nership for the corporations taxation yearthat contains the multi-tier alignment 85 and EAI that arises on anactual or deemed multi-tier alignment election. 86 QTI includes

ASPA for the year of a multi-tier alignment (rather than thecorporations rst taxation year ending after March 22, 2011, ason a single-tier alignment) because a multi-tier alignment could

74 Subparagraph (b)(ii) of the denition of qualifying transitional income in subsection 34.2(1).75 Paragraph (a) of the denition of qualifying transitional income in subsection 34.2(1).76 Paragraph (a) of the denition of eligible alignment income in subsection 34.2(1).77 Explanatory Notes , supra note 29, at the denition of eligible alignment income in subsection 34.2(1).78 Subparagraph (a)(ii) of the denition of eligible alignment income in subsection 34.2(1).

79 Subsection 96(1); and Explanatory Notes, supra note 29, at subparagraph (a)(ii) of the denition of eligible alignment income insubsection 34.2(1).

80 The description of element A of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1).81 The description of element B of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1).82 The same reasoning explains why ASPA included in QTI excludes deductible dividends.83 The description of element C of the formula in subparagraph (a)(i) of the denition of eligible alignment income in subsection 34.2(1). This

is consistent with the rules that govern the computation of QTI under subsection 34.2(15). A corporation must compute QTI on the basis thatthe partnership deducts the maximum amount of any expense, reserve, allowance, or other amount and has elected to include in income anyamount of work in progress. The computation of EAI on this basis puts the corporation in the same position as it would be if the partnershipwere able to claim resource deductions and claimed the maximum amount in respect thereof.

84 Shreeram and Jolly, supra note 9.85 Subparagraph (b)(i) of the denition of qualifying transitional income in subsection 34.2(1).86 Paragraph (a) of the denition of qualifying transitional income in subsection 34.2(1).



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occur in the corporations rst or a subsequent taxation yearending after March 22, 2011. 87

1.ASPA Included in QTI on a Multi-Tier Alignment There are two formulas for computing ASPA under a multi-tieralignment. Which formula applies depends on whether a scalperiod of the partnership ends in the corporations taxationyear before or after an eligible scal period. An eligible scalperiod arises if a scal period of the partnership ends in thecorporations taxation year and such year is the rst taxationyear in which the scal period of the partnership is aligned withthe scal period of one or more other partnerships under amulti-tier alignment. 88

If a scal period of the partnership ends in the taxation year ofthe corporation before the eligible scal period, the partnershiphas two scal periods that end in the year. In that case, ASPAis the difference between formulaic accrual (computed onthe basis of the corporations share of partnership incomefor the rst scal period of the partnership that ends inthe corporations taxation year only, without reference tothe partnerships eligible scal period) and the total of thecorporations designation of QRE and its designation for thestub period. 89

If the eligible scal period is the partnerships rst scal periodthat ends in the corporations taxation year, the partnership hasonly a single scal period that ends in the year. In that case,ASPA is the difference between formulaic accrual (computedon the basis of the corporations share of partnership incomefor the eligible scal period less EAI for the eligible scal period)and the total of EAI for the eligible scal period, the corporationsdesignation for QRE, and its designation for the stub period.ASPA excludes the proration over the stub period of EAI for theeligible scal period to avoid double-counting of QTI. 90

A corporation is not required to include in income ASPAthat arises in a taxation year before the year of a multi-tieralignment. 91 This coordinates the accrual of ASPA and thereserve for QTI on a multi-tier alignment, since QTI wouldnot include ASPA for a taxation year that preceded the year ofalignment. 92

2. EAI Included in QTI on a Multi-Tier Alignment On a multi-tier alignment, EAI arises if an eligible scal periodof the partnership ends in the taxation year of the corporationand the corporation is a member of the partnership at the endof the eligible scal period. 93 An eligible scal period is therst aligned scal period of the partnerships in the multi-tierstructure.

