Explanatory Notes to the Legislative Proposals and Draft Regulations Relating to Income Tax (February 2004): 2
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Preface

These explanatory notes describe proposed technical amendments to the Income Tax Act and related Acts. Those amendments are divided into two parts, the first part relating to general income tax amendments and the second part relating to amendments to the foreign affiliates regime.

Many of the provisions released in the December 2002 release of legislative proposals have been revised in response to consultations undertaken since that time. As a result, certain clauses of the explanatory notes previously released with the proposed amendments have also been revised or added as necessary.

These explanatory notes, like the amendments, are divided into two parts: notes in respect of general income tax amendments followed by notes in respect of the foreign affiliates regime. Under the first part, explanatory notes are provided only in respect of clauses which have been changed or which are new. Within each such clause, only those explanatory notes which have been changed or which are new are produced.

The explanatory notes contained under the second part replace the explanatory notes released in December 2002 concerning sections 17, 93, and 95 and the definition "qualifying member" in subsection 248(1) of the Act. Note also that the explanatory notes previously released concerning Part LIX of the Income Tax Regulations are replaced by the explanatory notes to Appendix C. Unless otherwise noted, any of the previously released explanatory notes concerning those provisions of the Act and Part LIX that are not reproduced have been deleted.

Note also that the amendments to the following provisions, originally proposed in the December 2002 draft legislative proposals were included in Bill C-48, which received Royal Assent in November 2003, and, accordingly, the explanatory notes for those provisions in Bill C-48 apply:

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Part I

General

Clause 2

Employment Income

ITA
6

Section 6 of the Act deals with employment income. This section provides for the inclusion in an employee's income of most employment-related benefits other than those specifically excluded.

Amounts Receivable for Covenant

ITA
6(3.1)

New subsection 6(3.1) of the Act provides that an employee is - if certain circumstances exist - required to include in the employee's income from employment for a taxation year an amount that is receivable at the end of a taxation year in respect of a covenant as to what the employee is, or is not, to do. Subsection 6(3.1) is added consequential to new section 56.4 of the Act which concerns the tax treatment of amounts received or receivable in respect of a restrictive covenant (additional commentary is provided in the explanatory notes accompanying new section 56.4)). In contrast, amounts related to covenants made in the context of an office or employment are generally included in income on a "received" basis.

New subsection 6(3.1) applies to a receivable of an employee in respect of a covenant if

• the amount is not receivable under a salary deferral arrangement to which paragraph 6(1)(a) applies because of subsection 6(11) (in such cases, the amount is currently taxable as employment income even though it is receivable),

• the employee agreed to the covenant more than 36 months before the end of the taxation year, and

• the amount would be included in the taxpayer's income, as income from an office or employment, if it were received by the taxpayer in the year.

If applicable, subsection 6(3.1) provides that the amount receivable is deemed to be received by the taxpayer at the end of the taxation year for services rendered as an officer or during the period of employment, and that the amount is deemed not to be received at any other time (thereby precluding an inclusion because of the receipt).

In cases where subsection 6(3.1) deems an amount that is receivable to be received, new paragraph 60(f) provides a deduction in a subsequent year if the amount becomes a bad debt.

Subsection 6(3.1) applies to amounts receivable in respect of a covenant agreed to after October 7, 2003.

 

Clause 5

Income Inclusions

Inducements, Reimbursements, etc.

ITA
12(1)(x)(v.1)

Paragraph 12(1)(x) of the Act provides that certain inducements, reimbursements, contributions, allowances and assistance received by a taxpayer in the course of earning income from a business or property must be included in income "to the extent that" the particular amounts have not otherwise been included in income or reduced the cost of a property or the amount of an outlay or expense. Paragraph 12(1)(x) is amended consequential to the restrictive covenant rules in new section 56.4 of the Act (additional commentary is provided in the explanatory notes accompanying new section 56.4).

New subparagraph 12(x)(v.1) provides that the income inclusion referred to in paragraph (x) does not apply to the extent the amount in respect of a restrictive covenant (as defined by new subsection 56.4(1)) was included under subsection 56.4(2) in computing the income of a person related to the taxpayer. In other words, to the extent that a taxpayer receives an amount for a restrictive covenant that a person related to the taxpayer is required under subsection 56.4(2) to include in computing income, paragraph 12(1)(x) will not apply to require the taxpayer to include the amount in computing the taxpayer's income.

New subparagraph 12(1)(x)(v.1) applies after October 7, 2003.

 

Clause 7

Eligible Capital Property

Election re Capital Gain

ITA
14(1.01)

Subsection 14(1.01) of the Act permits a taxpayer to elect, in the taxpayer's return of income for a taxation year, to report a capital gain on the disposition of an eligible capital property in respect of which the taxpayer can identify the cost of the particular property. Where the taxpayer has so elected, the taxpayer is deemed to have disposed of a capital property with an adjusted cost base equal to that cost, for proceeds of disposition equal to the actual proceeds of the eligible capital property. Paragraph 14(1.01)(a) removes the property from the cumulative eligible capital pool by coincidentally deeming the proceeds of disposition of the eligible capital property to be equal to its original cost.

Subsection 14(1.01) is amended to clarify that it is the eligible capital expenditure by the taxpayer to acquire the eligible capital property that must be verifiable.

The amended provision will allow a taxpayer to elect in the taxpayer's return of income for the taxation year of the disposition, or with an election under subsection 83(2) of the Act. This allows a taxpayer to consider the resulting capital gain when making a capital dividend election.

The amendments generally apply to dispositions of eligible capital property that occur on or after December 20, 2002.

Election re Property Acquired with pre-1972 Outlays or Expenditures

ITA
14(1.02)

Amended subsection 14(1.01) of the Act does not allow a taxpayer to elect under that subsection in respect of a property acquired prior to 1972. New subsection 14(1.02) of the Act is added to allow a taxpayer to make a similar election in respect of property that would, if an outlay or expenditure were made after 1971 to acquire the property, be eligible for the election under subsection 14(1.01). For the purposes of calculating the capital gain to the taxpayer under this election, the adjusted cost base of such property is deemed to be nil and the proceeds of disposition would be determined under subsection 21(1) of the Income Tax Application Rules.

New subsection 14(1.02) applies to dispositions of eligible capital property that occur after December 20, 2002.

Non-application of Subsections (1.01) and (1.02)

ITA
14(1.03)

New subsection 14(1.03) of the Act is added, concurrently with the amendment of subsection 14(1.01) of the Act and the addition of new subsection 14(1.02) of the Act, to preclude a taxpayer from making an election under those subsections in respect of eligible capital property that is goodwill. Subsection 14(1.03) also precludes an election by a corporation under those subsections for property acquired in circumstances where an election was made under subsection 85(1) or (2) of the Act, if the amount agreed on as the corporation's cost under those subsections was less than the fair market value of the property at the time it was so acquired. However, this rule only applies in circumstances where the corporation is dealing at non-arm's length with the transferor of the property and the eligible capital expenditure of the transferor to acquire the property cannot be determined. The exclusion from electing for property acquired in a rollover prevents the conversion of property with no determinable cost into property with a cost that is determinable for tax purposes.

New subsection 14(1.03) generally applies to dispositions of eligible capital property that occur after Announcement Date + 1.

Acquisition of Eligible Capital Property

ITA
14(3)

Subsection 14(3) of the Act provides rules regarding non-arm's length transfers of eligible capital property. The provision prevents the deduction, under paragraph 20(1)(b) of the Act, of the portion of the purchaser's cost that is reflected in a capital gains exemption claimed by the vendor under section 110.6 of the Act. Absent any claim by the vendor of a capital gains exemption under subsection 110.6, the eligible capital expenditure to the purchaser generally equals the proceeds of disposition of the vendor. That is, the eligible capital expenditure of the purchaser equals 4/3 of the amount determined in respect of the vendor under the description of E in the formula in the definition "cumulative eligible capital" in subsection 14(5) of the Act.

Paragraph 14(3)(a) is amended, for taxation years that end after February 27, 2000, to ensure that, if the eligible capital property is the subject of an election by the vendor under subsection 14(1.01) or (1.02) of the Act, the eligible capital expenditure of the purchaser will, subject to the adjustments in subsection 14(3) for deductions under section 110.6, equal the actual proceeds of disposition to the vendor.

Definition of Cumulative Eligible Capital

ITA
14(5)

The definition "cumulative eligible capital" in subsection 14(5) of the Act provides for the calculation of a taxpayer's cumulative eligible capital property pool for the purpose of determining the taxpayer's allowable deduction in respect of eligible capital property (ECP) for the year.

Variable A in the definition "cumulative eligible capital" represents 3/4 of the eligible capital expenditures of a taxpayer as the result of the acquisition of an eligible capital property after the taxpayer's "adjustment time" (generally since 1987). Variable A is amended to ensure that the taxpayer's pool includes only the taxable portion of the gain realized by the non-arm's length transferor on the disposition after December 20, 2002 of eligible capital property.

Variable A is generally reduced by 1/2 of the gain of the transferor in respect of the property under paragraph 14(1)(b) or 38(a) of the Act. (Where the transferor has claimed a capital gains exemption in respect of the transfer under subsection 110.6 of the Act, subsection 14(3) of the Act reduces the taxpayer's eligible capital expenditure accordingly. The reduction in Variable A will therefore not include 1/2 of the amount of that claim.) Where the transferor has realized such a gain in a taxation year in respect of more than one property, the amount of the gain of the transferor for the purposes of this calculation is that proportion of the gain that the proceeds of disposition of the eligible capital property acquired by the taxpayer is of the total proceeds of disposition of all such property disposed of in the transferor's taxation year.

The reduction to Variable A does not apply where the eligible capital property has previously been disposed of by the taxpayer or was acquired on or before December 20, 2002.

Example 1

Mr. X purchased a farm production quota several years ago for $300,000 and claimed no cumulative eligible capital amounts, such that his cumulative eligible capital at the end of his previous taxation year was $225,000. This year he sold the production quota to his sister, Mrs. Y, for its fair market value of $1,200,000. Mr. X reported income of $450,000 under paragraph 14(1)(b) of the Act, and did not claim a capital gains exemption under section 110.6 of the Act. (Alternatively, Mr. X could have made an election under subsection 14(1.01) of the Act to report a taxable capital gain under paragraph 38(a) of the Act.)

Because Mrs. Y purchased the production quota in a non-arm's length transaction, the amount included in Variable A of her cumulative eligible capital balance at the end of the year of acquisition would be $675,000 (i.e. 3/4 of $1,200,000, less 1/2 of the taxable gain of Mr. X of $450,000). This result may also be illustrated as the total of the taxable gain of Mr. X of $450,000 and 3/4 of his eligible capital expenditure of $300,000.

Example 2

Assume the same facts as Example 1, except that Mr. X claimed a capital gains exemption of $250,000 in respect of his $450,000 taxable gain under paragraph 14(1)(b) of the Act.

Mrs. Y's eligible capital expenditure under subsection 14(3) of the Act is deemed to be $700,000, calculated as 4/3 of the excess of

• 3/4 of the actual proceeds of disposition of $1,200,000 (i.e. $900,000)

• 3/2 of the $250,000 capital gains exemption claimed by Mr. X (i.e. $375,000)

3/4 of her deemed eligible capital expenditure of $700,000 less 1/2 of the amount by which the taxable gain of Mr. X		$525,000
exceeds	$450,000
the capital gains exemption claimed by Mr. X	250,000
	200,000
	x 1/2
		100,000
Amount included in Variable A		$425,000

The calculation of "cumulative eligible capital" is designed so that the pool cannot be negative immediately after the end of the year. In this regard, variable F in the calculation generally reduces the pool by the total amount of ECP deductions claimed in prior years (generally, variable P), net of amounts included in income in prior years (variable R) under subsection 14(1) of the Act as recapture of ECP deductions or as deemed capital gains.

Variable R in the definition "cumulative eligible capital" is amended to ensure that amounts included in the income of a corporation under former paragraph 14(1)(b) of the Act (as it applied to taxation years that ended before February 28, 2000) continue to be included in the calculation of variable F.

The amendments apply to taxation years that end after February 27, 2000.

Exchange of Property

ITA
14(6)

Where a taxpayer has disposed of an eligible capital property in a taxation year and has acquired a replacement eligible capital property before the end of the subsequent taxation year, subsection 14(6) of the Act allows the taxpayer to elect to defer the inclusion of an amount in income under subsection 14(1) of the Act that would normally result from a negative balance in the taxpayer's cumulative eligible capital account at the end of the year of disposition.

Subsection 14(6) is amended to accommodate taxation years that are shorter than 12 months, by providing that the period for acquiring a replacement property ends at the later of the end of the subsequent taxation year and the time that is 12 months after the end of the taxation year in which the property was disposed of. This amendment applies in respect of dispositions of eligible capital property that occur in taxation years that end on or after the day that is 12 months before December 20, 2002.

 

Clause 10

Prohibited Deductions

Securities Lending Arrangement Compensation Payments

ITA
18(1)(w)

Section 260 of the Act provides special rules relating to securities lending arrangements. Former subsection 260(6) prohibited a borrower, other than in certain circumstances, from deducting in computing its income an amount paid as a compensation payment pursuant to a securities lending arrangement.

As part of the restructuring of section 260, particularly subsection 260(6), new paragraph 18(1)(w) is enacted to prohibit a borrower from deducting a compensation payment, except where expressly permitted by the Act. This new paragraph, therefore, continues the function of the former subsection 260(6).

This amendment applies after 2001.

 

Clause 12

Deductions

Reserve Not Available

ITA
20(8)

Paragraph 20(1)(n) of the Act allows a taxpayer to claim a reserve in respect of the taxpayer's profit from the sale of certain property, where all or part of the proceeds of the sale are not due until at least two years after the time of sale. However, subsection 20(8) of the Act provides that this reserve is limited to taxation years that end less than 36 months after the time of the sale. For example, where the taxation year is 12 months, the reserve is available in the taxation year in which the sale occurred and the two subsequent taxation years.

New paragraphs 20(8)(c) and (d) generally apply, in respect of dispositions of property that occur after December 20, 2002, to provide that the reserve under paragraph 20(1)(n) is not available to a taxpayer where the purchaser of the property is a corporation controlled by the taxpayer or is a partnership of which the taxpayer is a majority interest partner.

 

Clause 18

Exchanges of Property

Where Subparagraph 44(1)(e)(iii) Does Not Apply

ITA
44(7)

Subsection 44(7) of the Act restricts a taxpayer from claiming a capital gains reserve under subparagraph 44(1)(e)(iii) where the former property of the taxpayer was disposed of to a non-resident or a corporation that, immediately after the disposition, controlled the taxpayer or was controlled by the taxpayer or by a person or group of persons who controlled the taxpayer. Subsection 44(7) is amended, generally in respect of dispositions of property that occur after December 20, 2002, to provide that the capital gains reserve is also not allowed to a taxpayer where the purchaser of the property is a partnership of which the taxpayer is a majority interest partner.

 

Clause 19

Capital Gains Deferral - Eligible Small Business Investments

Special Rule - Eligible Small Business Corporation Share Exchanges

ITA
44.1(6)

Subsection 44.1(6) of the Act provides rules that apply where an individual exchanges an eligible small business corporation share for new eligible small business corporation share. Subsection 44.1(6) is amended to substitute the reference to subsection 85.1(3) with a reference to subsection 85.1(1) and to add a reference to sections 51 and 86. These changes apply to dispositions of shares made after February 27, 2000.

Special Rule - Active Business Corporation Share Exchanges

ITA
44.1(7)

Subsection 44.1(7) of the Act provides rules that apply where an individual, in the course of a qualifying disposition, disposes of common shares of an active business corporation for consideration consisting only of new common shares of another active business corporation issued to the individual. Subsection 44.1(7) is amended to substitute the reference to subsection 85.1(3) with a reference to subsection 85.1(1) and to add a reference to sections 51 and 86.

These changes apply to dispositions of shares made after February 27, 2000.

Anti-Avoidance Rule

ITA
44.1(12)

Subsection 44.1(12) of the Act is an anti-avoidance rule. It applies where an individual or persons related to the individual dispose of shares of a particular corporation (which would normally result in the use of the corporate reorganization rules or a return of paid-up capital of shares of the corporation) and acquire new shares of the particular corporation or a corporation that does not deal at arm's length with the particular corporation principally for the purpose of increasing the total amount of permitted deferrals with respect to qualifying dispositions of the individual and the related persons. Where the rule applies, the permitted deferral with respect to qualifying dispositions of the new shares is deemed to be nil.

Subsection 44.1(12) is amended to apply to the following circumstances:

• when the new shares are issued by a corporation that, at or immediately after the time of issue of the new shares, was a corporation that was not dealing at arm's length with the individual; and

• when the new shares are issued, by a corporation that acquired the old shares (or by another corporation related to that corporation), as part of the transaction or event or series of transactions or events that included that acquisition of the old shares.

This amendment applies to disposition that occur after Announcement Date.

 

Clause 20

Adjustments to Cost Base

ITA
53

Section 53 of the Act sets out rules for determining the adjusted cost base (ACB) of property. Certain adjustments are made under this section. Subsection 53(1) provides for additions in computing the ACB of a property, and subsection 53(2) for deductions in computing the ACB of a property.

Recomputation of Adjusted Cost Base on Transfers and Deemed Dispositions

ITA
53(4)

Subsection 53(4) of the Act provides rules that affect the computation of the adjusted cost base (ACB) to a taxpayer of any "specified property". As defined in section 54, "specified property" is capital property that is a share, a capital interest in a trust, a partnership interest or an option to acquire any such property. The rules in subsection 53(4) apply where the proceeds of disposition of a specified property are determined under any one of a number of specified provisions in the Act set out in the subsection.

Subsection 53(4) is amended to reflect amendments to a number of those specified provisions; namely, subsections 107(2.1), (4) and (5) of the Act. The references in subsection 53(4) to subsections 107(4) and (5) are removed because those provisions no longer provide for a deemed disposition of trust property. Instead, where subsection 107(4) or (5) applies, a disposition of property will result under paragraph 107(2.1)(a). Therefore, the reference to paragraph 107(2.1)(a) in subsection 53(4) is sufficient.

This amendment applies after Announcement Date.

 

Clause 24

Other Sources of Income

ITA
56 to 59.1

Sections 56 to 59.1 of the Act list some of the types of "other income" that are required by paragraph 3(a) of the Act to be included in computing the income of a taxpayer for a taxation year from sources of income (these sources are sources other than the taxpayer's income for the year from each office, employment, business and property).

Restrictive Covenant - Bad Debt Recovered

ITA
56(1)(m)

New paragraph 56(1)(m) of the Act is added to provide that a taxpayer is required to include in income any amount received in a taxation year on account of a debt in respect of which a bad debt deduction was made under new paragraph 60(f) of the Act in computing the taxpayer's income for a preceding taxation year. In other words, if a taxpayer makes a bad debt deduction for an amount receivable in respect of a restrictive covenant that was previously included in computing the taxpayer's income because of new section 56.4 (or new subsection 6(3.1)) of the Act, and the taxpayer (or a person not dealing at arm's length with the taxpayer) subsequently receives the amount, the amount so received is to be included in computing the taxpayer's income.

Government Assistance

ITA
56(1)(r)

Paragraph 56(1)(r) requires that certain amounts received as earnings supplements under government sponsored projects or as financial assistance under programs established by the Canada Employment Insurance Commission or under similar programs established by other government entities or organizations pursuant to agreements with the Commission are to be included in computing the recipient's income.

