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For tax purposes, a partnership is not considered a taxpayer, but rather an entity that calculates and allocates its taxable income to its partners. The partners then include this allocation in their taxable income in the year containing the fiscal year end of the partnership. For example, if a corporation had a December 31 fiscal year end and it owned an interest in a partnership with a January 31 fiscal year end, it would include the partnership income from January 2011 in its December 2011 year end. This effectively enables an eleven month deferral of the taxes payable compared to if the income had been earned directly by the corporation.
A similar deferral for individuals who carried on business through partnerships was eliminated in 1995; however corporate partnerships were excluded from those rule changes.
The proposed changes apply to a corporate partner for a taxation year if:
The proposed changes will require the corporate partners to accrue an amount as an estimation of the income deferred for the stub period based between the partnership’s year end and the corporation’s year end. The corporation will be required to include this stub period adjustment into the current year’s income and will be entitled to deduct the same amount the following year. Depending on the volatility of the partnerships earnings from year to year, this stub period adjustment can significantly magnify increases or decreases in the partnership’s income.
As part of the rules eliminating the deferrals there is an election available to have the year end of the partnership change to align with one or more of its corporate partners. The timing to make this election is critical for corporations that have year ends ending in March or April 2011 as the election must be filed in writing no later than the last day of the first taxation year ending after Budget day, March 22, 2011. It remains to be seen how the implementation timelines are impacted if the budget does not pass.
The change of the partnerships fiscal year end will potentially result in two partnership fiscal year ends in a single corporate taxation year. There is relief provided for corporations that elect to align the partnership’s year end with a corporate partner’s. Essentially, a reserve will be available to bring the second partnership’s fiscal period income into the corporation’s income over the next 5 years at the rates of 15%, 20%, 20%, 20% and 25% respectively. This reserve will allow the corporate partners a reasonable time frame to bring this partnership income into taxable income and budget for the related cash flows accordingly.
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