EAI represents the corporations direct or indirect share ofincome or loss of each of the partnerships in a multi-tierstructure that is allocated to the corporation by the partnershipas a result of the alignment. The corporation computes EAIin the same way for a multi-tier alignment as for a single-tieralignment, except that EAI specically excludes any amountthat would have been included in the corporations income forthe year without the multi-tier alignment. 94

Example 2 illustrates the application of these rules.

Example 2 C is a corporation with a calendar taxation year. P 1 is apartnership with a January 31 scal period. P 2 is a partnershipwith a February 28 scal period. C owns a signicant interest inP 1. P 1 owns an interest in P 2. A multi-tier alignment electionis deemed by subsection 249.1(11) to have been made to endthe scal periods of P 1 and P 2 on December 31, 2011.

C has EAI in respect of P 1 because there is a multi-tier alignment of the scal periods of P 1

and P 2 on December 31, 2011 under a deemed multi-tieralignment election;

P 1s December 31, 2011 scal period is an eligible scalperiod that ends in Cs calendar taxation year; and

C is a member of P 1 at the end of the eligible scal period.

EAI in respect of P 1 equals Cs share of P 1s income for theeligible scal period. This amount includes Cs indirect share ofP 2s income for its February 28, 2011 and December 31, 2011scal periods.

87 Explanatory Notes , supra note 29, at the denition of qualifying transitional income in subsection 34.2(1).88 Paragraph (b) of the denition of adjusted stub period accrual in subsection 34.2(1).89 The formula [( A B ) C / D ] (E + F ) in subparagraph (b)(i) of the denition of adjusted stub period accrual in subsection 34.2(1).90 On a multi-tier alignment, QTI includes both ASPA for the corporations taxation year that contains the multi-tier alignment and EAI for the

eligible scal period. Including EAI in ASPA would double-count EAI included in QTI.91 Subsection 34.2(9).92 Subparagraph (b)(i) of the denition of qualifying transitional income in subsection 34.2(1).93 Paragraph (b) of the denition of eligible alignment income in subsection 34.2(1).94 Subparagraph (ii) of the description of element A of the formula in paragraph (b) of the denition of eligible alignment income in

subsection 34.2(1).



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Partnership Income ComputationA corporation computes the income of a partnership for ascal period for the purposes of determining its ASPA or EAIincluded in QTI on the basis that the partnership has deductedthe maximum amount of any expense, reserve, allowance,or other amount and elected not to include in income anyamount for work in progress. 95 These rules seek to ensure thata corporation cannot manipulate the computation of QTI tomaximize the amount eligible for deferral under the reserve.

The 1995 amendments contained a parallel provision that didnot require an individual to deduct the maximum amount of anyexpense in computing income from a business eligible fortransitional relief. 96 The individual could augment the reservededuction if the business deferred or avoided deductibleexpenses. The different rule under paragraph 34.2(15)(a) of the

2011 amendments aims to address that mischief.True-Up of QTIIf QTI includes ASPA, QTI merely approximates partnershipincome for the stub period. After the stub period, QTI adjusts upor down as ASPA is recalculated based on the corporations shareof the actual partnership income for the stub period but withoutreference to a designation for the stub period. 97 The recalculationof ASPA takes into account a designation of QRE, so such adesignation permanently reduces ASPA included in QTI.

ASPA included in QTI adjusts if the corporations share ofpartnership income changes, if formulaic accrual differs fromactual partnership income prorated backward over the stubperiod, or if the corporation has made a designation for thestub period. If QTI includes EAI only, QTI does not adjust sinceEAI constitutes actual partnership income for the eligible scalperiod and not a mere estimate.