In recent years, there have been a number of income replacement benefits paid under government programs, usually in response to an unforeseen event, or as bridging benefits payable until another program is implemented. These income replacement benefits are generally paid to individuals who are not eligible for employment insurance (EI) benefits either because they have not worked enough weeks or because they have otherwise exhausted their benefits. However, the benefits paid are generally calculated by reference to the amounts that the individual would receive under the Employment Insurance Act if they were eligible for benefits under that Act.

Paragraph 56(1)(r) is amended, for the 2003 and subsequent taxation years, to clarify that income replacement benefits received under government assistance programs that are similar to income replacement payments provided under the Employment Insurance Act are to be included in computing the recipient's income.

 

Clause 24.1

Restricted Covenants

ITA
56.4

New section 56.4 of the Act sets out rules with respect to amounts that are received or receivable in respect of a restrictive covenant. New section 56.4 reflects changes to the income tax law proposed by the Minister of Finance on October 7, 2003 (release 2003-049), and it applies to amounts received or receivable by a taxpayer after October 7, 2003, other than to amounts received by the taxpayer before 2005 under a grant of a restrictive covenant made in writing on or before October 7, 2003 between the taxpayer and a person with whom the taxpayer deals at arm's length.

In addition to new section 56.4, there are consequential changes to other provisions of the Act, including section 6 (employment income), section 56 (amounts to be included in income), section 60 (other deductions), section 68 (allocation of consideration) and section 212 (Part XIII tax, non-resident withholding tax) of the Act. The notes accompanying those consequential changes contain additional details about each change.

Definitions

ITA
56.4(1)

New subsection 56.4(1) defines an "eligible interest", a "restrictive covenant" and a "taxpayer" - these definitions are relevant for the purpose of computing the amount, if any, that a taxpayer is required to include in income, or in proceeds of disposition in respect of certain capital property, in respect of amounts received or receivable for a restrictive covenant.

"eligible interest"

"Eligible interest", of a taxpayer, means capital property of the taxpayer that is

• a partnership interest in a partnership that carries on a business, or

• a share of the capital stock of a corporation that carries on a business.

"restrictive covenant"

"Restrictive covenant", of a taxpayer, means an arrangement entered into, an undertaking made, or a waiver of an advantage or right by a taxpayer (other than an arrangement or undertaking for the disposition of the taxpayer's property), that affects, in any way whatever, the acquisition or provision of property or services by a taxpayer or by another taxpayer that does not deal at arm's length with the taxpayer.

"taxpayer"

"Taxpayer" includes a partnership.

Income - Restrictive Covenants

ITA
56.4(2)

New subsection 56.4(2) of the Act provides that there is to be included in computing a taxpayer's income for a taxation year amounts in respect of a restrictive covenant that are received or receivable in the taxation year by the taxpayer (or by a person not dealing at arm's length with the taxpayer). If an amount that is receivable is included because of subsection 56.4(2) in computing a taxpayer's income in a taxation year, the amount will not be included in computing the taxpayer's income in a subsequent year. Subsection 56.4(2) does not apply in certain circumstances described in subsection (3).

Non-application of Subsection (2)

ITA
56.4(3)

There are three exceptions to the income inclusion rule in subsection 56.4(2) of the Act for amounts received or receivable in respect of a restrictive covenant granted by a taxpayer to a person with whom the taxpayer deals at arm's length (the "purchaser").

First, subsection 56.4(2) does not apply to an amount if section 5 or 6 of the Act applies to include the amount in computing the taxpayer's income for the year or would have so applied if the amount had been received in the taxation year.

Second, subsection 56.4(2) does not apply to an amount if it is required by the description E in the definition "cumulative eligible capital" in subsection 14(5) of the Act to be taken into account by the taxpayer in computing the taxpayer's cumulative eligible capital in respect of a business. The taxpayer and the purchaser of the restrictive covenant are required to elect in prescribed form to apply this exception. In doing so, they must each include a copy of the form in their income tax return for the taxation year that includes the day on which the restrictive covenant was agreed to and file the return with the Minister on or before the filing-due date for that year.

Third, subsection 56.4(2) does not apply to an amount to the extent that the amount is additional "proceeds of disposition" from the disposition of an eligible interest (see the definition "eligible interest" in subsection 56.4(1)) of the taxpayer if certain conditions are met. For this to be the case:

• The amount must directly relate to the taxpayer's disposition of an eligible interest.

• The disposition of the eligible interest must be to the purchaser of the restrictive covenant (or to a person related to that purchaser).

• The amount received or receivable must be consideration for an undertaking by the taxpayer not to provide property or services in competition with the property or services provided by the purchaser (or by a person related to the purchaser).

• The amount cannot exceed the amount determined by the formula A - B

• The amount is included in the taxpayer's proceeds of disposition of the eligible interest.

• The taxpayer and the purchaser of the restrictive covenant elect in prescribed form to apply this exception. In doing so, they must each include a copy of the form in their income tax return for the taxation year that includes the day on which the restrictive covenant was agreed to and file the return with the Minister on or before the filing-due date for that year.

Assumed facts:

• The facts are a variation of those provided in the example included in the Backgrounder to the Minister of Finance's release of October 7, 2003 (2003-049). Both Terence and Isabelle receive $900,000 for selling their 50 shares of X Ltd. to Y Ltd. However, instead of Terence receiving $200,000 for his restrictive covenant, he is to receive $150,000 and Isabelle grants a restrictive covenant to Y Ltd. for which she is to receive $50,000.

• The required elections and prescribed forms are filed on time.

[Note that this calculation of ordinary income is in error and should read as follows: "Nil ($50,000 less $50,000 allocated to proceeds of disposition for shares)."]

Treatment of Purchaser

ITA
56.4(4)

New subsection 56.4(4) of the Act provides rules that apply to an amount paid or payable by a purchaser of a restrictive covenant in certain circumstances.

If the amount paid or payable by a purchaser of a restrictive covenant is employment income of an employee of the purchaser, the amount is considered to be wages paid or payable by the purchaser to the employee.

If the purchaser elected under paragraph (3)(b), the amount paid or payable for the restrictive covenant is, for the purposes of applying to the purchaser the definition "eligible capital expenditure" in subsection 14(5) of the Act, to be considered to be an outlay incurred by the purchaser on account of capital.

If the purchaser elected under subparagraph (3)(c)(v), and the amount relates to the purchaser's acquisition of property that is, immediately after the acquisition, an eligible interest, the amount that is paid or payable is to be included in computing the cost to the purchaser of that interest.

Non-application of Section 42

ITA
56.4(5)

New subsection 56.4(5) of the Act provides that section 42 of the Act does not apply to an amount received or receivable as consideration for a restrictive covenant.

 

Clause 25

Deductions in Computing Income

Restrictive Covenant - Bad Debt

ITA
60(f)

New paragraph 60(f) provides a taxpayer with a deduction for a bad debt in respect of an amount that was receivable on a restrictive covenant and previously included in computing the taxpayer's income because of new section 56.4 (or new subsection 6(3.1)) of the Act. This amendment applies after October 7, 2003.

Transfers of Refund of Premiums under RRSP

ITA
60(l)

Section 60 of the Act provides for various deductions in computing income.

When an individual who is a spouse, common-law partner or financially dependent child or grandchild of another person receives, on the death of that person, a distribution from a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) under which that person was the annuitant, the individual is required to include the amount in income. However, paragraph 60(l) of the Act provides an offsetting deduction if the amount is used within a specified period of time to acquire an annuity described in subparagraph 60(l)(ii). (Under certain circumstances, the amount may also be paid into an RRSP or RRIF.)

There are two basic types of annuity described in subparagraph 60(l)(ii). The first (described in clause 60(l)(ii)(A)) is a life annuity (or an annuity payable to age 90), under which the individual is the annuitant. Where the individual is a child or grandchild of the deceased RRSP or RRIF annuitant, a deduction for this type of annuity is available only if the child or grandchild was dependent on the deceased by reason of physical or mental infirmity. The second (described in clause 60(l)(ii)(B)) is an annuity payable for a fixed number of years not exceeding 18 minus the individual's age in years at the time the annuity is acquired. In this case, the annuitant can be either the individual or a trust under which the individual is the sole person beneficially interested in amounts payable under the annuity.

Paragraph 60(l) is amended in two ways. First, clause 60(l)(ii)(A) is amended to allow (as is the case in clause 60(l)(ii)(B)) a trust to be named as the annuitant under the annuity. This option will be available if the individual is mentally infirm and is the sole person beneficially interested in amounts payable under the annuity. The latter requirement applies only while the individual is alive, thus ensuring that provision can be made for any residual amounts that remain in the trust after the individual's death.

This amendment applies to taxation years that end after 2000, except that, for those taxation years that end before 2004, the option to use a trust will also be available for individuals who are physically infirm.

Second, clause 60(l)(ii)(B) is amended to ensure consistency with amended clause 60(l)(ii)(A) in describing the trust option. Specifically, the requirement that the individual be the sole person beneficially interested in amounts payable under the annuity is modified so that it no longer applies after the individual's death.

This amendment applies to taxation years that end after 1988, which reflects the introduction of the trust option for minor children.

 

Clause 30.1

Allocation of Amounts in Consideration for Property, Services or Restrictive Covenants

ITA
68

Section 68 of the Act applies where an amount received or receivable can reasonably be regarded as being in part consideration for the disposition of a particular property of a taxpayer or as being in part consideration for the provision of particular services. If the amount is in part consideration for the disposition of property, that part of the consideration that can reasonably be regarded as being for the disposition of property is deemed to be the proceeds of disposition of that property and, reciprocally, the cost of the property for the acquirer. If the amount is in part consideration for the provision of particular services, that part of the consideration that can reasonably be regarded as being for the provision of particular services is deemed to be an amount received or receivable by the taxpayer in respect of those services and, reciprocally, an amount paid or payable by the person to whom the services are rendered.

Section 68 is amended to apply in circumstances where consideration received or receivable by a taxpayer is in part for a restrictive covenant (as defined by new subsection 56.4(1) of the Act) agreed to by the taxpayer. In such a case, the part of the consideration that can reasonably be regarded as being for the restrictive covenant is considered to be an amount that is received or receivable by the taxpayer in respect of the restrictive covenant, and that part is also considered to be paid or payable to the taxpayer by the person to whom the restrictive covenant was granted.

The change applies on and after Announcement Date, other than to a taxpayer's grant of a restrictive covenant made in writing before Announcement Date between the taxpayer and a person with whom the taxpayer deals at arm's length.

 

Clause 31.1

Death of a Taxpayer

ITA
70

Section 70 of the Act deals in particular with the transfer or distribution of property at the time of the death of a taxpayer. The French version of subsections 70(3), (6), (6.1), (7), (9), (9.1), (9.2) and (9.3) is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the taxpayer's beneficiaries and not simply set aside for them. Stylistic changes have also been made to these subsections. The amendments will come into force on Royal Assent.

 

Clause 31.2

Election by Legal Representative and Transferee re Reserves

ITA
72(2)

Subsection 72(2) of the Act sets out the rules that apply in instances where the property of a deceased taxpayer that has a right to receive any amount is transferred or distributed to the taxpayer's spouse or common-law partner or to a trust. The French version of this subsection is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. Stylistic changes have also been made to the French version of this subsection. The amendments will come into force on Royal Assent.

 

Clause 32

Inter Vivos

Transfers by Individuals

ITA
73

Section 73 of the Act provides rules for the tax treatment of certain inter vivos transfers of property.

Capital Cost and Amount Deemed Allowed

ITA
73(2)

Subsection 73(2) of the Act applies where a person ("transferor") transfers depreciable capital property ("DCP") of a prescribed class to a taxpayer ("transferee") in circumstances in which subsection 73(1) applies. If the capital cost to the transferor of the DCP is greater than the amount at which the transferee is deemed under subsection 73(1) to have acquired the DCP, subsection 73(2) ensures that the proper amount of capital cost allowance allowed to the transferor is available for recapture on a subsequent disposition of the DCP by the transferee.

Subsection 73(2) of the Act is amended to replace the reference to paragraph 73(1)(e) with a reference to paragraph 73(1)(b). Paragraph 73(1)(b) now provides for the amount at which the transferee is deemed to acquire property on a transfer to which subsection 73(1) applies.

This amendment applies to transfers that occur after 1999.

 

Clause 32.1

Compensation Payments Deductible by Individuals

ITA
82(1)(a)(ii)(B)

Clause 82(1)(a)(ii)(B) of the Act allows an individual who has entered into a securities lending arrangement to deduct, to the extent of the individual's dividend income, the dividend compensation payment paid by the individual.

Due to the amendments made to the securities lending arrangement rules in section 260 of the Act, clause 82(1)(a)(ii)(B) is amended in two ways. First, it is amended to apply in respect of an individual's specified proportion of a dividend compensation payment made by a partnership of which the individual is a member. Secondly, since new subsection 260(5.1) of the Act now sets out the treatment of dividend compensation payments, the clause is amended to replace the reference to "subsection 260(5)" with a reference to "subsection 260(5.1)".

Whether this amendment applies in respect of a particular securities lending arrangement depends on when the arrangement is made and, in the case of an arrangement made after November 2, 1998 and before December 21, 2002, whether the parties to the arrangement have elected to have the amended definition of "dividend rental arrangement" in subsection 248(1) of the Act apply. The following table shows these alternative results.

Clause 32.2

Deemed Dividend

ITA
84(4.1)

Subsection 84(4.1) of the Act treats a payment on a reduction of paid-up capital by a public corporation as a dividend, except where the payment is made by way of a redemption, acquisition or cancellation of a share or in the course of a transaction described in subsection 84(2) or section 86 of the Act.

Subsection 84(4.1) is amended to introduce a new exception. Generally, this exception will apply where the amount paid on a reduction of paid-up capital may reasonably be considered to be a distribution of proceeds realized from a transaction or event that did not occur in the ordinary course of the corporation's business and those proceeds were derived from a transaction or event that occurred no more than 24 months before the return of the paid-up capital.

In the case of a transaction or event that funds the payment, generally relief from the deemed dividend rule in subsection 84(4.1) will apply if the paid-up capital distribution can be traced to proceeds realized in connection with a transaction or event that may reasonably be considered to be derived from a transaction that occurs outside of the ordinary course of the corporation's business. For example, a paid-up capital distribution paid out of proceeds realized on the sale of a business unit of a corporation, where the proceeds were not required for reinvestment, would generally not be considered to be a distribution from amounts realized in the ordinary course of the corporation's business. In general terms, this aspect of the amendment to subsection 84(4.1) is intended to ensure that only a return of corporate capital, as opposed to a distribution of earnings, is subject to the new exception to subsection 84(4.1).

In order to ensure that the proceeds from an extraordinary transaction are not used to fund a stream of regular or periodic distributions, only one return of paid-up capital will be permitted in respect of any particular extraordinary transaction and that return must occur within 24 months of the proceeds being realized. However, this one-time return rule and 24 month limitation will not apply to distributions of paid-up capital made after 1996 and before Announcement Date.

 

Clause 33

Transfer of Property to a Corporation By Shareholders

ITA
85(1)(d.1), (d.11) and (d.12)

Subsection 85(1) of the Act provides a tax deferral for the transfer of various types of property by a taxpayer to a taxable Canadian corporation for consideration that includes shares of the corporation's capital stock. In general, tax deferral may be achieved if the taxpayer and the corporation jointly elect that the proceeds of disposition of the taxpayer and the eligible capital expenditure of, or cost to, the corporation are deemed to be less than the fair market value of the property transferred.

Paragraph 85(1)(d.1) generally reduces, for the corporation that has acquired an eligible capital property (ECP), the gain that would be included in income under paragraph 14(1)(b) of the Act on a subsequent disposition of the property. Paragraph 85(1)(d.1) adjusts the gain, in order to take into account the 1988 change of the rate of income inclusion and expenditure deductibility from 1/2 to 3/4, by adjusting the calculation of variable Q in the definition "cumulative eligible capital" in subsection 14(5) of the Act. Variable Q generally represents, for the period prior to the taxpayer's "adjustment time", the difference between ECP deductions claimed under paragraph 20(1)(b) of the Act and the total of recapture and gains from prior dispositions of eligible capital property by the taxpayer. Paragraph 85(1)(d.1) adjusts variable Q only for the purposes of calculating the amount to be included in a corporation's income under paragraph 14(1)(b), but not for the purpose of calculating the corporation's cumulative eligible capital balance for other purposes, such as the claiming of ECP deductions. Specifically, the adjustment of variable Q adjusts the value of variables A, B and C in the formula in paragraph 14(1)(b). Variables A and B are affected indirectly, since variable Q affects variable F in the calculation of the cumulative eligible capital balance.

Paragraph 85(1)(d.1) is amended concurrently with the addition of new paragraph 85(1)(d.11) of the Act. New paragraph 85(1)(d.11) generally applies to ensure that an amount that would have been recaptured ECP deductions to the taxpayer under subsection 14(1), if the taxpayer had disposed of the eligible capital property for an amount greater than the taxpayer's cumulative eligible capital at the time of the disposition, is subject to recapture in the hands of the corporation upon a subsequent sale of the property. This result is achieved by adding an allocation of the potential recapture to the taxpayer (i.e., variable F of the taxpayer) simultaneously to the corporation's eligible capital expenditures and aggregate ECP deductions (i.e., variables A and F respectively in the definition "cumulative eligible capital" of the corporation). This adjustment applies only for the purpose of calculating the amount to be included in income of the corporation under subsection 14(1) upon the subsequent disposition of eligible capital property. In this regard, variable F of the taxpayer is determined at the beginning of the taxpayer's following taxation year if the taxpayer's taxation year that included the transfer had ended immediately after the disposition time, determined without reference to new paragraph (d.12). Variable F of the taxpayer is apportioned to the corporation in the same proportion as the fair market value of the property transferred is to the fair market value of total eligible capital property of the taxpayer immediately before the transfer.

Because new paragraph 85(1)(d.11) now accommodates variable F of the corporation, paragraph 85(1)(d.1) is amended to add 1/2 of the taxpayer's variable Q amount directly to the corporation's variable C amount in paragraph 14(1)(b), rather than adjusting variable Q of the corporation (and thus variable F as well).

New paragraph 85(1)(d.12) of the Act is added, concurrently with new paragraph 85(1)(d.11), to ensure that a subsequent disposition of other ECP by the taxpayer does not result in recapture of depreciation under paragraph 14(1)(a) when the resulting gain from that disposition should have been taxed at a lower rate under paragraph 14(1)(b). This could happen, for instance, if the taxpayer were to defer all of the recapture to the corporation, such that the taxpayer's cumulative eligible capital balance at the end of the taxation year that includes the rollover is nil. In this case, if in the next taxation year the taxpayer were to make another disposition of ECP, paragraph 85(1)(d.12) would reduce to nil the amounts that would be determined for the taxpayer by subparagraph 14(1)(a) and variable B of paragraph 14(1)(b).

These amendments apply in respect of dispositions that occur after Announcement Date.

