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Taxation of Corporate Groups Under Review

14/01/2011


On November 23, 2010 the federal Department of Finance (Finance) issued a consultation paper entitled “The Taxation of Corporate Groups”. Finance is asking for public comments by February 25, 2011.

Currently, Canada does not have a formal system to consolidate the tax reporting of corporate groups or to offset losses against profits of the members of a corporate group. If a company has a profit of $1,000,000 and its subsidiary or sister company has a loss of $1,500,000, then tax will still be payable on $1,000,000. By comparison, over two-thirds of OECD countries have a formal group tax system. Canada’s international competitiveness is affected by our lack of such a system.

Policy issues

Canada’s current system is fairly flexible in allowing taxpayers to shift income between related companies. Examples of techniques available include the transfer of property between related companies to shift income producing activities, amalgamations and wind-ups, inter-corporate financing activities, and reasonable inter-company charges for services provided. However, these measures often involve costly and complex transactions and usually don’t result in the use of losses until after the transactions are completed and (or) until a later fiscal year. In addition, these techniques are often not practical for business or legal reasons.

In designing a new loss utilization system, Finance has stated that the entire corporate system must be examined. For example, in addition to loss utilization, a new system would consider the ability to carry losses over to offset profits of other years or to take certain deductions such as tax depreciation or resource expenditure and Scientific Research and Experimental Development expenditure (SR&ED) pools on a discretionary basis. The objectives are to achieve a fair and efficient system that avoids undue complexity.

A new system of group taxation would also need to consider the effect on both federal and provincial tax revenues. The provinces have expressed concern that the existing system can undermine revenues by transferring losses within corporate groups and across provincial/territorial borders. The effect of a group tax system on individual provinces is unclear. A new system could impact the provincial income allocation formula and federal-provincial arrangements.

Finance has concluded that a group tax model would focus on common ownership and control.

Possible approaches

There is a range of approaches or spectrum of options in designing a group tax system, with a consolidation system at one end and a loss transfer system at the other. A loss transfer system would generally be less complex than a consolidation system.

A consolidation system taxes the members of a corporate group as if they were a single entity. In Australia, the individual group members do not file tax returns. Rather, only the parent company files a return. The system is optional for the parent company, but once elected, is irrevocable and mandatory for all wholly-owned subsidiaries. In the United States, each member files its own federal tax return and then a consolidated return is filed for the group. The system is optional for the parent company, but once elected, is mandatory for all group companies meeting an 80% ownership threshold and is generally irrevocable.

A loss transfer system taxes each group member separately, but allows a member with a loss to transfer part or all of the loss to one or more profitable members of the same group. In Finland, a profitable group company can make a tax deductible cash payment to a loss company, which includes the receipt in its taxable income. A 90% ownership threshold is used for membership in the group. In the United Kingdom, certain losses and other tax attributes can be “surrendered” to a profitable member of the same group. There, the ownership threshold for group membership is 75%.

Design parameters of a new group taxation system

The design parameters identified by Finance and the main issues to be considered in each are briefly outlined below.

  1. Eligible groups – the degree of common ownership required for group membership, the meaning of ownership (votes, value, or both), the treatment of trusts and other non-corporate entities and Canadian branches of non-resident corporations, requirement for a common parent corporation, and treatment of groups without a common parent.
  2. Attributes – in addition to current year operating losses, the treatment of other types of losses, deductions (depreciation) and pools (SR&ED and resource), and investment tax credits.
  3. Elective components – whether participation in a group system should be mandatory for the group and (or) individual group members, the extent of flexibility to allow groups to determine which attributes to transfer or consolidate.
  4. Unused tax attributes – determining appropriate limitations on the use of existing pools and losses when a group is formed, when a company enters or exits the group, and those arising while part of a corporate group.
  5. Grandfathering – whether to restrict the ability to use loss utilization transactions among group members outside the formal system and, if so, considering a transitional period during which the current approach could continue to be used (particularly for transactions initiated before the new system was introduced).
  6. Use of previously accumulated attributes – whether to restrict, and if so, to what extent, the use of losses and other attributes accumulated by corporate groups before the introduction of the new system.

Members of MNP’s tax team have the technical knowledge and experience to assist you to understand the issues and the implications to your company should Canada implement a formal group tax reporting system. We would also be pleased to assist you in any submission you may wish to make to Finance or in optimizing your group’s tax situation under the existing system. For more information on this development please contact me or your local MNP Tax advisor.