Normally, QTI adjusts in the corporations taxation yearimmediately following the taxation year in which QTI rst arose.QTI may adjust in a subsequent year if short taxation years ofthe corporation intervene before the end of the partnershipsscal period that contains the stub period. 98

Deduction of Reserve for QTIA corporation may deduct for a taxation year a reserve for QTI inany amount up to the least of the following amounts: the specied percentage for the year of QTI; 99

if a reserve was deductible in the prior year, the total of the prioryears reserve deduction included in income for the year andthe amount of any increase to QTI in the year under a true-upof QTI (the prior year reserve limit); 100 and n the corporationsincome for the taxation year computed before the deductionof the reserve for QTI and of an offset or a reserve for incomeattributable to debt forgiveness 101 (the income limit). 102

Specied Percentage for the Year of QTIIf QTI arises in 2011, the corporation may deduct a reserve of

100 percent of QTI for 2011, 85 percent for 2012, 65 percentfor 2013, 45 percent for 2014, and 25 percent for 2015. 103 If QTIarises in 2012 or 2013, the specied percentage of QTI adjuststo permit the corporation to deduct a reserve of 100 percentof QTI in 2012 or 85 percent of QTI in 2013, as the case maybe, and the specied percentages for each subsequent yearadjust accordingly. 104 The specied percentage of QTI for eachcalendar year applies to all of the corporations taxation yearsthat end in that calendar year. 105

Prior-Year Reserve LimitUnder the prior-year reserve limit, if a reserve for QTI wasdeductible by a corporation in the immediately preceding

taxation year, the corporation may deduct a reserve for QTI in ataxation year to the extent of the total of the prior years reserveadded back into income for the year and any increase to QTI inthe year under the true-up of QTI. If QTI increases under thetrue-up, the prior-year reserve limit increases by that amountonly in the particular taxation year in which QTI adjusts. 106

Income LimitThe income limit restricts the reserve for QTI to the corporationsincome for the taxation year from all sources computed before

95

Subsection 34.2(15).96 Former paragraph 34.2(2)(c).97 Subsection 34.2(17).98 Subsection 34.2(16).99 Paragraph 34.2(11)(a).100 Paragraph 34.2(11)(b).101 Sections 61.3 and 61.4.102 Paragraph 34.2(11)(c).103 Paragraph (a) of the denition of specied percentage in subsection 34.2(1).104 Paragraphs (b) and (c) of the denition of specied percentage in subsection 34.2(1).105 Explanatory Notes , supra note 29, at subsection 34.2(11).106 Subparagraph 34.2(11)(b)(ii); and Explanatory Notes , supra note 29, at example 2 after section 34.2.



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deduction of the reserve for QTI and an offset or a reserve forincome attributable to debt forgiveness. The corporation cannotdeduct a reserve for QTI to create a loss for a taxation year.

The income limit refers to income, not taxable income.Deductions in computing taxable income, such as losscarryovers and dividends, do not reduce the income limit.

If the income limit applies to restrict the reserve for QTI in ataxation year, the prior-year reserve limit generally applies tolimit the reserve for QTI in the following year (and thereafterthroughout the transitional period). 107 The corporation does notface a cash ow constraint from additional tax payable that isattributable to the transition to the new regime if a loss absorbsQTI, so the corporations reserve is restricted by the incomelimit accordingly.

Reserve Denial RulesA corporation is not entitled to deduct a reserve for QTI in ataxation year if the corporation has not been a member of the partnership

continuously since before March 22, 2011 until the end ofthat taxation year; 108

at the end of the year or at any time in the following taxationyear, the corporations income is exempt from tax, or thecorporation is non-resident and the partnership does notcarry on business through a permanent establishment inCanada; 109 or

the corporations taxation year ends immediately beforeanother taxation year in which the corporation becomesa bankrupt, 110 in which the corporation is dissolved orwound up (other than pursuant to a tax-deferred windupunder subsection 88(1)), 111 or at the beginning of which thepartnership no longer principally carries on the activities towhich the reserve relates. 112

Relieving and Anti-Avoidance ProvisionsA corporation cannot deduct a reserve for QTI for a taxationyear if the corporation disposes of its partnership interest orwinds up on a taxable basis. 113

On a tax-deferred windup under subsection 88(1), paragraph88(1)(e.2) deems the parent to be the same corporation as, anda continuation of, the wound-up subsidiary for the purposes ofsection 34.2. Similarly, on a tax-deferred amalgamation undersubsection 87(1), paragraph 87(2)(j) deems the amalgamatedcorporation to be the same corporation as, and a continuationof, the predecessor corporations for the purposes of section34.2. The parent or amalgamated corporation inherits the QTIof the subsidiary or the predecessor corporations, as the casemay be. The reserve denial rules in paragraph 34.2(13)(a) andsubparagraph 34.2(13)(c)(iii) do not apply in those cases.