Eligible capital expenditure	$300,000
Rate applicable in 1984	50%
	150,000
Depreciation before 1988	< 40,650>
Cumulative eligible capital
at adjustment time	109,350
"C" amount: 3/2 of 109,350	164,025
"D" amount: depreciation before 1988	40,650
"P" amount: depreciation after 1987	<11,482>
"Q" amount: depreciation before 1988	<40,650>
Cumulative eligible capital of Mr. X	$152,543

Upon the subsequent sale of the property by the corporation for actual proceeds of disposition of $500,000, the amount included in the corporation's income under subsection 14(1) is calculated as follows:

Agreed amount of eligible capital expenditure (4/3 of $152,543)	$203,391
Eligible capital expenditure rate	75%
"A" amount in cumulative eligible capital balance of corporation	152,543
14(1)(a) calculation for corporation:
Proceeds	$500,000
Rate applicable	75%
"E" amount in cumulative
eligible capital balance
of corporation		375,000
Excess		222,457
"F" for corporation: bumped by
85(1)(d.11) ($40,650 + $11,482)		52,132
14(1)(a) income: lesser of "F"
and excess			$52,132
14(1)(b) calculation for corporation:
Excess (as above)	$222,457
Less:"B" amount: amount "F",
as bumped by 85(1)(d.11)	<52,132>
"C" amount: ½ of "Q" (above),
as bumped by 85(1)(d.1)	<20,325>
Net	150,000
multiply by 2/3	2/3
14(1)(b) income			$100,000
Total 14(1) income inclusion
to corporation			$152,132

Clause 36

Winding-up of a Corporation

ITA
88(1.1)(e)

Subsection 88(1.1) of the Act allows a parent corporation under certain circumstances to use losses of a subsidiary corporation that has been wound up. Paragraph 88(1.1)(e) limits the use that can be made of the former subsidiary's non-capital losses and farm losses where either the parent or the subsidiary has undergone an acquisition of control. In its current form, the paragraph applies these limits regardless of when the acquisition of control took place. This can produce results that are unnecessarily restrictive. If, for example, a newly-acquired corporation is made the parent of an existing subsidiary that has losses, but the subsidiary itself has not undergone an acquisition of control since it incurred those losses, there is no reason for paragraph 88(1.1)(e) to limit the use that the parent corporation can make of the subsidiary's losses after the winding-up.

To ensure that it applies more appropriately, paragraph 88(1.1)(e) is amended to distinguish between acquisitions of control of the parent corporation and acquisitions of control of the subsidiary. In respect of the parent, the limits imposed by the provision will apply only where a person or group of persons has acquired control after the commencement of the winding-up. In respect of the subsidiary, those limits will continue to apply if control has been acquired at any time.

Amended paragraph 88(1.1)(e) applies to windings-up that begin after May 1996.

 

Clause 38.1

Application of Certain Provisions to Trusts Not Resident in Canada

ITA
94(1)

Paragraph 94(1)(c) of the Act deals with the case where an amount of the income or the capital of a trust is to be distributed to a beneficiary of the trust. The French version of this paragraph is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

Definitions

ITA
95(1)

"relevant tax factor"

[The proposed measure concerning this definition that was included with the legislative proposals released in December 2002 has been removed from these proposals and incorporated in the "Legislative Proposals Relating to the Income Tax Act (Taxation of Non-Resident Trusts and Foreign Investment Entities)" announced on October 30, 2003.]

Agreement or Election of Partnership Members

ITA
96(3)

[this explanatory note is deleted]

 

Clause 42

Trusts and Their Beneficiaries

Deemed Disposition and Election

ITA
104(4) and (5.3)

Paragraphs 104(4)(a.2) and (5.3)(b.1) of the Act deal with cases where a trust distributes property to a beneficiary. The French version of these paragraphs is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. These amendments will come into force on Royal Assent.

Designation in Respect of Taxable Dividends

ITA
104(19)

Subsection 104(19) of the Act permits a trust to designate a taxable dividend received by it in a taxation year on the share of a taxable Canadian corporation. Where the designation is made in respect of a beneficiary under the trust, the dividend is treated, for the purposes of the Act (other than Part XIII), as a taxable dividend received by the beneficiary from the corporation, and is treated, for the purposes of the dividend gross-up in paragraph 82(1)(b) and stop-loss rules in paragraphs 107(1)(c) and (d) and section 112, as not having been received by the trust.

Subsection 104(19) is amended to clarify that where a designation, in respect of a taxpayer, is made by a trust in respect of a taxable dividend received by the trust in a particular taxation year of the trust, on a share of the capital stock of a taxable Canadian corporation, the portion of the dividend in respect of which the designation is made is

• for the purposes of paragraphs 82(1)(b) and 107(1)(c) and (d) and section 112, deemed not to have been received by the trust, and

• for the purposes of the Act other than Part XIII, deemed to be a taxable dividend on the share received by the taxpayer in the taxpayer's taxation year in which the particular taxation year of the trust ends.

These deeming rules do not apply, however, unless a number of conditions are met. One of these conditions - that a designated amount not be made in respect of more than one beneficiary under the trust - is replaced with a new requirement that the total of all amounts designated by the trust under subsection 104(19) for the particular taxation year of the trust not exceed the total of all amounts each of which is the amount of a taxable dividend received by the trust in the particular taxation year on a share of the capital stock of a taxable Canadian corporation.

This amendment applies to taxation years that end after Announcement Date.

Designation in Respect of Taxable Capital Gains

ITA
104(21)

Subsection 104(21) of the Act permits a trust to designate, in respect of a beneficiary under the trust, a portion of its net taxable capital gains. Where the designation is made, the amount designated is deemed, for the purposes of sections 3 and 111 (except as they apply for the purposes of determining whether a beneficiary is entitled to claim a capital gains exemption under section 110.6), to be a taxable capital gain for the year of the beneficiary from the disposition of capital property.

Subsection 104(21) is amended to clarify that where a designation, in respect of a taxpayer, is made by a trust in respect of its net taxable capital gains for a particular taxation year of the trust, the designated amount is deemed to be a taxable capital gain, for the taxation year of the taxpayer in which the particular taxation year ends, from the disposition by the taxpayer of capital property.

The deeming rule does not apply, however, unless a number of conditions are met. One of these conditions - that a designated amount not be made in respect of more than one beneficiary under the trust - is replaced with a new requirement that the total amounts designated under subsection 104(21) by the trust for a particular taxation year of the trust not exceed the trust's net taxable capital gains for the particular taxation year.

Subsection 104(21) is also amended to clarify that the deeming rule does not apply to a designation made by a trust, for a particular taxation year of the trust, in respect of a non-resident beneficiary, unless the trust is a mutual fund trust throughout the particular taxation year.

These amendments apply to taxation years that end after Announcement Date.

Deemed Gains - Subsection (21.4) Applies

ITA
104(21.6)

Subsection 104(21.6) of the Act provides rules for the determination of the inclusion rate to be used by a taxpayer for capital gains realized by a trust in 2000. This subsection applies to a taxpayer who has a taxation year that begins after October 17, 2000 and who is deemed by subsection 104(21.4) to have capital gains from the disposition of capital property in the year in respect of dispositions of property by a trust of which the taxpayer is a beneficiary.

This subsection ensures that the inclusion rate for capital gains realized on property disposed of by a trust prior to February 27, 2000 is 3/4, and is 2/3 in respect of property disposed of by a trust after February 27, 2000 and before October 18, 2000.

Subsection 104(21.6) is amended by adding new paragraph (f.1) to ensure that where the deemed gains are in respect of capital gains from dispositions of property by the trust that occurred after February 27, 2000 and before October 17, 2000 in circumstances where the taxation year of the taxpayer began after February 27, 2000 and ended after October 17, 2000, the gains are deemed to be a capital gain of the taxpayer from the disposition by the taxpayer of capital property in the taxpayer's taxation year and in the period that began after February 27, 2000 and ended before October 18, 2000.

Paragraph 104(21.6)(g) is amended to correct a technical deficiency in a reference to a date. The reference to "October 17, 2000" is changed to "October 18, 2000" which reflects the date on which the reduction of the capital gain inclusion rate from 2/3 to 1/2 was announced.

This amendment applies to taxation years that end after February 27, 2000.

Designation in Respect of Foreign Income

ITA
104(22)

Subsection 104(22) of the Act permits a trust to designate, in respect of a beneficiary under the trust, an amount of its foreign income. Such a designation is made by the trust on a source-by-source basis. Where the designation is made, the amount designated is deemed, for the purpose of subsections 104(22) and (22.1) and section 126, to be the beneficiary's income for the year from that source.

Subsection 104(22) is amended to clarify that where an amount is designated, in respect of a taxpayer, by a trust in respect of the trust's income for a particular taxation year of the trust from a source in a country other than Canada, the designated amount is deemed to be income of the taxpayer, for the taxation year of the taxpayer in which the particular taxation year of the trust ends, from that source.

The deeming rule does not apply, however, unless a number of conditions are met. One of these conditions - that a designated amount not be made in respect of more than one beneficiary under the trust - is replaced with a new requirement that the total amounts designated, in respect of the trust's income from a particular foreign source, under subsection 104(22) by the trust for a particular taxation year of the trust not exceed the trust's income for the particular taxation year from that source.

These amendments apply to taxation years that end after Announcement Date.

Amounts Deemed Payable to Beneficiaries

ITA
104(29)

[this explanatory note is deleted]

Clause 42.1

Proceeds of Disposition of Income Interest

ITA
106(3)

Subsection 106(3) of the Act stipulates that the trust that distributes any property to its beneficiary in satisfaction of the taxpayer's interest in the income of the trust is deemed to have disposed of the property for proceeds of disposition equal to the fair market value of the property. The French version of this subsection is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 43

Interests in Trusts

Cost Reduction Rule

ITA
107(1)(e)

Subsection 107(1) of the Act contains special rules applicable to the disposition of an interest in a trust. A trust can distribute non-taxable amounts, such as returns of capital and the non-taxable portion of a capital gain, to the holders of interests in the trust. Currently, the Act requires a return of capital to be accounted for by reducing the recipient's adjusted cost base of the interest in the trust. While the effect of this general rule is clear where the interest is held as capital property, it is not as clear where the property is held as inventory.

New paragraph 107(1)(e) applies when an interest in a trust that is not held as capital property is disposed of. The paragraph deems the cost amount of that interest to be the cost amount used for inventory valuation purposes less the total of all returns of capital and non-taxable capital gains received prior to the disposition. This is to recognize that all receipts for a property held on income account should be treated as either income or a reduction in the cost of the property to the holder.

The new paragraph applies to dispositions after 2001 if the trust interest is a security that is the subject of a securities lending arrangement as defined in section 260 of the Act. Otherwise, the new rule applies to dispositions after Announcement Date, except that it will not apply to a disposition to take place between Announcement Date and before 2005, if the taxpayer has on or before Announcement Date entered into an agreement in writing for the disposition of the interest.

Inventory Valuation - Deemed Fair Market Value

ITA
107(1.2)

Where an interest in a trust is held as an inventory, the fair market value of the interest at valuation for the purpose of section 10 of the Act can be affected by non-taxable distributions from the trust, potentially producing a tax loss to the holder of the interest even though the holder had suffered no economic loss (thanks to the non-taxable distribution the holder has already received).

New subsection 107(1.2) requires that at any particular valuation time the fair market value of an interest in a trust be deemed to be the total of the fair market value otherwise determined and the sum of any returns of capital and non-taxable capital gains payable before that time.

The new paragraph applies to valuations of trust interest that take place after Announcement Date, and to valuations after 2001 if the trust interest in question is a security that is the subject of a securities lending arrangement.

Distribution by Personal Trust

ITA
107(2)

Subsection 107(2) of the Act applies where a personal trust or a prescribed trust described in section 4800.1 of the Regulations distributes property to a beneficiary and there is a resulting disposition of part or all of the beneficiary's capital interest in the trust. Under paragraph 107(2)(a), the trust is deemed to have disposed of the property for proceeds of disposition equal to the property's cost amount. Under paragraph 107(2)(b), the property is deemed to have been acquired by the beneficiary for an amount equal to the total of the amount described in paragraph 107(2)(a) and a "bump" equal to the specified percentage of any excess of the adjusted cost base to the beneficiary of the capital interest over its cost amount (as defined by subsection 108(1) of the Act) to the beneficiary of the interest. Under subparagraph 107(2)(b.1)(iii), the specified percentage for property (other than non-depreciable capital property and eligible capital property) is 75%. Where subsection 107(2) applies, paragraph 107(2)(c) provides that the beneficiary is deemed to have disposed of all or part, as the case may be, of the capital interest for proceeds equal to the amount determined under that paragraph.

Subparagraph 107(2)(b.1)(iii) is amended to replace the reference to 75% with a reference to 50%, consistent with the current capital gains inclusion rate.

This amendment applies to distributions, from a trust, made after December 20, 2002.

Paragraph 107(2)(c) is amended to clarify that it applies to determine a taxpayer's proceeds of disposition of the capital interest in a trust (or of the part of it) disposed of by the taxpayer on a distribution, to which subsection 107(2) applies, of property by the trust.

This amendment applies to distributions, from a trust, made after 1999.

Paragraph 107(2)(d.1) determines the tax consequences of the disposition of taxable Canadian property by a trust to a non-resident beneficiary before October 2, 1996. In the event that the property was explicitly deemed to have been taxable Canadian property under a number of specified provisions of the Act, paragraph 107(2)(d.1) ensures that it continues to be taxable Canadian property of the beneficiary.

Paragraph 107(2)(d.1) is amended by adding to the list of specified provisions, that explicitly deem property to be taxable Canadian property, a reference to subsection 85.1(5) of the Act.

This amendment applies in determining after October 1, 1996 whether property is taxable Canadian property.

Distribution of Property Received on Qualifying Disposition

ITA
107(4.2)

New subsection 107(4.2) of the Act prevents a tax-deferred distribution of property after December 20, 2002 from a personal trust or a trust prescribed for the purpose of subsection 107(2) of the Act to a beneficiary of the trust if specified conditions are met. The specified conditions are that:

• at a particular time before December 21, 2002there was a qualifying disposition (within the meaning assigned by subsection 107.4(1) of the Act) of the property, or of other property for which the property is substituted, by a particular partnership or a particular corporation, as the case may be, to any trust; and

• the beneficiary is neither the particular partnership nor the particular corporation.

Where the specified conditions are met, subsection 107(2.1) will apply so that the trust is deemed to have disposed of the property for proceeds equal to the property's fair market value at the time of distribution.

This amendment applies to distributions, from a trust, that are made after December 20, 2002.

Distribution of Property to a Non-Resident Beneficiary

ITA
107(5)

Subsection 107(5) of the Act applies to the distribution of property (other than shares in non-resident-owned investment corporations or property described in any of subparagraphs 128.1(4)(b)(i) to (iii)) of the Act) by a trust resident in Canada to a non-resident beneficiary. In these circumstances, the rollover under subsection 107(2) is not available and instead subsection 107(2.1) of the Act will apply to determine the Canadian income tax consequences of the distribution to the trust and the beneficiary.

Subsection 107(5) is amended so that it applies whether the trust making the distribution is resident in Canada or not.

This amendment applies to distributions made after Announcement Date.

Amendments to French Version of Section 107

ITA
107

Subsections 107(2), (2.001), (2.002), (2.01), (2.1), (2.11), (2.2), (4), (4.1), (5) and (5.1) of the Act deal with distributions by trusts. The French version of these subsections is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. Stylistic changes have also been made to the French versions of these subsections. The amendments will come into force on Royal Assent.

 

Clause 43.1

Distribution by Employee Trust, Employee Benefit Plan or Similar Trust

ITA
107.1

Section 107.1 of the Act prescribes the rules that apply where an employee trust, a trust governed by anemployee benefit plan or trust described in paragraph (a.1) of the definition "trust" in subsection 108(1) distributes any property to its beneficiary in satisfaction of any part of the beneficiary's interest in the trust. The French version of this section is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. The amendments will come into force on Royal Assent.

 

Clause 43.2

Distribution by a Retirement Compensation Arrangement

ITA
107.2

Section 107.2 of the Act prescribes the rules that apply where a trust governed by a retirement compensation arrangement distributes any property to its beneficiary in satisfaction of any part of the taxpayer's interest in the trust. The French version of this section is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. Stylistic changes have also been made to the French version of this section. The amendments will come into force on Royal Assent.

 

Clause 44

Qualifying Disposition

ITA
107.4(1)

Subsection 107.4(3) of the Act generally provides for a rollover of property to a trust where the property is transferred to the trust by way of a qualifying disposition. For this purpose, subsection 107.4(1) defines "qualifying disposition" to be a disposition of property to a trust that does not result in any change in the beneficial ownership of the property and that otherwise meets the conditions set out in that subsection. A partnership, corporation or individual (including a trust) are all qualified transferors for the purpose of applying the definition "qualifying disposition" in subsection 107.4(1). Where the transferee trust is a non-resident trust, a qualifying disposition will occur only where the conditions in paragraph 107.4(1)(c) are satisfied. Another condition that must be met for there to be a qualifying disposition is found in paragraph 107.4(1)(d), which requires that the disposition not be by a partnership, if the disposition is part of a series of transactions or events that begins after December 17, 1999 and includes the cessation of the partnership's existence and a subsequent distribution from a personal trust to a former member of the partnership in circumstances to which subsection 107(2) of the Act applies.

Subsection 107.4(1) is amended so that after December 20, 2002 only an individual (including a trust) may make a qualifying disposition to a trust. As a result, paragraph 107.4(1)(d) is repealed.

These amendments are deemed to come into force on December 20,2002. For a related amendment, see the commentary to new subsection 107(4.2) of the Act.

In addition, paragraph 107.4(1)(c) is amended so that a qualifying disposition can only be made where the transferee trust is resident in Canada at the time of the transfer. This amendment applies to dispositions that occur after Announcement Date.

ITA
107.4(1)(g)

The French version of paragraph 107.4(1)(g) of the Act has been amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

ITA
107.4(3)

Subsection 107.4(3) of the Act provides a number of income tax consequences that apply in respect of a "qualifying disposition" (as defined in subsection 107.4(1) of the Act) of property to a trust. Paragraph 107.4(3)(f) ensures that, in the event that the property was explicitly deemed to have been taxable Canadian property under a number of specified provisions of the Act, the property continues to be taxable Canadian property of the trust.

Paragraph 107.4(3)(f) is amended by adding to the list of specified provisions, that explicitly deem property to be taxable Canadian property, a reference to paragraph 44.1(2)(c) and to subsection 85.1(5) of the Act.

This amendment applies to dispositions that occur after December 23, 1998, and also applies in respect of the 1996 and subsequent taxation years, to transfers of capital property that occurred before December 24, 1998.

 

Clause 45

Taxation of Trusts and Their Beneficiaries

Definitions

ITA
108(1)

"testamentary trust"

Subsection 108(1) of the Act defines "testamentary trust" generally as a trust or estate that arose on and in consequence of the death of an individual, and provides some exceptions to that definition.

Subsection 104(1) of the Act provides that references to a "trust" in subdivision k (i.e., sections 104 to 108) of Division B of Part I of the Act include a trust or estate. The definition "testamentary trust" in subsection 108(1) is therefore amended to remove the reference to "estate" because the references in that definition to a "trust" include an estate. For more detail, see the commentary to subsection 104(1).

New paragraph (d) of the definition "testamentary trust" is an anti-avoidance rule. That new paragraph provides that a testamentary trust in a taxation year does not include a trust (in the commentary on this amendment, references to "trust" include an estate) that incurs, after December 20, 2002 and before the end of the taxation year, a debt or any other obligation to pay an amount to, or guaranteed by, a beneficiary or any other person or partnership (referred to in this commentary as the "specified party") with whom any beneficiary of the trust does not deal at arm's length. However, such a debt will not affect the status of the trust as a testamentary trust if it is a debt or other obligation owed to the specified party and

• it is incurred by the trust in satisfaction of the specified party's right as a beneficiary under the trust to enforce payment of an amount of income or capital gains payable by the trust to the specified party or to otherwise receive any part of the capital of the trust,

• it arose because of a service (for greater certainty, not including any transfer or loan of property) rendered by the specified party to, for or on behalf of the trust; for example, this would include debts or other obligations arising in respect of services rendered in a person's capacity as an executor or administrator of an estate, as a liquidator of succession or as a trustee of a the trust, or

• it arose because of a payment made by the specified party for or on behalf of the trust; for example, a payment of funeral expenses on behalf of the deceased's estate. However, to qualify under this provision, additional conditions must be satisfied. In very general terms, these conditions are that the trust fully reimburse the specified party within a year of the specified party making the payment. More precisely, in exchange for the payment the trust must transfer a property to the specified party within 12 months after the specified party made the payment (or, where written application has been made to the Minister by the trust within that 12 months, within any longer period that the Minister considers reasonable in the circumstances). It must also be reasonable to conclude that the specified party would have been willing to make the payment if the specified party dealt at arm's length with the trust.