Another relieving rule in subsection 34.2(14) deems a corporationto be a member of a partnership at the end of a taxation yearif the corporation has disposed of its partnership interest to arelated or afliated corporation and the same or another related

or afliated corporation owns the partnership interest at the endof the year. The provision facilitates internal reorganizations thatwould otherwise result in forfeiture of the reserve.

An anti-avoidance rule in subsection 34.2(18) disallows thereserve if it is reasonable to conclude that one of the mainreasons for the corporations membership in a partnership in ataxation year is to avoid the application of subsection 34.2(13).The provision targets a corporation that substantially withdrawsfrom a partnership but retains a nominal partnership interest, notfor a commercial purpose, but instead to qualify for the reserve.

Adjusted Cost Base AdjustmentsNeither ASPA nor apportioned income included in income fora corporations taxation year increases the adjusted cost baseto a corporation of a partnership interest. If the corporationsells the partnership interest in the following taxationyear before the end of the partnerships scal period, thecorporation may realize a gain on the disposition attributablein part to partnership income for the stub period previouslyaccrued. Double taxation will not arise, however, because thecorporation may deduct in the year of disposition such prioryears ASPA or apportioned income, as the case may be.

107 Explanatory Notes , supra note 29, at subsection 34.2(11).108 Paragraph 34.2(13)(a).109 Paragraph 34.2(13)(b).110 Subparagraph 34.2(13)(c)(ii). As dened in subsection 248(1), bankrupt means a person who has made an assignment or against whom a

bankruptcy order has been made, or the legal status of that person: Bankruptcy and Insolvency Act, RSC 1985, c. B-3, as amended, section 2.111 Subparagraph 34.2(13)(c)(iii).112 Subparagraph 34.2(13)(c)(i).113 Paragraph 34.2(13)(a) and subparagraph 34.2(13)(c)(iii).



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EAI constitutes actual income of the partnership for acompleted scal period. EAI increases the adjusted cost base toa corporation of a partnership interest; 114 however, a corporationmay deduct a reserve for QTI that includes EAI. On a dispositionby the corporation of the partnership interest, the corporationwill not be subject to double taxation on the portion of anygain attributable to EAI. Therefore, the adjusted cost base of apartnership interest to a passive corporate partner is reduced tothe amount that would have prevailed without the EAI. 115

Character of ASPA, Partitioned Income, and Reserve for QTIASPA, partitioned income, and QTI include all sources ofpartnership income. Sourcing rules in subsection 34.2(5)deem the accrual and the reserve to have the same characteras the partnership income from which they derive so thatthe appropriate corporate tax rate applies to the amount.

Partitioned income and the reserve for QTI are deemed to beincome and taxable capital gains with the same character andin the same proportions as any income and taxable capital gainsmaking up the constituent elements of the partnership incomethat is allocated to the corporation and used to compute theparticular amount.

Example 3 illustrates the effect of this provision.

Example 3 Under the characterization rule, if a partnership allocates toa corporation $100,000 of partnership income composedof $40,000 of active business income, $30,000 of propertyincome, and $30,000 of taxable capital gains, ASPA will bedeemed to be 40 percent active business income, 30 percentproperty income, and 30 percent taxable capital gains. 116 Thecorporate tax rate applicable to business income (including thesmall business deduction, if applicable) will apply to 40 percentof the ASPA, while the rate applicable to investment income(including refundable taxes, if applicable) will apply to theproperty income and taxable capital gains.

Deemed Allowable Capital LossSubsection 34.2(4) permits a corporation to deduct in ataxation year ASPA or partitioned income, as the case may be,previously included in income in the immediately precedingtaxation year. If a portion of the deduction derives from

amounts deemed by the characterization rule to be a taxable

capital gain, that portion is deductible only against taxablecapital gains of the corporation. If the corporation does not havesufcient actual taxable capital gains, or ASPA or added-backQTI that is deemed by paragraph 34.2(5)(a) to be taxable capitalgains, in the year to absorb that portion of the deduction, theexcess is deemed to be an allowable capital loss for the year. 117 The deemed allowable capital loss prohibits the deduction of anoveraccrued taxable capital gain against ordinary income.

The deemed allowable capital loss is equal to the differencebetween 118

1. the portion of the deduction of ASPA or partitioned income,as the case may be, that is deemed by paragraph 34.2(5)(a)to be a taxable capital gain; and

the difference between

2. the total of

a. taxable capital gains allocated to the corporation by thepartnership for the taxation year; and

b. accrued taxable capital gains for the current stub period(namely, the portion of ASPA and the add-back of QTI that isdeemed by paragraph 34.2(5)(a) to be a taxable capital gain);

and

3. allowable capital losses allocated to the corporation by thepartnership for the taxation year that contains the stub periodto the extent of the taxable capital gains included in the

computation of the deemed allowable capital loss.Accrued taxable capital gains for the current stub period reducethe deemed allowable capital loss because the deduction of theprior years accrued taxable capital gains applies against themrst. Allowable capital losses are deductible only to the extentof actual and accrued taxable capital gains included in thecomputation so that actual allowable capital losses allocatedto the corporation by the partnership are not duplicated in thedeemed allowable capital loss calculated under the formula setout above.

ExceptionsThree situations are specically excluded from the application

of the new regime.

114 Subparagraph 53(1)(e)(i).115 Subparagraph 53(2)(c)(i.4).116 The example is t aken from the Explanatory Notes , supra note 29, at subsection 34.2(5).117 Paragraph 34.2(5)(b).118 The formula A (B C ) in paragraph 34.2(5)(b).



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First, the accrual of ASPA and partitioned income does notapply in a taxation year in which the corporation becomesbankrupt. 119 The accrual applies for all taxation years of thecorporation that follow the year of bankruptcy. 120

Second, the regime does not apply in computing foreignaccrual property income (FAPI) in respect of a corporation. 121 The exception avoids technical problems that would otherwisearise in computing FAPI. 122 The exception does not extendto a Canadian-resident corporation that owns a partnershipthat in turn owns a foreign afliate that earns FAPI. 123 Thislimitation forecloses deferral of FAPI by a Canadian-residentcorporation through a transfer of shares of a foreign afliate to apartnership.

Third, the regime does not apply in computing exempt surplusand taxable surplus of a foreign afliate, except to the extentthat the context otherwise requires. 124 This exception doesnot apply to hybrid surplus, which ought not to arise. 125 Theexception relieves the obligation on a foreign afliate to applythe regime in computing surplus where the afliate does notdefer partnership income subject to Canadian tax. The contextmay require the afliate to compute surplus differently if thesurplus is computed by reference to Canadian-source incomeof the afliate affected by the new regime.

Joint VenturesAs an administrative concession, the Canada Revenue Agency(CRA) formerly permitted a joint venture to adopt a scalperiod that could differ from that of its participants. 126 If thejoint ventures scal period ended before the taxation year ofa participant, the participant deferred income from the jointventure until the participants following taxation year. The CRAhas withdrawn its prior administrative position to conform tothe policy of the 2011 amendments. 127

A participant in a joint venture, whether a corporation, a trust,a partnership, or an individual, must include in income fora taxation year its share of income of a joint venture for theportion of the joint ventures scal period that falls within theparticipants taxation year. On an administrative basis, the CRAgrants transitional relief that mimics the reserve for QTI and is

subject to the same conditions. The CRA initially stated that,to claim transitional relief, a participant must elect in writingon or before the ling-due date for its rst taxation year thatends after March 22, 2011. The CRA subsequently extended thedeadline for the election to September 22, 2012. 128