These amendments apply to trust taxation years that end after December 20, 2002.

French Version of the Definitions "cost amount", "trust" and "eligible offset"

ITA
108(1)

The French version of the definitions of "cost amount", "trust" and "eligible offset" in subsection 108(1) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. These amendments will come into force on Royal Assent.

 

Clause 47

Charitable Donations Deduction

ITA
110.1

Section 110.1 of the Act provides a deduction in computing taxable income in respect of gifts made by corporations to registered charities and to certain other entities. Section 110.1 is amended to expand the entities referred to in this section to include municipal or public bodies performing a function of government in Canada. This amendment is in response to the Quebec Court of Appeal decision in Tawich Development Corporation v. Deputy Minister of Revenue of Quebec, 2001 D.T.C. 5144. For additional information, see the commentary to paragraph 149(1)(d.5).

Section 110.1 is also amended as a consequence of the addition of new subsections 248(30) to (38) of the Act. Generally, those subsections clarify the circumstances under which a transfer of property will be considered a gift notwithstanding that the transferor may be entitled to receive an advantage or benefit in respect of the property. New subsection 248(30) generally provides that the "eligible amount" of the gift is the excess of the fair market value of a property transferred by way of gift over the value of the advantage or benefit, if any, to which the transferor is entitled. For additional information, see the commentary to new subsections 248(30) to (38).

Deduction for Gifts

ITA
110.1(1)

Paragraphs 110.1(1)(a) to (d) of the Act provide, respectively, for the deduction by a corporation of amounts in respect of "charitable gifts", "gifts to Her Majesty", "gifts to institutions" and "ecological gifts". The amount deductible by the corporation is generally the fair market value of the gift. These paragraphs are amended, consequential to the addition of new subsection 248(30) of the Act, to provide that the amount deductible by the corporation is generally the "eligible amount" of a gift.

In addition, paragraphs 110.1(1)(a) and 110.1(1)(d) are expanded to provide that a deduction is available in respect of gifts made by corporations to municipal or public bodies performing a function of government in Canada.

Paragraph 110.1(1)(d) is also amended to clarify its application to "real servitudes" under the Civil Code of Quebec.

The amendments to subsection 110.1(1) apply in respect of gifts made after December 20, 2002, except that the amendments to subparagraphs 110.1(1)(a)(iv.1) and 110.1(1)(d)(iii) apply in respect of gifts made after May 8, 2000.

Gifts of Capital Property

ITA
110.1(2.1) and (3)

Subsection 110.1(3) of the Act provides that, if a corporation donates capital property to a charity, it may designate a value between the adjusted cost base and the fair market value of the donated property to be treated both as the proceeds of disposition for the purpose of calculating its capital gain and the amount of the gift for the purpose of the deduction allowed for charitable donations under subsection 110.1(1) of the Act.

Subsection 110.1(3) is restructured as new subsection 110.1(2.1) and revised subsection 110.1(3). New subsection 110.1(2.1) describes the circumstances under which amended subsection 110.1(3), which remains generally unchanged, will apply. However, where the property is depreciable property, subsection 110.1(2.1) includes those situations where the actual value of the gifted property is between the undepreciated capital cost of that class at the end of the taxation year of the corporation and the fair market value of the donated property.

Amended subsection 110.1(3) provides for the amount that may be designated by the corporation. As with the former provision, the amount designated is considered to be the corporation's proceeds of disposition of the gift. The subsection also continues to provide that the amount designated is treated as the fair market value of the property transferred by way of gift. However, under the amended version, this is for the purpose of new subsection 248(30) of the Act instead of for subsection 110.1(1). New subsection 248(30) generally provides that the "eligible amount" of a gift is the excess of the fair market value of a property transferred by way of gift over the value of the advantage or benefit, if any, to which the transferor is entitled. The "eligible amount" is relevant to the determination of the amount deductible under subsection 110.1(1) by the corporation.

Finally, amended subsection 110.1(3) allows a corporation to reduce the amount of recaptured depreciation that might otherwise be calculated in respect of a gift of depreciable property, with a corresponding reduction to the eligible amount deductible under subsection 110.1(1) in respect of the gift. However, the designated amount may not be lower than the amount of any actual proceeds of disposition in respect of the property (or, more specifically, the amount of the advantage in respect of the gift, as defined in new subsection 248(31) of the Act).

In particular, the amount designated by the corporation in respect of the property transferred may not exceed the fair market value of the property otherwise determined, and may not be less than the greater of

• the amount of the advantage, if any, in respect of the gift, and

• the adjusted cost base of the property or, if the property is depreciable property of the corporation, the undepreciated capital cost of the class of the property at the end of the corporation's taxation year (determined without reference to the proceeds of disposition designated in respect of the property).

See also the example in the commentary to subsections 118.1(5.4) and (6) of the Act, which apply similarly to individuals as do subsections 110.1(2.1) and (3) to corporations.

Subsections 110.1(2.1) and (3) of the Act (as amended) generally apply in respect of gifts made after 1999. For additional details regarding the eligible amount and the amount of the advantage in respect of a gift, see the commentary to new subsections 248(30) and (31) of the Act.

 

Clause 48

Lifetime Capital Gains Exemption

Deduction Not Permitted

ITA
110.6(7)

The French version of paragraph 110.6(7)(b) is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 50.1

Personal Tax Credits

Married Status

ITA
118(1)(a)

Paragraph 118(1)(a) of the Act deals with the tax credit to persons who are married or in a common-law partnership. In 2000, the Act was amended to include common-law partners, but some provisions, including the English version of paragraph 118(1)(a), were overlooked. This paragraph is therefore amended to correct this omission. The amendment applies, in general, to the 2001 and subsequent taxation years. However, it may apply as of 1998 if the common-law partners jointly choose to be deemed as such, beginning in that year, for the purposes of the application of the Act.

Pension Credit

ITA
118(7)

"pension income"

Section 118 of the Act provides for a number of credits that are deductible in computing the tax payable by an individual, including the pension credit in subsection 118(3). The pension credit available to a taxpayer who is 65 years of age or older is based on the taxpayer's "pension income", as defined in subsection 118(7). Pension income includes lifetime annuity payments under a pension plan and payments under a registered retirement income fund (RRIF).

The definition "pension income" is amended to add periodic payments under a money purchase provision of a registered pension plan (RPP), to the extent that such payments are not already included. This amendment is consequential on proposed amendments to the pension registration rules in the Regulations. The amendments allow money purchase RPPs to provide members with retirement benefits that are payable in the same manner as is permitted under a RRIF. Since these benefits would not be considered to be lifetime annuity payments, it is necessary to ensure that they qualify for the purpose of the pension credit. For more details, refer to the commentary on Regulation 8506 set out in Appendix A.

This amendment applies to the 2004 and subsequent taxation years.

 

Clause 51

Charitable Donations Tax Credit

ITA
118.1

Section 118.1 of the Act provides for a charitable donations tax credit to individuals in respect of gifts made to registered charities and to certain other entities. Section 118.1 is amended to expand the entities referred to in this section to include municipal or public bodies performing a function of government in Canada. This amendment is in response to the Quebec Court of Appeal decision in Tawich Development Corporation v. Deputy Minister of Revenue of Quebec, 2001 D.T.C. 5144. For additional information, see the commentary to paragraph 149(1)(d.5).

The amendments to section 118.1, described below, are made consequential to the addition of new subsections 248(30) to (38) of the Act. Generally, those subsections clarify the circumstances under which a transfer of property will be considered a gift notwithstanding that the donor may be entitled to receive an advantage or benefit in respect of the property. New subsection 248(30) generally provides that the "eligible amount" of the gift is the excess of the fair market value of a property transferred by way of gift over the value of the advantage or benefit, if any, to which the transferor is entitled. For additional information, see the commentary to new subsections 248(30) to (38).

Definitions

ITA
118.1(1)

Subsection 118.1(1) of the Act provides definitions of the terms "total charitable gifts", "total Crown gifts", "total cultural gifts" and "total ecological gifts". These definitions apply for the purpose of the tax credit available under subsection 118.1(3) of the Act to individuals who make such gifts. The amount of a gift that is eligible for a tax credit is, generally, the fair market value of the property disposed of by the individual in the making of the gift.

The definitions "total charitable gifts", "total Crown gifts", "total cultural gifts" and "total ecological gifts" in subsection 118.1(1) are amended, as a consequence of the addition of new subsection 248(30) of the Act, to provide that the amount that qualifies for the credit under subsection 118.1(3) is the "eligible amount" of a gift.

In addition, the definition of "total charitable gifts" and the definition of "total ecological gifts" in subsection 118.1(1) are expanded to include a gift to a municipal or public body performing a function of government in Canada.

The definition "total ecological gifts" is also amended to clarify its application to "real servitudes" under the Civil Code of Quebec.

Variable B in the formula the definition "total gifts" in subsection 118.1(1) generally provides that 100% of a taxable capital gain that results from a gift is included in the annual income limit that applies to gifts. This is an enhancement of the 75% income limit that generally applies to other types of income. Variable B is amended as a consequence of the addition of new subsection 248(30) of the Act, to ensure that the enhanced income limit only applies to the portion of a taxable capital gain that relates to the eligible amount of a gift.

The amendments to subsection 118.1(1) apply in respect of gifts made after December 20, 2002, except that the amendments to paragraph (d.1) of the definition of "total charitable gifts" and paragraph (c) of the definition of "total ecological gifts" apply in respect of gifts made after May 8, 2000.

Gift of Capital Property

ITA
118.1(5.4) and (6)

Subsection 118.1(6) of the Act provides that, if an individual donates capital property to a charity, the individual may designate a value between the adjusted cost base and the fair market value of the donated property to be treated both as the proceeds of disposition for the purpose of calculating the individual's capital gain and the amount of the gift for the purpose of calculating the tax credit allowed for charitable donations under subsection 118.1(3) of the Act.

Subsection 118.1(6) is restructured as new subsection 118.1(5.4) and revised subsection 118.1(6). New subsection 118.1(5.4) describes the circumstances under which amended subsection 118.1(6), which remain generally unchanged, will apply. However, where the property is depreciable property, subsection 118.1(5.4) includes those situations where the actual value of the gifted property is between the undepreciated capital cost of that class at the end of the taxation year of the individual and the fair market value of the donated property.

Amended subsection 118.1(6) provides for the amount that may be designated by the individual. As with the former provision, the amount designated is deemed to be the individual's proceeds of disposition of the gift. The provision also continues to provide that the amount designated is treated as the fair market value of the property transferred by way of gift. However, under the amended version, this is for the purpose of new subsection 248(30) of the Act (changed from subsection 118.1(1) of the Act). New subsection 248(30) generally provides that the "eligible amount" of the gift is the excess of the fair market value of a property transferred by way of gift over the value of the advantage or benefit, if any, to which the transferor is entitled. The "eligible amount" is relevant to the determination of the tax credit deductible by the individual under subsection 118.1(3).

Finally, amended subsection 118.1(6) effectively allows an individual to reduce the amount of recaptured depreciation that might otherwise be calculated in respect of a gift of depreciable property, with a corresponding reduction to the eligible amount deductible in respect of the gift under subsection 118.1(6). However, the designated amount may not be lower than the amount of any actual proceeds of disposition in respect of the property (or, more specifically, the amount of the advantage in respect of the gift, as defined under new subsection 248(31) of the Act).

In particular, the amount designated by the individual in respect of the property transferred may not exceed the fair market value of the property otherwise determined, and may not be less than the greater of

• the amount of the advantage, if any, in respect of the gift, and

• the adjusted cost base of the property or, if the property is depreciable property of the individual, the undepreciated capital cost of the class of the property at the end of the individual's taxation year (determined without reference to the proceeds of disposition designated in respect of the property).

Subsections 118.1(5.4) and (6) (as amended) generally apply in respect of gifts made after 1999. For additional details regarding the eligible amount and the amount of the advantage in respect of a gift, see the commentary to new subsections 248(30) and (31).

Designated proceeds		$150,000
Adjusted cost base
(original cost)	65,000	65,000
Capital Gain		85,000
Taxable Capital Gain		42,500
Undepreciated Capital
Cost		45,000
Recaptured depreciation		20,000
Total Income Inclusion		$ 62,500

The eligible amount of the gift is calculated as follows:

Designated proceeds	$150,000
Amount of advantage (consideration)	95,000
Eligible amount of the gift	55,000

 

Clause 52

Medical Expense Tax Credit

ITA
118.2(2)(l.1)

Paragraph 118.2(2)(l.1) of the Act allows for the deduction, as medical expenses, of certain expenses related to a bone marrow or organ transplant. The French version of the paragraph refers to "moelle épinière" rather than "moelle osseuse". The amendment corrects this error and will come into force on Royal Assent.

 

Clause 59

Tax on Split Income

ITA
120.4

Section 120.4 of the Act provides a special 29% tax applicable to certain passive income of individuals under the age of 18. These tax on split income rules were first proposed in the 1999 Budget Plan. At the time, the Government indicated that it "would monitor the effectiveness of this targeted measure, and may take appropriate action if new income-splitting techniques develop".

Definitions

ITA
120.4(1)

"split income"

The expression "split income" describes the type of income to which this measure applies.

Among other things, split income of an individual includes all amounts (other than excluded amounts) required to be included in the individual's income in respect of partnership or trust income if the source of the income is the provision of goods or services by the partnership or trust to, or in support of, a business carried on by

• a person who is related to the individual,

• a corporation of which a person who is related to the individual is a specified shareholder, or

• a professional corporation of which a person related to the individual is a shareholder.

The phrase "goods or services" in the English version of subparagraph (b)(ii) and clause (c)(ii)(C) in the definition "split income" is replaced by the phrase "property of services". This ensures that the split income rules will apply to income from property, such as rental income. This change applies in computing the split income of a specified individual for taxation years that begin after December 20, 2002, other than in computing an amount included in that income that is from a trust or partnership for a fiscal period or taxation year of the trust or partnership that began before December 21, 2002. Also see the commentary to subsection 160(1.2) of the Act, which is amended consequential to this amendment.

[Note the incorrect wording of the phrase "property of services" in this explanatory note, which should read "property or services".]

Clause 61

Small Business Deduction

ITA
125(1)

Under subsection 125(1) of the Act, a CCPC's small business deduction for a taxation year is calculated as 16% of the least of three amounts. One of these, set out in paragraph 125(1)(b), is the amount by which the corporation's taxable income for the year exceeds income that has supported a foreign tax credit (FTC) or that is statutorily exempt from tax. The amount of income that has supported an FTC is determined by multiplying the corporation's FTCs for the year (subject to certain adjustments) by a factor that reflects an assumed rate of tax. For FTCs in respect of foreign non-business income, the factor is currently 10/3, reflecting an assumed tax rate of 30%. For business-income FTCs, the factor is currently 10/4, which reflects an assumed tax rate of 40%.

Subparagraph 125(1)(b)(ii) is amended to adjust the factor for foreign business income, as part of a series of amendments reflecting recent and planned reductions in income tax rates. The factor for business-income FTCs will become 3. This implies an assumed tax rate of 33.3%. This amendment applies to the 2003 and subsequent taxation years.

 

Clause 62

Manufacturing and Processing Profits Deduction

ITA
125.1(1)(b)(ii)

Subsection 125.1(1) of the Act provides the basic rules for the calculation of a corporation's manufacturing and processing profits deduction. The deduction for a given taxation year is the lesser of two amounts, one of which is the corporation's taxable income less certain other amounts. One of these other amounts, described in subparagraph 125.1(b)(ii), is the grossed up amount of the corporation's foreign tax credits (FTCs) for the year in respect of foreign businesses. Currently, the corporation's FTCs are grossed up by a factor of 10/4, which assumes this income was subject to tax at a rate of 40%.

Subparagraph 125.1(1)(b)(ii) is amended to adjust this factor to reflect recent reductions to income tax rates. The new factor will be 3, which implies an assumed tax rate of 33.3% on foreign source business income.

This amendment applies to the 2003 and subsequent taxation years.

 

Clause 62.1

Resource Income

"taxable resource income"

ITA
125.11

Section 125.11 of the Act has the effect of reducing the federal corporate income tax rate for income earned from resource activities from 28% to 21% by 2007. This is accomplished for the years 2003-2006 by providing a deduction against the 28% rate for income that falls within the definition of "taxable resource income". After 2006 resource income will be included in full rate taxable income and be subject to the general rate reduction rules.

Currently, a taxpayer's "taxable resource income" is the lesser of the taxpayer's taxable income for the taxation year and the amount calculated by the following formula: 3(A/B) + C- D. A represents the deduction taken as a resource allowance under paragraph 20(1)(v.1). B is a reduction of the resource allowance, which is being phased out between 2003 and 2006, prorated for non-calendar year-ends. C represents additions to the taxpayer's income resulting from negative resource pools. Lastly, D is any amounts deducted from income on account of resource pools.

The definition "taxable resource income" is being amended to ensure that resource income that was earned by a Canadian-controlled private corporation (CCPC) and received a small business deduction under section 125(1) of the Act is not also eligible for this rate reduction. The result is that a taxpayer's "taxable resource income" will now be the lesser of two amounts. The first amount is the taxpayer's taxable income for the year less 100/16 of the amount the taxpayer deducted from tax payable pursuant to section 125(1) of the Act. The second amount is calculated by the formula 3(A/B) + C - D - E. Elements A to D are unchanged from the previous formula contained in this definition, and remain as described above. New element E is 100/16 of the amount deducted from tax otherwise payable pursuant to subsection 125(1) of the Act. This amendment ensures that resource income earned by a CCPC can only benefit from one rate reduction.

This amendment applies to taxation years that begin after Announcement Date.

 

Clause 63

Canadian Film or Video Production Tax Credit

ITA
125.4

Section 125.4 of the Act sets out the rules that apply for the purpose of computing the Canadian film or video production tax credit ("CFVPTC"). Generally, this tax credit is available at a rate of 25% of qualified labour expenditures incurred by a qualified corporation for a production certified by the Minister of Canadian Heritage to be a Canadian film or video production.

Except as noted below, the amendments to subsection 125.4 generally apply in respect of productions for which development commences on or after November 14, 2003 or the first labour expenditures (as determined under subsections 125.4(1) and (2) as they applied before that date - the "old rules") of the production corporation are incurred after 2003. As well, if development commenced before November 14, 2003 and the first labour expenditures (as defined under the old rules) were incurred by the corporation in its taxation year that includes November 14, 2003, the corporation may elect to have the new rules apply. Subject to this election, corporations must continue to claim the CFVPTC under the old rules for productions that qualified under those rules. Where, in the case of a co-production, more than one qualified corporation is eligible to claim a CFVPTC in respect of the production, the election to have the new rules apply must be made jointly. A production cannot qualify under both schemes.

Definitions

ITA
125.4(1)

"assistance"

In computing the CFVPTC, qualified labour expenditures in respect of a film or video production are limited to 48% of the amount by which the cost of the production exceeds any "assistance" in respect of that cost that has not been repaid.

The definition "assistance" is amended to provide that the equity share of a production of a government or other public authority is treated in the same manner as government assistance. This could include, for example, a loan from a government agency where repayment of the loan is dependent on profit from the production.

"Canadian film or video production certificate"

A qualified corporation must file a Canadian film or video production certificate with its tax return for a taxation year in which it claims a Canadian film or video production tax credit in respect of the production. A "Canadian film or video production certificate", as defined in subsection 125.4(1) of the Act, is issued by the Minister of Canadian Heritage. The definition is amended to provide that that Minister will also certify that the public funding of the production would not be contrary to public policy and that, generally, a qualified corporation or a related taxable Canadian corporation will retain an acceptable share of revenues from the exploitation of the production in non-Canadian markets. The Minister of Canadian Heritage will issue guidelines as to how these criteria can be met.

This amendment generally applies in respect of Canadian film or video productions for which certificates are issued by the Minister of Canadian Heritage after December 20, 2002.

The definition is also amended to remove the requirement for the Minister of Canadian Heritage to provide estimates relevant to the calculation of the CFVPTC, in respect of certificates issued after 2003.

"investor"

The definition "investor" describes a person who is not actively engaged on a regular, continuous, and substantial basis in a Canadian film or video production business carried on through a permanent establishment in Canada. A CFVPTC may not be claimed in respect of a Canadian film or video production where an investor, or a partnership in which an investor has an interest, may deduct an amount in respect of the production.

The definition of investor is repealed, applicable to taxation years that end after November 14, 2003, as well as to productions in respect of which a qualifying production corporation has, in a return of income filed before November 14, 2003, claimed an amount under subsection 125.4(3) of the Act in respect of a labour expenditure incurred after 1997 in respect of the production.

"labour expenditure"

The definition "labour expenditure" describes the underlying expenditures of a qualified corporation in respect of a film or video production that will be eligible for the CFVPTC. The definition is amended concurrently with the repeal of the definition "investor" in subsection 125.4(1) and the amendment of subsections 125.4(2) and (4) of the Act, to include those production expenditures incurred by the qualified corporation for or on behalf of another person. That is, labour expenditures are no longer limited to those included in the cost to the qualified corporation of the production. The definition is also amended concurrently with the introduction of the definition "production commencement time", which represents the time after which an eligible expenditure will qualify for the CFVPTC.

Where a particular corporation is a co-producer with another qualified corporation, and that other corporation has incurred expenditures for or on behalf of the taxpayer, new paragraph 125.4(2)(d) of the Act prevents the particular corporation from claiming a CFVPTC in respect of those expenditures.

For more information on subsections 125.4(2) and (4) and the definitions "investor" and "production commencement time", refer to the commentary for those provisions.

"production commencement time"

For the purpose of the definition "labour expenditure" in subsection 125.4(1) of the Act, in order to be eligible for the CFVPTC, expenditures in respect of a film or video production must be incurred by a qualified corporation from the time that is the "final script stage" of the production. The definition "labour expenditure" is amended to instead refer to expenditures incurred after the production commencement time. The new definition "production commencement time" describes the time that is the latest of the following:

1. The time at which a qualified corporation or its parent company first incurs development labour costs for the development of property of the corporation that is script material on which a Canadian film or video production is based.

2. The first time at which the qualified corporation or its parent company acquires a right in respect of the story that is the basis of the final script. Such rights might include a published literary work, play or screenplay.

3. Two years before the date on which principal photography of the production begins.

It is intended that the in-house development labour costs of an initial draft of a script, as well as the cost of modifications, should fall within the period of production for which labour expenditures qualify for the CFVPTC. These in-house costs could include the cost to hire an independent writer to create a script on the basis of some other story or literary work for which the rights have been acquired by the corporation.

Existing conditions on eligible labour expenditures also apply to scriptwriting labour. (See, for example, amounts excluded from the definition "salary and wages" in subsection 125.4(1) of the Act, such as amounts determined by reference to profits or revenues). As well, the cost to acquire an initial script or any other right referred to above will, like other rights, not qualify. Such an expenditure represents the cost of a property, not a labour expenditure.

The new definition "script material" in subsection 125.4(1) is defined for the purpose of the definition "production commencement time".

"qualified labour expenditure"

The definition "qualified labour expenditure" describes the portion of a qualified corporation's labour expenditures upon which it can claim a 25% investment tax credit for a Canadian film or video production. Under a formula in the definition, qualified labour expenditures in respect of a production are limited to 48% of the amount by which the cost of the production to the qualified corporation exceeds any "assistance" in respect of that cost that has not been repaid.

Variable A in the formula is amended to increase the maximum amount of labour expenditure that qualify for the CFVPTC from 48% to 60% of the cost of the production. The definition is also amended concurrently with the repeal of the definition "investor" in subsection 125.4(1) and the amendment of subsections 125.4(2) and (4) of the Act, to include in the production cost those production expenditures incurred by the qualified corporation for or on behalf of another person. That is, production expenditures are no longer limited to those included in the cost to the qualified corporation of the production.

Where the taxpayer corporation is a co-producer with another qualified corporation, and that other corporation has incurred expenditures for or on behalf of the taxpayer, those expenditures are excluded from the formula by new paragraph 125.4(2)(b) of the Act.

For more information on subsections 125.4(2) and (4) and the definition "investor", refer to the commentary for those provisions.

"salary or wages"

For the purposes of the Canadian film and video production tax credit, the definition "salary or wages", which is generally defined in subsection 248(1) of the Act, does not include an amount described in section 7 of the Act (share option benefits) or any amount determined by reference to profits or revenues.

The definition "salary or wages" is amended to provide that it also does not include an amount paid to a person in respect of services rendered by the person at a time when the person was non-resident, unless the person was at that time a Canadian citizen.

"script material"

The new definition "script material" applies for the purpose of determining the "production commencement time" of a production. Script material is written material describing the story on which the production is based and, for greater certainty, includes a draft script, original story, screen story, narration, television production concept, outline or scene-by-scene schematic, synopsis or treatment. These descriptions are terms commonly used in the film production industry.

Rules Governing Labour Expenditure of a Corporation

ITA
125.4(2)

Subsection 125.4(2) of the Act provides rules that apply for the purpose of the definition of "labour expenditure" in subsection 125.4(1). Paragraph 125.4(2)(a) provides that remuneration does not include remuneration determined by reference to profits or revenues.

Subsection 125.4(2) is amended to provide that it also applies to the definition "qualified labour expenditure" in subsection 125.4(1). In addition, paragraph 125.4(2)(a) is amended to provide that remuneration also does not included remuneration in respect of services rendered by a person at a time when the person was non-resident, unless the person was at that time a Canadian citizen.

A film or video production may be produced jointly by two or more qualified corporations. New paragraph 125.4(2)(d) of the Act is added to ensure that only one qualified corporation may claim a CFVPTC in respect of any particular expenditure. Where another qualified corporation supplies goods to or renders services for or on behalf of the taxpayer corporation, new paragraph 125.4(2)(d) provides that the related expenditure by the taxpayer is not a labour expenditure, a cost or capital cost of the production to the taxpayer. This provision does not affect the calculation of the cost of the production for other purposes of the Act.

Exception

ITA
125.4(4)

Subsection 125.4(4) of the Act provides that a Canadian film or video production tax credit is not available for a production if an investor may deduct an amount in respect of the production in computing its income for any taxation year. An investor is defined in subsection 125.4(1) to include, generally, any person, other than a prescribed person, that does not carry on a film or video production basis in Canada on a substantial basis.

Subsection 125.4(4) is amended concurrently with the repeal of the definition "investor", to deny the CFVPTC only in circumstances where the production or a person or partnership holding an interest in the production is a tax shelter investment for the purpose of section 143.2 of the Act.

However, proposed Income Tax Regulations include a requirement that, for a film or video production to qualify as a Canadian film or video production eligible for the CFVPTC, a prescribed taxable Canadian corporation must retain worldwide ownership of copyright.

This amendment applies to taxation years that end after November 14, 2003, or if a qualifying production corporation has, in a return of income filed before November 14, 2003, claimed an amount under subsection 125.4(3) in respect of a labour expenditure incurred after 1997 in respect of the production.

Revocation of a Certificate

ITA
125.4(6)

Subsection 125.4(6) of the Act provides that a Canadian film or video production certificate in respect of a production may be revoked by the Minister of Canadian Heritage. The revocation of a certificate may occur if an incorrect statement or an omission was made in order to obtain the certificate, or if the production is not a Canadian film or video production. A revoked certificate is considered never to have been issued, so a Canadian film or video production tax credit under new subsection 125.4(3) cannot be claimed in respect of the decertified production.

Subsection 125.4(6) is amended, applicable after November 14, 2003, to clarify that a Canadian film or video production certificate may be revoked in respect of one episode of a television series without affecting the eligibility of other episodes in the series and that, in such a case, the expenditures attributable to that episode do not qualify for the CFVPTC.

Guidelines

ITA
125.4(7)

New subsection 125.4(7) of the Act, which applies in respect of Canadian film or video productions for which certificates are issued by the Minister of Canadian Heritage after December 20, 2002, requires the Minister of Canadian Heritage to issue guidelines respecting the circumstances under which new conditions in the definition "Canadian film or video production certificate" in subsection 125.4(1) are met. For further details, see the commentary for that definition.

 

Clause 64

Foreign Tax Credit

Former Resident - Trust Beneficiary

ITA
126(2.22)

The French version of subsection 126(2.22) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. These amendments will come into force on Royal Assent.

Rules of Construction

ITA
126(6)(d)

Section 126 of the Act permits a taxpayer to claim a foreign tax credit. Subsection 126(1) sets out the rules for claiming the credit in respect of foreign non-business-income tax - that is, the foreign taxes imposed on investment income and other categories of foreign source non-business income. A credit in respect of foreign taxes on business income is provided under subsection 126(2).

Subsection 126(1) has been interpreted to allow a non-business foreign tax credit for non-business foreign tax paid on interest income earned abroad by a Canadian business that does not carry on business in the foreign jurisdiction, and therefore is not eligible for a business foreign tax credit. In order to ensure that the credit continues to be available in these situations, subsection 126(6), which contains interpretation rules that apply to the section, is amended to add new paragraph 126(6)(d). New paragraph 126(6)(d) deems foreign interest income earned from a business carried on in Canada, and for which the business has paid a non-business foreign tax to a country other than Canada, to be from a source in that other country. Therefore, if a taxpayer includes in its Canadian business income for the year foreign interest income, and has paid foreign tax with respect to this amount, the taxpayer will eligible to claim a non-business foreign tax credit subject to the limits set out in section 126.

New paragraph 126(6)(d) applies to amounts received after Announcement Date.

 

Clause 66

Deductions in Computing Tax

Logging Tax Deduction

ITA
127(2)

The amendments to the French version of subsection 172(2) of the Act correct a grammatical error. In this subsection, the expression "revenu tiré pour l'année des opérations forestières dans la province" has the meaning set out in the Income Tax Regulations. However, the expression that appears in the Regulations is "revenu tiré pour l'année d'opérations forestières dans la province", which is grammatically correct. The Act is therefore amended accordingly on Royal Assent.

Contributions to Registered Parties and Candidates

ITA
127(3)

Subsection 127(3) of the Act provides a tax credit to a taxpayer in respect of amounts contributed to a registered party or to a candidate. Subsection 127(3) is amended consequential to the addition of new subsections 248(30) and (31) of the Act, to provide that the amount of a contribution that is eligible for the political contributions tax credit is to be reduced by the amount of any advantage or benefit, as defined by subsection 248(31), to which the taxpayer is entitled in respect of the contribution.

It is proposed that subsections 2000(1) and (6) of the Regulationsbe amended to provide that every official receipt issued by a registered party in respect of a contribution contain, in addition to the information already prescribed, a the eligible amount and the amount of the advantage, if any, in respect of the contribution.

For additional details, see the commentary to new subsections 248(30) and (31) regarding the amount of the advantage in respect of a contribution.

 

Clause 67

Labour-Sponsored Venture Capital Corporations

Definitions

ITA
127.4(1)

"approved share"

Subsection 127.4(2) of the Act allows an individual (other than a trust) a tax credit for the acquisition of an "approved share", which is defined in subsection 127.4(1) as, generally, a share issued by a prescribed LSVCC. LSVCCs prescribed for this purpose under section 6701 of the Regulations include LSVCCs registered under Part X.3 of the Act, as well as specified provincially registered LSVCCs. Paragraph (b) of the definition "approved share" excludes from the definition certain shares issued by a provincially-registered LSVCC that is not a federally-registered LSVCC. This exclusion applies only in the event that, at the time of the issue of the shares, no assistance is available in respect of the acquisition of such shares because of a suspension or termination of assistance to the LSVCC under the laws of every province in which the LSVCC is registered.

Paragraph (b) of the definition "approved share" is amended to provide that an approved share does not include a share issued by a provincially-registered LSVCC (that is not a federally-registered LSVCC) if, at the time of the issue, no province under the laws of which the corporation is an LSVCC that is a prescribed LSVCC provides assistance in respect of the acquisition of the share. This amendment is provided to have the definition "approved share" better reflect the policy that a federal income tax credit be available in respect of a share issued by a provincially-registered LSVCC (that is not a federally-registered LSVCC) only if a provincial income tax credit is also available in respect of the share.

Paragraph (b) of the definition will continue to apply if, at the time of the issue by such an LSVCC of a share, no assistance is available in respect of the acquisition of shares of the LSVCC because of a suspension or termination of assistance to the LSVCC under the laws of every province in which the LSVCC is registered.

Amended paragraph (b) of the definition will also apply where there has not been a suspension or termination of assistance with respect to the issuance of the LSVCC's shares generally, but assistance is not available with respect to the acquisition of a particular share. For example, if under the laws of a province under which an LSVCC is a prescribed LSVCC, a taxpayer who acquires a share is not entitled to any assistance in respect of the acquisition either because of having reached the age of 65 years or because of the province of residence of the taxpayer, the share will not be treated as an approved share.

This amendment applies to the 2003 and subsequent taxation years.

"qualifying trust"

Subsection 127.4(1) of the Act contains the definition of "qualifying trust". In 2000, the Act was amended to include common-law partners, but some provisions, including the English version of the definition of "qualifying trust", were overlooked. This definition is therefore amended to correct this omission. The amendment applies, in general, to the 2001 and subsequent taxation years. However, it may apply as of 1998 if the common-law partners jointly choose to be deemed as such, beginning in that year, for the purposes of the application of the Act.

 

Clause

69.1

Returning Trust Beneficiary

ITA
128.1(7)

The French version of subsection 128(7) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 70

Private Corporations - "refundable dividend tax on hand"

ITA
129(3)(a)

Section 129 of the Act allows a private corporation that pays a taxable dividend to obtain a partial refund of the income taxes it has paid on its investment income. For this purpose, paragraph 129(3)(a) adds to the refundable dividend tax on hand of a Canadian-controlled private corporation at the end of a taxation year the least of three amounts.

One of these amounts, which is described in subparagraph 129(3)(a)(ii), is 26 2/3% of a corporation's taxable income, less income that either benefited from the section 125 small business deduction or supported a foreign tax credit (FTC). Income that supported an FTC is measured by multiplying both the corporation's non-business- and its business-income FTCs by factors that reflect assumed Canadian tax rates. Subparagraph 129(3)(a)(ii) is amended to adjust the factor for foreign business income. The factor for business-income FTCs will become 3. This implies an assumed tax rate of 33.3%.

This amendment applies to the 2003 and subsequent taxation years.

 

Clause 70.1

Definition "mutual fund trust"

ITA
132(6)(c)

Subsection 132(6) of the Act sets out the definition "mutual fund trust". Under paragraph 132(6)(c), a trust will qualify at any time as a mutual fund trust only if at that time it meets prescribed conditions relating to the number of its unit holders, dispersal of ownership of trust units issued by it and public trading of trust units issued by it.

Paragraph 132(6)(c) is amended so that the prescribed conditions that a trust may be required to satisfy in order to qualify as a mutual fund trust are not limited to those relating to ownership and trading of its units.

This amendment applies to the 2000 and subsequent taxation years.

 

Clause 72

Mutual Fund Qualifying Exchanges

Definition "designated beneficiary"

ITA
132.2(3)(g)(iii) and 132.2(1)(j)(iii)

New subparagraph 132.2(3)(g)(iii) of the Act applies in determining whether a person is a "designated beneficiary" (as defined in section 210 of the Act) of a trust. Under the definition designated beneficiary, certain persons or partnerships that are beneficiaries under a trust may be treated (or may cause trusts or partnerships of which they are beneficiaries or members to be treated) as designated beneficiaries under the trust, unless the relevant interest in the trust is held at all times by the person or partnership, as the case may be, or by another person exempt because of subsection 149(1) of the Act from tax, under Part I of the Act, on all of the other person's taxable income.

In a qualifying exchange, a mutual fund trust or mutual fund corporation (transferor) transfers all or substantially all of its property to another mutual fund trust (transferee) and takes back units of the transferee. Those units are then provided by the transferor to its investors in exchange for their shares or units of the transferor. New subparagraph 132.2(3)(g)(iii) ensures that, in these circumstances, the transferor is treated, for the purpose of the definition designated beneficiary, as not having held the units of the transferee.

This amendment applies for qualifying exchanges that occur after 1998. A similar rule, in former subparagraph 132.2(1)(j)(iii), applies for qualifying exchanges that occurred after June 1994 and before 1999.

 

Clause 73

Non-resident-owned Investment Corporations - Transition

ITA
134.1(2)

Section 134.1 of the Act was enacted, along with section 134.2, in 2001 to provide transitional relief for corporations that cease to be non-resident owned investment corporations (NROs). The essence of the relief provided in section 134.1 is to allow such a corporation to recover refundable tax by paying a dividend in its "first non-NRO year". In its current form, the section applies only in respect of dividends paid to a non-resident person or another NRO. There is, however, another kind of shareholder to whom an NRO may pay a dividend in respect of which it is appropriate to apply the section - a trust for the benefit of non-resident persons or their unborn issue. Since such a trust could, under the rules that have governed NROs themselves, have held the shares and debt of an NRO, a dividend to the trust ought to support a refund of the former NRO's refundable tax. Subsection 134.1(2) is therefore amended to include such dividends within the section's scope.

In addition, subsections 104(10) and (11) of the Act are added to the list of provisions in subsection 134.1(2) for which a former NRO is deemed to be an NRO during its first non-NRO year. Prior to the repeal of the NRO system, a trust that received a dividend from an NRO and that did not in turn distribute the amount of the dividend to its non-resident beneficiaries was entitled to deduct that amount from the trust's income under subsection 104(10). Subsection 104(11) then deemed the amount deducted under subsection 104(10) to have been paid to a non-resident beneficiary, with the result that Part XIII withholding tax would typically be payable. These two subsections are included in subsection 134.1(2) in order to allow a trust to benefit from these provisions in the year it receives the final payment of dividends from the former NRO.

Both of these amendments apply on the same basis as section 134.1: that is, to a corporation that ceases to be an NRO because of a transaction or event that occurs, or a circumstance that arises, in a taxation year of the corporation that ends after February 27, 2000.

 

Clause 77

Insurance Corporations

Insurer's Income or Loss

ITA
138(2)

Subsection 138(2) of the Act provides rules relating to the calculation of the income of a resident life insurer that carries on an insurance business in Canada and in a country outside Canada in a taxation year.