119 Subsection 34.2(7) . See the denit ion of bankrupt, supra note 110.120 The Department of Finance misstated this aspect of the exception in the Explanatory Notes , supra note 29, at subsection 34.2(7).121 Paragraph 34.2(8)(a).122 Paragraph 95(2)(f) requires a foreign afliate to compute FAPI under the provisions of the Act. Absent the exception, if a foreign afliate owned

an interest in a partnership that earned passive property income, the foreign afliate would be required to include in income ASPA that wouldbe deemed by paragraph 34.2(5)(a) to be property income. Although ASPA would be included in FAPI, it would bear no foreign tax, so theafliate would not be able to deduct foreign accrual tax in respect of the inclusion. Thus, the afliate would bear a higher effective Canadiantax rate on accrued FAPI than on actual FAPI. Further, the character of ASPA in a taxation year of the afliate could differ from the characterof the partnership income allocated to the afliate in the following year. This might arise if, for example, the afliate met the investmentbusiness denition in subsection 95(1) in one year but not in the following year. The computation of FAPI would be distorted by the mismatchbetween the character of ASPA and actual partnership income allocated to the corporation by the partnership.

123 Explanatory Notes , supra note 29, at paragraph 34.2(8)(a).124 Paragraph 34.2(8)(b).125 Hybrid surplus arises on a disposition by a foreign afliate of shares of another foreign afliate. The characterization rule in paragraph 34.2(5)(a)

does not deem the afliate to have disposed of property, so hybrid surplus ought not to arise on accrual of partnership income for a stub period.The technical notes apply similar reasoning to conclude that ASPA deemed by paragraph 34.2(5)(a) to be a taxable capital gain, and an allowablecapital loss deemed to arise under paragraph 34.2(5)(b), do not affect a corporations capital dividend account (CDA) because the characterizationrule does not deem a disposition of capital property to have occurred: see Explanatory Notes , supra note 29, at subsection 34.2(5).

126 Revenue Canada Round Table, in Report of Proceedings of the Forty-First Tax Conference , 1989 Conference Report (Toronto: Canadian TaxFoundation, 1990), 45:1-60, question 40, at 45:23-24.

127 CRA document nos. 2011-0403081C6, June 6, 2011, and 2011-0429581E5, November 29, 2011.128 Letter to Ian Pryor of Cadesky and Associates from Gwen Moore of the CRA, Re: Revised Administrative Policy for Participants in Joint

Ventures, dated January 10, 2012.



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ISSUES AND TAX-PLANNING OPPORTUNITIESThere are a number of policy considerations, interpretive

issues, and planning opportunities that arise out of the 2011amendments.

Policy ConsiderationsSignicant Interest ThresholdThe budget stated that the government introduced the 2011amendments in part to address a corporations opportunity todefer income through the use of captive partnerships for littlepurpose other than tax savings. However, the provisions extendbeyond captive partnerships, applying to all corporations thatown a signicant interest in a partnership.

The 10 percent threshold for a signicant interest may havebeen selected by Finance to balance the mischief of deferral

against the cost of compliance. 129 In this regard, mostpartnerships that have partners with an ownership interestbelow the threshold are publicly traded. Publicly tradedpartnerships invariably have individual partners and thusmust have a calendar scal period, 130 which limits deferralopportunities. Private operating partnerships seldom havepartners that do not have a signicant interest as dened insubsection 34.2(1). It is doubtful that the signicant interestthreshold will exempt many corporate partners.

Specied Percentage of QTIBy virtue of the denition of specied percentage of QTI insubsection 34.2(1), transitional relief applies over a ve-year

period. The parallel rule under the 1995 amendments permittedtransitional relief over a 10-year period. Finance has notexplained the policy behind the shorter transition period in thecorporate context. 131 The explanation may lie in the underlyingpolicy of the provisions to raise revenue.

Deadline To Make an Alignment ElectionPrior to nalization of the 2011 amendments, a procedural rulerequired some corporate partners to le an alignment election

under paragraph 249.1(10)(a) as early as September 23, 2011on the basis of proposed legislation without the benet of aprescribed form. Commentators criticized the short deadlineas unnecessarily restrictive. 132 There is no obvious policy oradministrative reason to impose such a short deadline. Itcould be that Finance simply wished to match the languageof the ling deadlines imposed under the 1995 amendmentsgoverning an individuals election of an off-calendar scal periodfor a business. 133

On December 16, 2011, Finance announced an intention tointroduce further legislation to treat late alignment electionsas having been led on time if the election is led on or beforeJanuary 31, 2012. 134 The amendment will provide only limitedrelief.

Multi-Tier Alignment ElectionsEach partnership in a multi-tier partnership structure formedafter March 22, 2012 must align to a calendar scal period,without the ability to make a multi-tier alignment electionto adopt an off-calendar scal period. 135 Commentatorshave criticized a mandatory calendar scal period for eachpartnership in a multi-tier partnership structure on the basis thatcommercial considerations may favour an off-calendar scalperiod, and corporate partners may have off-calendar taxationyears that do not coincide with the partnerships calendar scalperiod. 136

Interpretive IssuesMeaning of CharacterParagraph 34.2(5)(a) deems the inclusion and deduction ofASPA and apportioned income to be income or taxable capitalgains of the same character and in the same proportion as theincome or taxable capital gains that make up the constituentelements of the partnership income that is allocated to thecorporation and used to compute the particular amount. Thedeeming rule serves a function similar to paragraph 96(1)(f).

129 At a meeting between the joint committee and the Department of Finance in the summer of 2011 (supra note 9), the joint committeecriticized the 10 percent threshold as too low. It submitted that accrual ought to apply only if the corporation controls the choice of thepartnerships scal period. In answer to the criticism, Finance responded that accrual is supposed to apply whether or not deferral of incomeachieved by a corporation through the use of a partnership is intentional.

130 Subsection 249.1(1).131 For criticism of the difference, see the submissions of the Tax Executives Institute dated June 21, 2011, supra note 9, at 2-3, and September

16, 2011, ibid., at 2.132 Ibid., the submission of June 21, 2011, at 4, and the submission of September 16, 2011, at 2.133 Subsection 249.1(4).134 Canada, Department of Finance, Minister of Finance Announces Extension of Time To File Corporate Partnership Alignment Elections,

News Release 2011-138, December 16, 2011.135 Paragraph 249.1(1)(c).136 See the joint committee submission, supra note 9, at 17.



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The term character is unusual for Canadian tax purposes.In the few provisions of the Act that refer to the character ofa payment, 137 the term refers to characteristics, source, andpurpose.138 Elsewhere in the Act, the term compositionaccompanies the term character. 139

Character connotes the collective qualities, features, traits, orpeculiarities that distinguish a thing. 140 In the context of theAct, at a minimum, character refers to the source of an amountas income or capital earned or realized in a particular place.Yet character connotes a more general concept than source,so ASPA, partitioned income, and the reserve for QTI ought toacquire all of the traits of the partnership income from whichthey derive.

A number of technical issues result from this deemingprovision.

Capital Dividend Account Finance states that the portion of ASPA deemed by paragraph34.2(5)(a) to be a taxable capital gain does not affect thecorporations capital dividend account (CDA). 141 The reason isthat paragraph 34.2(5)(a) does not deem the corporation tohave disposed of capital property, and so there is no addition toCDA.142 Commentators have questioned the merit of Financestechnical position. 143

The issue is that character connotes a broad concept,including not only the source of income but also every otherquality, feature, trait, or peculiarity that distinguishes income.

The event that gives rise to income may qualify as a quality,feature, trait, or peculiarity that distinguishes the income andthus may form part of its character. Further, if paragraph 34.2(5)(a) creates a legal ction and does not merely declare the law,the consequences and incidents that inevitably and logicallyaccompany the deeming of ASPA as a taxable capital gainought to be deemed to arise as well. 144 As a corollary, the ASPAdeemed to be a taxable capital gain may thus be deemed tohave derived from a disposition of a capital property. Therefore,

paragraph 34.2(5)(a) may imbue ASPA with the disposition ofcapital property, giving rise to an underlying taxable capital gainrealized by the partnership from which the ASPA derives. If so,the ASPA could be included in a corporations CDA.