Paragraph 138(2)(a) provides that the resident life insurer's income or loss for a taxation year from an insurance business carried on both inside and outside Canada by the insurer is the insurer's income or loss for the year from carrying on that insurance business in Canada. Resident life insurers are, therefore, not subject to Canadian tax on their foreign insurance business income.

Paragraph 138(2)(b) provides that taxable capital gains and allowable capital losses from dispositions of property that are not designated insurance property are not included in computing the resident life insurer's income where the property is used or held in the course of carrying on its insurance business.

The expression "designated insurance property" is defined in subsection 138(12) of the Act and in section 2401 of the Regulations.

Subsection 138(2) of the Act is amended in the following ways.

New paragraph (a) ensures that the gross investment revenue from property of a resident life insurer (used or held by it in the course of carrying on an insurance business) will be included in computing the insurer's income from its insurance business in Canada only where the property is a designated insurance property of the insurer for the year.

It also ensures that taxable capital gains and allowable losses from dispositions of the insurer's property used or held by the insurer in the course of carrying on an insurance business will be included in computing the insurer's income for a taxation year from its insurance business in Canada only where the property disposed of was designated insurance property for the taxation year in which the insurer disposed of the property.

New paragraph (b) ensures that the gross investment revenue from property of a non-resident insurer that carries on an insurance business in Canada (used or held by it in the course of carrying on an insurance business) will be included in computing the insurer's income from its insurance business in Canada only where the property is a designated insurance property of the insurer for the year.

It also ensures that taxable capital gains and allowable losses from dispositions of the insurer's property used or held by the insurer in the course of carrying on an insurance business will be included in computing the insurer's income for a taxation year from its insurance business in Canada only where the property disposed of was designated insurance property for the taxation year in which the insurer disposed of the property.

The definition "designated insurance property" in subsection 248(1) of the Act adopts the definition in subsection 138(12).

These amendments to subsection 138(2) apply to taxation years that end after 1999.

 

Clause 78

Mark-to-Market Rules

ITA
142.6(1)

Subsection 142.6(1) of the Act contains rules that apply where a taxpayer becomes (or ceases to be) a financial institution. This is most likely to happen where the change of status occurs because the taxpayer becomes (or ceases to be) controlled by a financial institution.

If a taxation year of the taxpayer does not end immediately before the time at which its status as a financial institution changes, subparagraph 142.6(1)(a)(i) deems the taxpayer's taxation year that would otherwise have included that time to end immediately before that time. A new taxation year begins at that time, and the taxpayer is permitted to adopt a new fiscal period. One purpose for the deemed year-end is to ensure the proper application, in taxation years in which the taxpayer is a financial institution, of the rules, commonly known as the mark-to-market rules,

• in section 142.3 of the Act for specified debt obligations, and

• in section 142.5 of the Act for market-to-market properties.

The expressions "financial institution", "specified debt obligation" and "mark-to-market property" are defined in section 142.2 of the Act.

Paragraph 142.6(1)(b) applies where a taxpayer becomes a financial institution. This paragraph generally provides for a deemed disposition at fair market value of each property held by the taxpayer that is

• a specified debt obligation (other than a specified debt obligation that is a mark-to-market property to which subparagraph 142.6(1)(b)(ii) applies)^[1], or

• a mark-to-market property for the taxpayer's taxation year that ends immediately before the time of the change of status^[2].

This deemed disposition under paragraph 142.6(1)(b) is intended to ensure that amounts brought, because of the mark-to-market rules in sections 142.3 and 142.5, into the taxpayer's income for the taxpayer's subsequent taxation year (i.e., the taxation year that includes the time of the change of status) do not include gains or losses accrued before the beginning of that subsequent taxation year.

Paragraph 142.6(1)(b) is amended to ensure that this is achieved in connection with mark-to-market properties. Amended paragraph 142.6(1)(b) results in the taxpayer being deemed to have disposed of, immediately before the end of its particular taxation year that ends immediately before the time of the change of status, and for proceeds equal to its fair market value at the time of that disposition, a mark-to-market property of the taxpayer

• for the particular taxation year, or

• for the subsequent taxation year.

Paragraph 142.6(1)(c) provides for a deemed disposition of specified debt obligations (other than mark-to-market property) in the opposite situation of change of status, i.e., where the taxpayer ceases to be a financial institution. Paragraph 142.6(1)(d) provides that the taxpayer is deemed to have reacquired, at the end of the taxation year referred to in paragraph 142.6(1)(b) or (c), each property deemed by that paragraph to have been disposed of by the taxpayer, at a cost equal to the proceeds of disposition of the property.

Consequential to the amendments to paragraph 142.6(1)(b), paragraph 142.6(1)(d) is amended to provide that the taxpayer is deemed to have reacquired, at the end of its taxation year that ends immediately before the time of the change of status, each property deemed by paragraph 142.6(1)(b) or (c) to have been disposed of by the taxpayer, at a cost equal to the proceeds of disposition of the property.

Amended paragraphs 142.6(1)(b) and (d) apply to taxation years that end after 1998.

 

Clause 80.1

Limited-recourse Debt in Respect of a Gift or Monetary Contribution

ITA
143.2(6.1)

New subsection 143.2(6.1) of the Act describes limited-recourse debt in respect of a gift or monetary contribution made after February 18, 2003. Such an amount is an advantage under subsection 248(31) of the Act, such that it reduces the eligible amount of a gift or political contribution determined under subsection 248(30) of the Act. For additional details regarding the amount of an advantage, see the commentary to new subsection 248(31).

A limited-recourse debt includes the unpaid principal of any indebtedness for which recourse is limited, even if that limitation applies only in the future or contingently. It also includes any other indebtedness of the taxpayer, related to the gift or contribution, if there is a guarantee, security or similar indemnity or covenant in respect of that or any other indebtedness. For example, if a donor (or any other person mentioned below) enters into a contract of insurance whereby all or part of a debt will be paid upon the occurrence of either a certain or contingent event, the debt is a limited-recourse debt in respect of a gift if it is in any way related to the gift.

Such an indebtedness is also a limited-recourse debt if it is owed by a person dealing non-arm's length with the taxpayer or by a person who holds an interest in the taxpayer.

Information Located Outside Canada

ITA
143.2(13)

Subsection 143.2(13) of the Act applies where information related to an indebtedness in respect of an expenditure is located outside Canada, and the Minister of National Revenue is not satisfied that the indebtedness is not a limited-recourse amount. In such a case, the indebtedness is deemed to be a limited-recourse amount in respect of the expenditure. Subsection 143.2(13) is extended to also apply in respect of an indebtedness that relates to a gift or political contribution made after February 18, 2003.

 

Clause 83

Registered Education Savings Plans - Conditions for Registration

ITA
146.1(2)(g.3) and (2.3)

Subsection 146.1(2) of the Act sets out the conditions that must be satisfied in order for an education savings plan to be accepted for registration.

New paragraph 146.1(2)(g.3) is introduced to preclude non-residents and individuals who have not yet been assigned a Social Insurance Number (SIN) from becoming a beneficiary under a registered education savings plan (RESP) or from benefiting from RESP contributions.

Specifically, paragraph 146.1(2)(g.3) requires that an education savings plan not permit an individual to be designated as a beneficiary under the plan and not allow a contribution for a beneficiary under the plan, unless the individual's SIN has been provided to the promoter of the plan and the individual is resident in Canada.

If an individual is designated as a beneficiary under an RESP in conjunction with the transfer of property into the plan from another RESP under which the individual was a beneficiary immediately before the transfer, the requirement that the individual be resident in Canada in order to be designated as a beneficiary does not apply. However, subject to the exceptions in new subsection 146.1(2.3), the individual's SIN has to be provided to the promoter in order for the individual to be designated as a beneficiary under the transferee RESP. This special rule is intended primarily to accommodate transfers from an RESP to a replacement RESP after the beneficiary has ceased to be resident of Canada. (It should be noted that the transfer itself, as a contribution to an RESP, is not subject to the SIN and residency conditions that apply to ordinary contributions.)

New subsection 146.1(2.3) provides two additional exceptions to the SIN condition that are primarily of relevance to RESPs that were entered into before 1999 and RESPs that replace such plans. These exceptions recognize that the Canada Customs and Revenue Agency only began requiring the beneficiary's SIN to be provided on the application for registration for plans entered into after 1998.

The first new exception allows an education savings plan that was entered into before 1999 to not require that an individual's SIN be provided in respect of a contribution to the plan. Such contributions, however, continue to be ineligible for the Canada Education Savings Grant. It should be noted that this exception is only relevant for contributions made for existing beneficiaries under such plans. An individual without a SIN is prevented from being designated as a new beneficiary under such a plan.

Under the second new exception, an education savings plan may permit a non-resident individual who does not have a SIN to be designated as a beneficiary under the plan provided that the designation is being made in conjunction with a transfer of property into the plan from another RESP under which the individual was a beneficiary immediately before the transfer. This exception is intended, in particular, to accommodate the transfer of property from an RESP that was entered into before 1999, under which the beneficiary had always been non-resident or had ceased to be resident in Canada before having been assigned a SIN, to a replacement RESP (and successive transfers).

Paragraph 146.1(2)(g.3) and subsection 146.1(2.3) apply after 2003.

 

Clause 84

Registered Retirement Income Funds

Amount Included in Income

ITA
146.3(5.1)

In 2000, the Act was amended to include common-law partners, but some provisions, including the English version of subsection 146.3(5.1), were overlooked. This subsection is therefore amended to correct this omission. The amendment applies, in general, to the 2001 and subsequent taxation years. However, it may apply as of 1998 if the common-law partners jointly choose to be deemed as such, beginning in that year, for the purposes of the application of the Act.

 

Clause 87

Exemptions - Municipalities and Other Governmental Public Bodies

ITA
149(1)(d.5)

Paragraph 149(1)(d.5) of the Act exempts from tax, subject to an income test, the taxable income of any corporation, commission or association at least 90% of the capital of which is owned by one or more municipalities in Canada.

In accordance with the Tax Court of Canada decision in Otineka Development Corporation Limited and 72902 Manitoba Limited v. The Queen, 94 D.T.C. 1234, [1994] 1 C.T.C. 2424, an entity could be considered a municipality for the purpose of this paragraph on the basis of the functions it exercised. More recently, however, the decision in Tawich Development Corporation v. Deputy Minister of Revenue of Quebec, [1997] 2 C.N.L.R. 187 (Que. Civil Chamber), aff'd 2001 D.T.C. 5144 (Que. C.A.), a decision under the Taxation Act (Quebec), held that an entity could not attain the status of a municipality by exercising municipal functions but only by statute, letters patent or order. From a tax policy perspective, it is desired that the entities previously entitled to the exemption on the basis of the Otineka decision continue to have access to the exemption. This amendment resolves the uncertainty resulting from the two conflicting cases. The exemption in paragraph 149(1)(d.5) is therefore extended to include any corporation, commission or association at least 90% of the capital of which was owned by one or more entities each of which is a municipal or public body performing a function of government in Canada, which is consistent with the bodies described in paragraph 149(1)(c) of the Act.

This amendment applies to taxation years that begin after May 8, 2000.

Exemptions - Subsidiaries of Municipal Corporations

ITA
149(1)(d.6)

Paragraph 149(1)(d.6) of the Act exempts from tax, subject to an income test, a wholly-owned subsidiary of a corporation, commission or association referred to in paragraph 149(1)(d.5) of the Act. As a consequence of the amendment to paragraph 149(1)(d.5), the geographical boundaries of the entities referred to in subparagraphs (i) and (ii) of paragraph 149(1)(d.6) are expanded to include references to all of the entities in the amended 149(1)(d.5).

This amendment applies to taxation years that begin after May 8, 2000.

Income Test

ITA
149(1.2)

Subsection 149(1.2) of the Act excludes, for the purposes of paragraphs 149(1)(d.5) and (d.6) of the Act, certain income from the determination of where an entity to which either of those paragraphs applies derives its income. As a consequence of the amendment to paragraph 149(1)(d.5), a written agreement in subsection 149(1.2) is expanded to include reference to a municipal or public body.

In addition, subparagraph 149(1.2)(a)(vi) is added to clarify that the geographical boundary of a municipal or public body performing a function of government in Canada is defined to be the area described in new subsection (11).

This amendment applies to taxation years that begin after May 8, 2000.

Votes or de Facto Control

ITA
149(1.3)

Subsection 149(1.3) of the Act provides that, for the purposes of applying paragraph 149(1)(d.5) and subsection 149(1.2) of the Act to a corporation, 90% of the capital of the corporation is considered to be owned by one or more municipalities only if the municipalities are entitled to at least 90% of the votes associated with the shares of the corporation.

As a consequence of the amendment to paragraph 149(1)(d.5), subsection 149(1.3) is amended applicable to taxation years that begin after May 8, 2000, to include reference to municipal or public bodies performing a function of government in Canada.

In addition, subsection 149(1.3) is replaced, applicable to taxation years that begin after December 20, 2002, to provide that paragraphs 149(1)(d) to (d.6) do not apply to exempt a person's taxable income for a period in a taxation year in two cases.

First, under new paragraph 149(1.3)(a), a corporation is not exempt from tax on its taxable income for a period in a taxation year if at any time during the period the corporation has issued shares that are owned by one or more persons (other than certain tax-exempts) that, in total, give them more than 10% of the votes that could be cast at a meeting of shareholders. For this purpose, it is necessary to determine whether more than 10% of the votes could be cast at a meeting of the shareholders by a person or persons other than:

• Her Majesty in right of Canada or of a province,

• a municipality in Canada,

• a municipal or public body performing a function of government in Canada, or

• a commission, an association or a corporation, to which any of paragraphs 149(1)(d) to (d.6) apply.

Second, under new paragraph 149(1.3)(b), a person is not exempt because of any of paragraphs 149(1)(d) to (d.6) from tax on taxable income for a period in a taxation year if at any time in the period the person is, or would be if the person were a corporation, controlled, directly or indirectly in any manner whatever, by a person (or by a group of persons that includes a person) other than:

• Her Majesty in right of Canada or of a province,

• a municipality in Canada,

• a municipal or public body performing a function of government in Canada, or

• a commission, an association or a corporation, to which any of paragraphs 149(1)(d) to (d.6) apply.

For further details about the expression "controlled, directly or indirectly in any manner whatever", reference should be made to subsections 256(5.1) and (6) of the Act. In general, the expression refers to a controller, who has any direct or indirect influence that, if exercised, would result in control in fact of the person.

Geographical Boundaries - Body Performing Government Functions

ITA
149(11)

Subsection 149(11) of the Act is added to define, for the purposes of section 149, the geographical boundaries of a municipal or public body performing a function of government in Canada. Those boundaries are defined as encompassing the area in respect of which an Act of Parliament or an agreement given effect by an Act of Parliament recognizes or grants to the body a power to impose taxes; or if there has been no such recognition or grant, the area within which the body has been authorized by the laws of Canada or of a province to exercise that function.

For example, if a particular self-governing First Nation meets the definition of "a public body performing a function of government in Canada," it is intended that the relevant geographic boundary would delineate the area where the self-government agreement, or the statute enacting self-government powers, provides the First Nation authority to impose direct taxes. As a second example, if a particular Indian Band meets the definition of "a public body performing a function of government in Canada," it is intended that the geographic boundary of the Indian Band be the band's reserves as defined in the Indian Act. Similarly, if a particular school board meets the definition of "a municipal or public body performing a function of government in Canada" it is intended that the geographic boundary of the school board be the area of jurisdiction of the board as defined by provincial legislation or regulation.

This amendment applies to taxation years that begin after May 8, 2000.

 

Clause 88

Charities

Revocation of Registration

ITA
149.1(2), (3) and (4)

Subsections 149.1(2), (3) and (4) of the Act set out the reasons for which the Minister of National Revenue may revoke the registration of a charitable organization, a public foundation and a private foundation, respectively. These subsections are amended to permit the revocation of the registration of such entities if they make gifts (other than gifts made in the course of their charitable activities) to persons or entities that are not qualified donees. A "qualified donee" is essentially a person or entity to which a tax deductible or tax creditable donation may be made.

These amendments apply to gifts made after December 20, 2002.

 

Clause 107.1

Distribution Deemed Disposition

ITA
200

The French version of section 200 of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 108.1

Transfers Between Plans

ITA
204.9(5)

The French version of section 200 of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 109

Tax in Respect of Certain Property Acquired by Trusts, etc.

ITA
Part XI

Part XI of the Act sets out rules for the 1% per month penalty tax on registered pension plans, registered retirement savings plans and other deferred income plans and funds in respect of their excess foreign property holdings.

Definitions

ITA
206(1)

"foreign property"

"Foreign property" is defined in subsection 206(1) of the Act. Under paragraph (d.1) of the definition, foreign property includes certain shares and debt issued by Canadian corporations, if shares of the corporation may reasonably be considered to derive their value primarily from foreign property. Paragraph (g) of the definition treats as foreign property the indebtedness of a non-resident person other than indebtedness issued by various international organizations or indebtedness issued by an authorized foreign bank and payable at a Canadian branch of that bank.

Paragraphs (d.1) and (g) are amended to provide that an indebtedness that is a mortgage obligation secured by real property situated in Canada is not foreign property. For the exclusion to apply, the amount of the mortgage obligation (together with the amount of any other indebtedness in respect of the property that is of equal or superior rank) must not exceed the fair market value of the property, except as a result of a decline in the fair market value of the real property after issuance of the mortgage obligation. This test applies on an on-going basis. These amendments apply to months ending after October 2003.

 

Clause 110

Definitions and Application

ITA
210

Section 210 of the Act defines "designated beneficiary" for the purpose of Part XII.2.

Section 210 is amended so that a number of definitions that apply for the purposes of Part XII.2 are now found in new subsection 210(1). In addition, new subsection 210(2) replaces section 210.1 of the Act, which is being repealed.

Definitions

ITA
210(1)

New subsection 210(1) of the Act contains the definitions "designated beneficiary" (previously found in section 210 of the Act) and "designated income" (previously found in subsection 210.2(2) of the Act). These definitions apply in Part XII.2.

"designated beneficiary"

Under paragraphs (a) and (b) of the definition "designated beneficiary", a designated beneficiary includes, respectively, a non-resident person and a non-resident-owned investment corporation. Under paragraph (c) of the definition, a person exempt from tax under Part I of the Act is treated as a designated beneficiary because of owning an interest in a trust (acquired from a beneficiary under the trust) unless, generally speaking, no taxable entity previously owned that interest. Under paragraph (d) of the definition, a trust is a designated beneficiary of another trust if a beneficiary of the trust includes, generally, either a person or partnership described in any of paragraphs (a), (b), (c) or (e) of the definition or another trust (other than a testamentary trust resident in Canada). Under paragraph (e) of the definition, a partnership is a designated beneficiary of a trust if a member of the partnership is a person described in paragraph (a), (b) or (d) of the definition, another partnership or a person exempt from tax under Part I by reason of subsection 149(1) of the Act.

The opening words of the definition "designated beneficiary" are amended so that the references in the definition to a "trust" under which there may be a designated beneficiary are references to a "particular trust".

Paragraph (c) of the definition "designated beneficiary" is amended to clarify that a designated beneficiary of a particular trust includes, except as provided in subparagraphs (c)(i) and (ii) of the definition, a person who is, because of subsection 149(1), exempt from tax under Part I on all or part of their taxable income and who acquired an interest in the particular trust after October 1, 1987 directly or indirectly from a beneficiary under the particular trust.

Paragraph (d) of the definition "designated beneficiary" is amended so that a designated beneficiary of a particular trust includes another trust (in this commentary referred to as the "other trust") having as a beneficiary any one of the following persons or partnerships:

• under subparagraphs (d)(i) and (ii) of the definition, a non-resident person (including a trust) or a non-resident-owned investment corporation;

• under subparagraphs (d)(iii) of the definition, any trust, other than

• under subparagraph (d)(iv) of the definition, a person (including a trust) or partnership that

Note that a person or partnership that is a beneficiary of the other trust need only be described in any of one of subparagraphs (d)(i) to (iv) in order for the other trust to be a designated beneficiary of the particular trust. Note also that references in paragraph (d) of the definition to the expression "resident in Canada" are removed as these are unnecessary given that paragraph (a) of the definition provides that a non-resident person is a designated beneficiary.

Paragraph (d) of the definition is also amended to provide that the other trust will not be treated, under that paragraph, as a designated beneficiary of the particular trust if it is a testamentary trust, a mutual fund trust, or a trust that is exempt because of subsection 149(1) from tax under Part I on all or part of its taxable income. However, these excluded trusts may be treated as designated beneficiaries of the particular trust under paragraphs (a) or (c) of that definition (e.g., a non-resident testamentary trust).

Amended paragraph (e) of the definition provides, in new subparagraph (e)(i), that a designated beneficiary of a particular trust includes a particular partnership any of the members of which is another partnership. However, no such other partnership will cause the particular partnership to be a designated beneficiary under the particular partnership if

• all such other partnerships are Canadian partnerships (as defined in subsection 102(1) of the Act),

• the interest of each such other partnership in the particular partnership is held, at all times after the day on which the interest was created, by the other partnership or by persons who were exempt because of subsection 149(1) from tax under Part I on all of their taxable income,

• the interest of each member, of each such other partnership, that is a person exempt because of subsection 149(1) from tax under Part I on all or part of its taxable income was held, at all times after the day on which the interest was created, by that member or by persons who were exempt because of subsection 149(1) from tax under Part I on all of their taxable income, and

• the particular partnership's beneficial interest in the particular trust is held, at all times after the day on which the interest was created, by the particular partnership or by persons who were exempt because of subsection 149(1) from tax under Part I on all of their taxable income.

Under subparagraphs (e)(ii) to (iv), a particular partnership will be a designated beneficiary under a particular trust if any one of the partnership's members is a non-resident person, a non-resident-owned investment corporation, or a specified person. For this purpose, a specified person means a trust that is a designated beneficiary of the particular trust because of paragraph (d) of the definition or a trust that would be such a designated beneficiary on the following assumptions: the other trust were at that time a beneficiary under the particular trust whose interest as a beneficiary under the particular trust were

• acquired from each person or partnership from whom the particular partnership acquired its interest as a beneficiary under the particular trust, and

• held at all times after the later of October 1, 1987 and the day on which the particular partnership's interest as a beneficiary under the particular trust was created, by the same persons or partnerships that held at those times that interest of the particular partnership.

New subparagraph (e)(v) of the definition provides that a particular partnership will be a designated beneficiary of a particular trust if any of the members of the particular partnership is a person exempt because of subsection 149(1) from tax under Part I on all or part of its taxable income, unless the interest of the particular partnership in the particular trust was held, at all times after the day on which the interest was created, by the particular partnership or by persons who were exempt because of subsection 149(1) from tax under Part I on all of their taxable income.

Note that, for the purposes of the definition "designated beneficiary", a new rule in section 132.2 applies in respect of certain trust units acquired by a beneficiary under a "qualifying exchange" (as defined in subsection 132.2(1)). For more detail, see the commentary on section 132.2.

It will be proposed to amend paragraph 210.2(3)(b) to ensure that subsection 210.2(3) does not apply to a non-resident person that would be a designated beneficiary under the trust if the definition "designated beneficiary" in subsection 210(1) were read without reference to its paragraph (a). It also will be proposed to amend subsection 252(3) of the Act so that the reference in that subsection to existing subparagraph 210(c)(ii) is changed to a reference to new subparagraph (c)(ii) of the definition "designated beneficiary" in subsection 210(1).

These amendments apply to the 1996 and subsequent taxation years.

"designated income"

The tax under Part XII.2 of the Act is calculated by reference to a trust's "designated income" (as determined under subsection 210.2(2)).

Subsection 210.2(2) is being repealed and the definition "designated income" is now found in subsection 210(1) of the Act.

Paragraphs (a), (b) and (d) of the new definition "designated income" in subsection 210(1) are largely unchanged from the equivalent provisions found in repealed subsection 210.2(2).

Paragraph (c) of the new definition replaces paragraph 210.2(2)(b). Under subparagraph (c)(i), designated income is calculated by reference to taxable capital gains and allowable capital losses from dispositions of the trust's taxable Canadian property. Subparagraph (c)(ii) provides that a trust's designated income is also calculated by reference to taxable capital gains and allowable capital losses from a disposition by the trust of particular property (other than property described in any of subparagraphs 128.1(4)(b)(i) to (iii) of the Act).

In this context, particular property (or property for which the particular property is a substitute) must be property (referred to in this commentary as the "transferred property") that was transferred to a particular trust in circumstances in which subsection 73(1) or 107.4(3) of the Act applied. This condition will be met whether the particular trust is the trust in respect of which the designated income is being determined, or any other trust to which the transferred property was transferred in circumstances in which subsection 73(1) or 107.4(3) applied and that subsequently transferred, directly or indirectly, the property to the trust in respect of which the designated income is being determined.

In addition, clauses (c)(ii)(A) and (B) of the definition require

• that it be reasonable to conclude that the transferred property was, at a particular time, transferred to the particular trust in anticipation of the emigration of a person beneficially interested at the particular time in the particular trust and that a person (whether the anticipated person or another) beneficially interested at that time in the particular trust subsequently ceases to reside in Canada, or

• at the particular time that the transferred property was transferred to the particular trust, that the terms of the particular trust satisfy the conditions in subparagraph 73(1.01)(c)(i) or (iii) of the Act and that it be reasonable to conclude that the transfer was made in connection with the cessation of residence, on or before that time, of a person who was, at that time, beneficially interested in the particular trust and a spouse or common-law partner, as the case may be, of the transferor of the transferred property to the particular trust.

These amendments generally apply for the 1996 and subsequent taxation years. Subparagraph (c)(ii) of the definition applies, in effect, to dispositions, of property by a trust, that occur after December 20, 2002.

Application of Part XII.2

ITA
210(2)

Section 210.1 of the Act provides a list of types of trusts to which Part XII.2 does not apply.

Section 210.1 is being repealed. The list of types of trusts to which Part XII.2 does not apply is now found in new subsection 210(2). New subsection 210(2), consequential on the amendments to the definition "designated beneficiary" (described in the commentary above), also clarifies that it applies only to determine to which trusts the special Part XII.2 tax does not apply. Subsection 210(2) does not apply, for example, to determine whether a trust referred to in that subsection may have a designated beneficiary.

References in the Act to section 210.1 (e.g., see subsection 210.2(1.1)) will be proposed to be amended to reflect its repeal and its substantive re-enactment as new subsection 210(2).

This amendment applies to the 1996 and subsequent taxation years.

 

Clause 114

Taxation of Non-Residents

Non-resident Withholding Tax - Interest

ITA
212(1)(b)(xiii)

Securities lending arrangements often include an obligation for one party to compensate the other for certain income amounts. In the absence of special rules, these compensation payments may be subject to tax under Part XIII if they are paid by a person resident in Canada to a non-resident person.

New subparagraph 212(1)(b)(xiii) exempts from tax under Part XIII certain interest compensation payments made to a non-resident by a borrower resident in Canada under a securities lending arrangement. For this exemption to apply,

• the payments must be made by the borrower in the course of carrying on its business outside of Canada; and

• the borrowed securities must be issued by a non-resident issuer.

This amendment applies to securities lending arrangements entered into after May 1995, except that, before 2002, the reference to "subparagraph 260(8)(c)(i)" should be read as "subparagraph 260(8)(a)(i)".

Estate and Trust Income

ITA
212(1)(c)

The French version of paragraph 212(1)(c) is amended to replace the term "paiement" with the term "distribution" for consistency with other provisions of the Act dealing with amounts distributed by trusts and estates. This amendment will come into force on Royal Assent.

Rents, Royalties, etc.

ITA
212(1)(d)

Paragraph 212(1)(d) of the Act describes various amounts, in the nature of rent, royalties and similar payments, on which tax under Part XIII of the Act is imposed. Subparagraphs 212(1)(d)(vi) through (xi) list payments to which the tax does not apply. Two new exclusions are added to paragraph 212(1)(d).

First, subparagraph 212(1)(d)(xi), which currently provides that Part XIII tax does not apply to payments made to an arm's length person for the use of property that is an aircraft, certain attachments thereto as well as to spare parts for such property, is amended, applicable after July 2003, to also apply to air navigation equipment utilized in the provision of services under the Civil Air Navigation Services Commercialization Act, and to computer software that is necessary to the operation of that equipment that is used by the payer for no other purpose.

Second, new subparagraph 212(1)(d)(xii) clarifies that subsection 212(5) of the Act, which is amended as described below, is the sole provision in Part XIII that applies the tax to payments for rights in or to use a film or video that is used or reproduced in Canada. This change applies for the 2000 and subsequent taxation years.

Restrictive Covenant Amount

ITA
212(1)(i)

New paragraph 212(1)(i) of the Act includes, as amounts subject to the withholding tax, two amounts. First, the withholding tax applies to an amount in respect of a restrictive covenant to which new subsection 56.4(2) applies. Second, the withholding tax applies to an amount to which new paragraph 56(1)(m) applies (an amount received on a bad debt previously deducted).

New paragraph 212(1)(i) applies to amounts paid or credited after October 7, 2003.

Exempt Dividends

ITA
212(2.1)

New subsection 212(2.1) is added to exempt from Part XIII tax certain dividend compensation payments made to a non-resident by a Canadian securities borrower under a securities lending arrangement if

• the payments were deemed to be dividends by subparagraph 260(8)(c)(i) of the Act;

• the payments were made by the borrower in the course of carrying on its business outside of Canada; and

• the borrowed securities were issued by a non-resident issuer.

This amendment applies to securities lending arrangements entered into after May 1995, except that, before 2002, the reference to "subparagraph 260(8)(c)(i)" should be read as "subparagraph 260(8)(a)(i)".

Replacement Obligations

ITA
212(3)

Among the exceptions to the imposition of tax under Part XIII of the Act on interest is one found in subparagraph 212(1)(b)(vii) for interest paid by a corporation resident in Canada on its medium- and long-term arm's length debt. Subsection 212(3), which applies for the purpose of subparagraph 212(1)(b)(vii), allows a corporation in certain circumstances of financial difficulty to treat a debt obligation that replaces another as having been issued when that other obligation was issued. The circumstances in which this is possible are set out in paragraphs 212(3)(a) to (c). Paragraph 212(3)(b) requires that, for the subsection to apply, it must be possible to regard the proceeds of the replacement borrowing as being used in financing an active business that was carried on in Canada, by the issuing company or one with which it does not deal at arm's length, immediately before the replacement obligation was issued.

There is no clear basis in tax policy for this requirement. The condition in paragraph 212(3)(b) is repealed for replacement debt obligations that are issued after 2000.

Rent and Other Payments

ITA
212(13)

Subsection 212(13) of the Act imposes non-resident withholding tax on certain payments made by one non-resident to another non-resident. Subsection 212(13) is amended to add new paragraph (g), which imposes non-resident withholding tax on amounts paid or credited by a non-resident for a restrictive covenant to which paragraph 56.4(2) of the Act applies, or an amount to which paragraph 56(1)(m) of the Act applies (an amount received on a bad debt previously deducted), if the amount affects, or is intended to affect, in any way whatever,

• the acquisition or provision of property or services in Canada,

• the acquisition or provision of property or services outside Canada by a person resident in Canada, or

• the acquisition or provision outside of Canada of a taxable Canadian property.

New paragraph 212(13)(g) applies to amounts paid or credited after October 7, 2003.

Application of Part XIII Tax Where Non-Resident Operates in Canada

ITA
212(13.2)

Subsection 212(13.2) of the Act is one of several provisions that extend Part XIII tax to apply in particular circumstances - in this case, for the most part, the payment by a non-resident of royalties and similar amounts in respect of a Canadian income source. The principle that underlies subsection 212(13.2) is that if a non-resident has Canadian-source business or resource income, and can deduct in computing that income (strictly speaking, in computing "taxable income earned in Canada") a payment to another non-resident, that payment ought to be treated for purposes of Part XIII tax as though it had been made by a person resident in Canada. This is accomplished by treating the first non-resident - the one making the payment - as a person resident in Canada for those purposes.

In its current form, subsection 212(13.2) applies only if the non-resident making the payment carries on business principally in Canada, manufactures or processes goods in Canada or carries out any of various resource activities here. On the other hand, the rule does not explicitly link that business or activity to the deductibility of the payment: it can be read as applying whether or not the payment is made in relation to the particular business or activity.

Accordingly, subsection 212(13.2) is amended to apply in respect of any portion of a payment (other than one to which the generally comparable rule in subsection 212(13) applies) made by one non-resident person to another that is deductible in computing the first non-resident's taxable income earned in Canada from any source. The only exceptions are payments that are deductible in respect of treaty-protected businesses or treaty-protected properties (as defined in subsection 248(1) of the Act).

This amendment applies to amounts paid or credited under obligations entered into after December 20, 2002.

 

Clause 114.1

Deemed Payments

ITA
214(3)

The French version of paragraph 214(3)(k) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 115.1

Security for Tax on Distributions of Taxable Canadian Property to Non-resident Beneficiaries

ITA
220(4.6) and (4.61)

The French version of subsections 220(4.6) and (4.61) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

 

Clause 116.1

Tax Shelters

Definitions

ITA
237.1(1)

Subsection 237.1(1) of the Act provides definitions of terms that apply for the purpose of tax shelter identification and the definition of "tax shelter investment" in subsection 143.2(1) of the Act. The definition "gifting arrangement" includes an arrangement in respect of which it may reasonably be expected, having regard to representations made, that if a taxpayer makes a gift or political contribution under the arrangement, a person (whether or not it is the taxpayer) will incur an indebtedness in respect of which recourse is limited. This definition is amended in respect of gifts and contributions made after 6:00 p.m. (EST), December 5, 2003, to also refer to a limited-recourse debt determined under new subsection 143.2(6.1) of the Act. For additional details regarding limited-recourse debt in respect of a gift, see the commentary to subsection 143.2(6.1).

 

Clause 118

Interpretation

Definitions

ITA
248(1)

"disposition"

The expression "disposition" is used throughout the Act, particularly in provisions relating to transactions involving property.

The definition "disposition" was added to subsection 248(1) by S.C. 2001, chapter 17, ss. 188(5) [formerly Bill C-22]. In general, that definition is applicable to transactions and events that occur after December 23, 1998. The former definition "disposition" was contained in section 54 of the Act, applicable to transactions and events that occurred before December 24, 1998.

Under the definition "disposition" in subsection 248(1), a "disposition" of any property includes a transaction or an event described in any of paragraphs (a) to (d) of that definition but does not include a transaction or an event described in any of paragraphs (e) to (m) of that definition.

Under subparagraph (b)(i) of that definition, a disposition of a property includes any transaction or event by which, where the property is a share, bond, debenture, note, certificate, mortgage, agreement of sale or similar property, or an interest in it, the property "is redeemed in whole or in part or is cancelled".

The definition "disposition" in subsection 248(1) is amended in the following ways.

First, subparagraph (b)(i) of the definition now provides that a disposition of property includes any transaction or event by which, where the property is a share, bond, debenture, note, certificate, mortgage, agreement of sale or similar property, or an interest in it, the property "is in whole or in part redeemed, acquired or cancelled". This amendment makes it clear that a disposition will also include a transaction or event by which the property is acquired.

Second, paragraph (n) is added to the definition. New paragraph (n) provides that a redemption, an acquisition or a cancellation of a share, or of a right to be issued a share, (which share or which right, as the case may be, is referred to as the "security") of the capital stock of a corporation (the "issuing corporation") held by another corporation (the "disposing corporation") is considered not to be a "disposition" in the case where

• the redemption, acquisition or cancellation occurs as part of a merger or combination of two or more corporations (including the issuing corporation and the disposing corporation) to form one corporate entity (referred to as the "new corporation"),

• the merger or combination is

• either

Both amendments apply to redemptions, acquisitions and cancellations that occur after December 23, 1998, and, where the redemption, acquisition or cancellation takes place before December 21, 2002, the Minister of National Revenue shall, notwithstanding subsections 152(4) to (5) of the Act, make any assessment of a taxpayer's tax, interest and penalties payable under the Act for any taxation years that include the time at which such a redemption, acquisition or cancellation occurred that is necessary to take into account the application of the amendments.

In connection with redemptions, acquisitions and cancellations that occur before December 24, 1998, see the commentary to new subsection 248(1.1) of the Act.

Third, the definition "disposition" in subsection 248(1) is also amended by restricting the circumstances in which a transfer of property between trusts will not be treated as a disposition. In particular, paragraph (f) of the definition is amended so that a transfer of property from a trust to another trust will avoid, under that paragraph, characterization as a disposition only if both trusts are, at the time of the transfer, resident in Canada.

This amendment applies to transfers that occur after Announcement Date.

"dividend rental arrangement"

A "dividend rental arrangement" is, in general terms, an arrangement under which one person receives a dividend on a share that has been borrowed from another person who retains the risk of loss or opportunity for gain from fluctuations in the share value. To clarify its application where a partnership is a party to the arrangement, the definition is restructured and amended; its language is also updated in certain respects.

Under the amended definition, the "person" who is the subject of the arrangement - that is, the person who enters into the arrangement in order to receive a dividend - may be a partnership or a person as otherwise defined.

Existing paragraph (c) of the definition ensures that the definition includes an arrangement under which a corporation receives a taxable dividend that would be deductible but for subsection 112(2.3) of the Act, and is obligated to make dividend compensation payments. This paragraph is replaced by new paragraph (b), which adds to the arrangements described one in which it is not the corporation receiving the dividend that is obligated to make the compensation payment, but rather a partnership of which the corporation is a member.

At first reading, new paragraph (b) may seem asymmetrical, in that it expressly covers the case where a partnership is obligated to make the compensation payment, but not the case where a partnership receives the taxable dividend. In fact, the paragraph covers both: since in the latter case the corporate partner is itself already considered to receive the dividend, it is not necessary to add a reference to the partnership in that regard.

The reference to "subsection 260(5)" in this definition is replaced with "subsection 260(5.1)" consequential to the amendments to section 260. This amendment applies to paragraph (d) of the former definition and clause (b)(ii)(B) of the amended definition.

The amendment to paragraph (d) of the former definition applies between January 1, 2002 and December 20, 2002 unless an election noted below is filed.

The amended definition applies to arrangements made after December 20, 2002; it also applies to an arrangement made after November 2, 1998 and before the day after December 20, 2002, if the parties jointly elect in writing filed with the Minister of National Revenue within 90 days after this Act has been assented to, except that before 2002 the reference to "subsection 260(5.1)" in the amended definition should be read as "subsection 260(5)".

"qualifying environmental trust"

The French version of the definition of "qualifying environmental trust", in subsection 248(1) of the Act, is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

Non-Disposition Before December 24, 1998

ITA
248(1.1)

The definition "disposition" was added to subsection 248(1) of the Act by S.C. 2001, chapter 17, subsection 188(5) [formerly Bill C-22]. In general, that definition applies to transactions and events that occur after December 23, 1998. The former definition "disposition" was contained in section 54 of the Act, applicable to transactions and events that occurred before December 24, 1998.