An alternative interpretation of paragraph 34.2(5)(a), whicharrives at the same conclusion as Finance, is that the deemingrule applies only for the limited purpose of computing theincome of a corporation for a taxation year. The corporationreferred to in that phrase is the corporation subject to section34.2. The computation of CDA does not pertain to thecomputation of the income of that corporation. Although thedenition of capital dividend account 145 and the rules relatingto the payment of capital dividends 146 are both contained indivision B of part I of the Act, which concerns the computationof income, it is the income of the shareholder and not the

income of the corporation that is affected by the payment of acapital dividend. While the corporation is liable to a tax undersubsection 184(2) for the declaration of a capital dividend inexcess of the balance of its CDA, subsection 184(2) does notaffect the computation of the corporations income. Therefore,the deeming rule in paragraph 34.2(5)(a) should not apply forthe purposes of computing the CDA of the corporation.

From a policy perspective, we consider that ASPA should notbe included in a corporations CDA. ASPA is purely notional.While the corporation initially bears tax payable on the ASPA,it recovers the tax in the following year once the ASPA isdeducted. The inclusion of ASPA in the CDA cannot be justied

on that basis.Foreign Tax Credits If ASPA derives from partnership income that consists of, forexample, interest earned in a foreign country, paragraph 34.2(5)(a) should deem ASPA to be interest earned in that foreigncountry. The corporation does not bear foreign tax on ASPA.Thus, the corporation cannot claim a foreign tax credit for ASPAdeemed to be interest earned in the foreign country.

137 Proposed subsection 260(5.1) refers to character in the marginal notes: Canada, Department of Finance, Legislative Proposals To Amendthe Income Tax Act and Related Legislation To Effect Technical Changes and To Provide for Bijural Expression in That Act (Ottawa: Departmentof Finance, July 16, 2010). Proposed paragraph 260(8)(b) also refers to character, as does proposed paragraph 143.4(3)(b) in Canada,Department of Finance, Legislative Proposals Relating to Income Tax (Ottawa: Department of Finance, March 16, 2011).

138 Explanatory Notes , supra note 29, at subsection 260(5.1).139 See proposed paragraph 260(8)(b) in the July 16, 2010 draft legislation, supra note 137.140 See the denition of character in The Concise Oxford English Dictionary , 8th ed.; and Kennedy v. William C. Cavell Enterprises Ltd. (1987),

23 OAC 349 (Div. Ct.), cited in the denition of character in The Dictionary of Canadian Law , 2d ed.141 Explanatory Notes , supra note 29, at paragraphs 34.2(5)(a) and (b).142 Clause (a)(i)(A) in the denition of capital dividend account in subsection 89(1).143 Joint committee submission, supra note 9, at 21.144 East End Dwellings Co. Ltd. v. Finsbury Borough Council , [1952] AC 109, at 132 (HL).145 Subsection 89(1).146 Section 83.



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As a result, the corporation bears a higher effective Canadiantax rate on the accrual than on the actual income. The mismatchbetween the obligation to accrue unearned foreign-sourceincome and the inability to deduct an offsetting foreign taxcredit impinges on cash ows. Commentators have criticizedthis result. 147

Successor Rules The successor rules in section 66.7 permit a corporationthat acquires all or substantially all of the Canadian or foreignresource properties of another person to be treated as asuccessor entitled to resource expenses incurred by theprevious owner of such properties. The rules also apply on anacquisition of control of a corporation to treat the corporation asa successor of itself.

Where the successor rules apply, a successor corporation maydeduct an amount in respect of resource expenses incurredby the previous owner of the resource property. However, thededuction is limited to income from, and proceeds from thedisposition of, the particular res

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