New paragraph (n) is added to the definition "disposition" in subsection 248(1), applicable to redemptions, acquisitions and cancellations of certain securities that occur after December 23, 1998. For more detail, see the commentary to subsection 248(1).

New subsection 248(1.1) of the Act is added to deal, in a corresponding fashion, with such redemptions, acquisitions and cancellations that occurred before December 24, 1998.

New subsection 248(1.1) provides that a redemption, an acquisition or a cancellation, at any particular time after 1971 and before December 24, 1998, of a share, or of a right to acquire a share, (which share or which right, as the case may be, is referred to as the "security") of the capital stock of a corporation (referred to as the "issuing corporation") held by another corporation (referred to as the "disposing corporation") is not a disposition of the security within the meaning of the definition "disposition" in section 54 (as that section read in its application to transactions and events that occur at the particular time), if

• the redemption, acquisition or cancellation occurred as part of a merger or combination of two or more corporations (including the issuing corporation and the disposing corporation) to form one corporate entity (referred to as the "new corporation"),

• the merger or combination is

• either

New subsection 248(1.1) applies on Royal Assent and, notwithstanding subsections 152(4) to (5) of the Act, the Minister of National Revenue may make any assessment of a taxpayer's tax, interest and penalties payable under the Act for a taxation year that includes the time at which a redemption, acquisition or cancellation occurred that is necessary to take into account the application of new subsection 248(1.1) in respect of the redemption, acquisition or cancellation.

Occurrences as a Consequence of Death

ITA
248(8)

The French version of subsection 248(8) of the Act is amended to correct a terminology error. In effect, the concept of "attribution" is replaced by "distribution" so that it is clear that the property is actually remitted to the trust's beneficiary and not simply set aside for him or her. This amendment will come into force on Royal Assent.

Goods and Services Tax - Input Tax Credit and Rebate

ITA
248(16)

Subsection 248(16) of the Act provides rules under which amounts received by, or credited to, a taxpayer as an input tax credit or rebate with respect to the goods and services tax (GST) are deemed to be assistance from a government received by a taxpayer. As a consequence, such amounts are either included in income or reduce the cost or capital cost of the related property, or the amount of the related expenditure or expenditure pool, for tax purposes.

Subsection 248(16) also specifies the time at which the receipt (or credit) of an input tax credit or rebate is deemed to be received as assistance. With respect to input tax credits, subparagraph 248(16)(a)(i) provides that the assistance (i.e., the input tax credit) is considered to be received by a taxpayer at the time the GST in respect of the input tax credit was paid or became payable by the taxpayer if the GST was paid or became payable in the same reporting period under the Excise Tax Act in which the input tax credit was claimed. If a taxpayer does not claim the input tax credit in the same reporting period in which the GST was paid or became payable, subparagraph 248(16)(a)(ii) includes the amount of assistance in the taxpayer's income for the taxation year that includes the end of the reporting period in which the taxpayer claimed the input tax credit.

Subsection 248(16) is amended in three respects for input tax credits that become eligible to be claimed in taxation years that begin after December 20, 2002.

First, subparagraph 248(16)(a)(i) is amended to extend its application to cases where the input tax credit is claimed by a taxpayer in a reporting period that is subsequent to the period in which the related GST was paid or became payable if

• the taxpayer's threshold amount (as determined under subsection 249(1) of the Excise Tax Act) is greater than $500,000 for the taxpayer's fiscal year (as defined by that Act) that includes the earlier of the time that the GST in respect of the input tax credit was paid and the time that it became payable, and

• the taxpayer claimed the input tax credit at least 120 days before the end of the normal reassessment period (as determined under subsection 152(3.1) of the Income Tax Act) for the taxpayer in respect of the taxation year that includes that earlier time.

In general, the change to this subparagraph means that an input tax credit of a taxpayer (who is a GST filer with a threshold amount greater than $500,000 for GST purposes) is considered to have been received at the time the related GST was paid or became payable, even though the input tax credit is claimed in a later GST reporting period. However, this is the case only if the taxpayer claims the input tax credit at least 120 days before the taxation year in which the GST was paid or became payable becomes statute-barred for income tax purposes.

Second, subparagraph 248(16)(a)(ii) is amended to provide that an input tax credit is considered to be received at the end of the reporting period in which it is claimed only if

• subparagraph 248(16)(a)(i) does not apply, and

• the taxpayer's threshold amount (as determined under subsection 249(1) of the Excise Tax Act) is $500,000 or less for the fiscal year of the taxpayer that includes the earlier of the time that the GST in respect of the input tax credit was paid or became payable.

Thus, subparagraph 248(16)(a)(ii) does not apply if subparagraph 248(16)(a)(i) applies. Where subparagraph 248(16)(a)(i) does not apply, subparagraph 248(16)(a)(ii) provides that the input tax credit is considered to have been received at the end of the reporting period in which it is claimed only if the taxpayer's threshold amount for GST purposes was $500,000 or less at the time the GST was paid or became payable.

Third, new subparagraph 248(16)(a)(iii) is added to apply in any other case. If applicable, that subparagraph provides that the input tax credit is considered to have been received on the last day of the taxpayer's earliest taxation year

• that begins after the taxation year that includes the earlier of the time that the GST in respect of the input tax credit was paid and the time that it became payable, and

• for which the normal reassessment period for the taxpayer ends at least 120 days after the time at which the input tax credit was claimed.

Reference should also made to the commentary to new subsection 248(17.1) of the Income Tax Act which provides a special rule in respect of the timing of a claim in respect of certain input tax credits assessed under the Excise Tax Act.

Quebec Sales Tax - Input Tax Refund and Rebate

ITA
248(16.1)

New subsection 248(16.1) of the Act provides special rules for amounts received, or credited to, a taxpayer as an input tax refund or rebate in respect of Quebec sales tax. Such amounts are either included in a taxpayer's income or reduce the cost or capital cost of the related property, or the amount of the related expenditure or expenditure pool, for tax purposes.

In general, an input tax refund in respect of Quebec sales tax may - depending on the circumstances - have to be included in a taxpayer's income in the taxation year in which the taxpayer may first claim the refund, rather than the year in which it is received. A rebate of Quebec sales tax is included in income at the time the rebate is received or credited. For a more detailed explanation of the application of subsection 248(16.1), reference should be made to the commentary accompanying amendments to subsection 248(16), which provides analogous special rules in respect of the timing of the inclusion in income of certain input tax credits and rebates assessed under the Excise Tax Act.

Subsection 248(16.1) applies in respect of Quebec input tax refunds and rebates that become eligible to be claimed in taxation years that begin after Announcement Date.

Application of Subsection (16) to Passenger Vehicles and Aircraft

ITA
248(17)

Subsection 248(17) of the Act applies in the case of an input tax credit in respect of a passenger vehicle or aircraft claimable by an individual or partnership where the credit is determined by reference to capital cost allowance in respect of the vehicle or aircraft (i.e., where there is less than exclusive use in commercial activity). Subsection 248(17) is amended to reflect the amendments made to subsection 248(16) as described in the commentary to that subsection.

The amendments to subsection 248(17) apply in respect of input tax credits that become eligible to be claimed in taxation years that begin after December 20, 2002.

Application of Subsection (16.1) to Passenger Vehicles and Aircraft

ITA
248(17.1)

New subsection 248(17.1) of the Act applies in the case of an input tax refund of Quebec sales tax, in respect of a passenger vehicle or aircraft, claimable by an individual or partnership where the credit is determinable by reference to capital cost allowance in respect of the vehicle or aircraft (that is, where there is less than exclusive use in commercial activity). In general, this subsection defers the time the input tax refund is considered to be received for income tax purposes to the taxation year or fiscal period following that in which Quebec sales tax in respect of the property is considered as payable for the purposes of determining the input tax refund. This avoids circularity with subsection 248(16.1). The provision preserves the proper timing between the input tax refund entitlement and the adjustment to the capital cost. This change applies in respect of Quebec input tax refunds that become eligible to be claimed in taxation years that begin after Announcement Date.

Input Tax Credit on Assessment

ITA
248(17.2)

New subsection 248(17.2) of the Act determines, in respect of input tax credits that become eligible to be claimed in taxation years that begin after December 20, 2002, the time at which an input tax credit is considered to have been claimed in respect of certain input tax credit assessments made under the Excise Tax Act (ETA).

This subsection provides that, if an amount in respect of an input tax credit is deemed by subsection 296(5) of the ETA to have been claimed in a return or application filed under Part IX of that Act, the input tax credit is deemed to have been claimed for the GST reporting period that includes the time the Minister of National Revenue makes the GST assessment.

Accordingly, the rule in clause 248(16)(a)(i)(A) of the Income Tax Act (ITA) relating to the time at which an input tax credit is considered to have been received cannot apply to an input tax credit to which subsection 296(5) of the ETA applies. However, the other rules in paragraph 248(16)(a) of the ITA that determine the time at which an input tax credit is received are to be applied on the basis that an input tax credit (to which subsection 296(5) of the ETA applies) is not claimed by the taxpayer until the reporting period that includes the time at which the input tax credit is actually assessed - i.e., not the reporting period to which the assessment relates but the reporting period in which the input tax credit is deemed to be claimed for GST purposes.

Quebec Input Tax Credit on Assessment

ITA
248(17.3)

New subsection 248(17.3) of the Act provides that an input tax refund of Quebec sales tax, that is deemed to be claimed by section 30.5 of An Act respecting the Quebec Revenue Minister, is deemed to be claimed for the reporting period under An Act respecting Quebec Sales Tax that includes the day on which an assessment is issued to the taxpayer indicating that the refund has been allocated to the taxpayer. This change applies in respect of Quebec input tax refunds and rebates that become eligible to be claimed in taxation years that begin after Announcement Date.

Repayment of Quebec Input Tax Refund

ITA
248(18.1)

New subsection 248(18.1) of the Act provides that an amount added in determining net tax of a taxpayer under An Act respecting Quebec Sales Tax in respect of an input tax refund relating to a property or service that had previously been deducted in computing such net tax is treated as assistance repaid under a legal obligation to repay that assistance. Such an amount could be so added under Quebec law pursuant to an assessment of Quebec sales tax. As a consequence, such an amount will either be deducted in computing income under paragraph 20(1)(hh) or will increase the cost or capital cost of the related property or the amount of the related expenditure or expenditure pool for tax purposes (as provided under subsection 13(7.1), paragraphs 37(1)(c) and 53(2)(k) and under the definitions "cumulative Canadian exploration expense" in subsection 66.1(6), "cumulative Canadian development expense" in subsection 66.2(5) and "cumulative Canadian oil and gas property expense" in subsection 66.4(5)). This change applies after Announcement Date.

Trust-to-trust Transfers

ITA
248(25.1)

Subsection 248(25.1) of the Act applies where there is a transfer of a property from a particular trust to another trust (other than a RRSP trust or RRIF trust) in circumstances to which paragraph (f) of the definition "disposition" in subsection 248(1) (see the commentary above) applies. The result of the application of paragraph (f) is that the transfer does not constitute a disposition. Where this is the case, subsection 248(25.1) deems the other trust after the particular time to be the same trust as, and a continuation of, the particular trust.

Subsection 248(25.1) is amended, for greater certainty, to ensure that where the transferred property is deemed under a number of specified provisions to be taxable Canadian property of the particular trust, the property continues to be taxable Canadian property of the other trust.

This amendment applies in respect of transfers that occur after December 23, 1998.

Gifts and Contributions

ITA
248(30) to (38)

At common law, it is generally the view that a gift includes only a property transferred voluntarily, without any contractual obligation and with no advantage of a material character returned to the transferor.

In contrast, under section 1806 of the Civil Code of Quebec ("CCQ"), a gift in Quebec is a contract by which ownership of property is transferred by gratuitous title. However, the rights of ownership may be separated, such that it may be possible for a transferor to transfer part of the rights of ownership without any material advantage returned (i.e., by way of gift) and to transfer the other part separately for consideration. It is therefore possible, in Quebec, to sell a property to a charity at a price below fair market value, resulting in a gift of the difference.

Under both the common law and the CCQ, it is generally accepted that a transfer of property is not a gift unless the donor is impoverished by the transfer to the benefit of the donee and it is the donor's intention to enrich the donee without consideration.

At common law there is generally no ability to separate the rights of ownership of a single property in the course of making a gift. As such, at common law a contract to dispose of a property to a charity at a price below fair market value would not generally be considered to include a gift.

Nevertheless, there have been certain decisions made under the common law where it has been found that a transfer of property to a charity was made partly in consideration for services and partly as a gift.

Subsections 248(30), (31) and (32) are added to the Act to clarify the circumstances under which taxpayers and donees may be eligible for tax benefits available under the Act in respect of the impoverishment of a taxpayer in favour of a donee. In addition to the clarification provided by these new rules, on December 24, 2002, the Canada Customs and Revenue Agency released guidelines (Income Tax Technical News No. 26)that describe how it will apply the new rules to various situations and fundraising methods commonly used in the charitable sector. Subsections 248(34), (35), (36), (37) and (38) are added to the Act to provide technical rules, regarding the values of property transferred and benefits receivable, that apply in calculating the eligible amount of a gift or political contribution.

In general, these provisions are intended to reflect the policy that the amount eligible for an income tax benefit to a donor, by way of a charitable donation deduction or credit or a political contributions tax credit, should reflect the economic impact on the donor (before considering the income tax benefit) of the gift or contribution.

Eligible Amount of Gift or Monetary Contribution

ITA
248(30)

New subsection 248(30) of the Act, which applies in respect of gifts and political contributions made after December 20, 2002, defines the eligible amount of a gift or contribution as the amount by which the fair market value of the property that is the subject of the gift or contribution exceeds the amount of the advantage, if any, in respect of the gift or contribution. Subsection 248(30) is added concurrently with amendments to subsections 110.1(1) and 118.1(1) of the Act, which describe the types of gifts in respect of which an eligible amount will qualify for a deduction (for corporations) or a tax credit (for individuals). The amount of the advantage in respect of a gift or contribution is described in new subsection 248(31) of the Act.

It is proposed that subsections 3501(1), (1.1) and (6) of the Regulationsbe amended to provide that official receipts issued by a registered organization in respect of a gift made after December 20, 2002 contain, in addition to the information already prescribed, the eligible amount of the gift.

Amount of Advantage

ITA
248(31)

New subsection 248(31), which generally applies in respect of gifts or political contributions made after December 20, 2002, describes the amount of an advantage in respect of a gift or contribution as, in general, the total value of all property, services, compensation or other benefits to which the donor of a property is entitled.

Subsection 248(31) is added concurrently with the addition of subsection 248(30) of the Act, which defines the eligible amount of a gift or contribution, and with the amendment of subsection 127(3) of the Act in respect of contributions to a political party. The amount of an advantage reduces the eligible amount of a gift or contribution.

In general, new subsection 248(31) is intended to apply in respect of any transaction or series of transactions having either the purpose or the effect of reducing the economic impact to a donor of a gift or contribution. This includes, for instance, situations where a charity invests funds or acquires property in a manner that benefits the donor. The reduction to an eligible amount also includes an advantage that is partial consideration for, or in gratitude for, the gift or contribution, or is in any way related to the gift or contribution. An example would include the option of a donor to satisfy or pay a loan by assigning or transferring to another person a property (including the rights under an insurance policy) that has less economic value than the amount of loan outstanding. Another example would include an assumption of a donor's risk by a charity, where the acquisition, directly or indirectly, of an interest in a property of the donor by the charity may have the effect of reducing the potential loss of the donor from that investment. (However, a tax credit or deduction resulting from a charitable donation is not considered a benefit.)

An advantage may exist even though it is not received at the time of the gift or contribution. For example, it may have been received prior to the time of the gift or may be contingent or receivable in the future. The advantage may accrue either to the donor or to a person not dealing at arm's length with the donor. It is not necessary that the advantage be receivable from the donee.

Paragraph 248(31)(b) includes as an advantage any limited-recourse debt in respect of the gift or contribution. For additional details regarding limited-recourse debt, see the commentary to new subsection 143.2(6.1) of the Act.

It is proposed that subsections 2000(1) and (6) and 3501(1), (1.1) and (6) of the Regulationsbe amended to provide that official receipts issued by a registered organization or political party in respect of a gift or contribution contain, in addition to the information already prescribed, the eligible amount and the amount of the advantage, if any, in respect of the gift or contribution.

Intention to Give

ITA
248(32)

For the transfer of property to qualify as a gift, it is necessary that the transfer be voluntary and with the intention to make a gift. At common law, where the transferor of the property has received any form of consideration or benefit, it is generally presumed that such an intention is not present. New subsection 248(32) of the Act, which applies in respect of transfers of property after December 20, 2002 to qualified donees (such as registered charities), allows the opportunity to rebut this presumption. New paragraph 248(32)(a) provides that the existence of an amount of an advantage to the transferor will not necessarily disqualify the transfer from being a gift if the amount of the advantage does not exceed 80% of the fair market value of the transferred property.

If the amount of an advantage in respect of a transfer of property exceeds 80% of the fair market value of the transferred property, new paragraph 248(32)(b) provides that the transfer will not necessarily be disqualified from being a gift if the transferor can establish to the satisfaction of the Minister of National Revenue that the transfer was made with the intention to make a gift.

It is generally accepted that the tax benefit available to a taxpayer, by way of a charitable donation deduction or credit, is not considered an advantage or benefit that would reflect a lack of donative intent on the part of a taxpayer. However, there may be circumstances where the intention of a taxpayer to make a gift is in doubt because of the combination of tax and other benefits to the taxpayer. If the primary motivation of a taxpayer for entering into a transaction or series of transactions is to return a profit to the taxpayer by way of a combination of tax and other benefits, the taxpayer may not be impoverished by the transfer of a property to a charity. Subsection 248(32) is not intended to allow a taxpayer to profit by the making of a gift.

Cost of Property Acquired by Donor

ITA
248(33)

New subsection 248(33) of the Act, which applies in respect of gifts or political contributions made after December 20, 2002, provides that the cost to a taxpayer of property acquired by the taxpayer in the course of the making of a gift or contribution by the taxpayer is the fair market value of the property at the time of the making of the gift or contribution. The fair market value of such a property is relevant in computing the amount of the advantage in respect of the gift or contribution under subsection 248(31).

Repayment of Limited Recourse Debt

ITA
248(34)

New subsection 248(34) of the Act, which applies in respect of gifts or political contributions made after February 18, 2003, generally provides that a repayment of the principal amount of a limited-recourse debt in respect of a gift or political contribution is deemed to be a gift in the year it is paid. However, in some circumstances the total amount of limited-recourse debt and other advantages to the donor may exceed the fair market value of the property transferred to a charity, resulting in no eligible amount to the donor under subsection 248(30) of the Act. In this case, the donor must pay off the excess amount before any amount will be allowed as a gift. Also, a payment financed by other limited-recourse debt or made by way of assignment or transfer of a guarantee, security or similar indemnity or covenant is not recognized for these purposes. For example, the assumption of a taxpayer's limited-recourse debt by another person, in exchange for an insurance policy in favour of the taxpayer that guarantees a particular rate of return on an investment held by any person, would not qualify as a deemed gift under subsection 248(34).

Deemed Fair Market Value

ITA
248(35)

New subsection 248(35) of the Act, which applies in respect of gifts made after 6:00 p.m. (EST), December 5, 2003, provides that the fair market value of a property that is the subject of a gift is, for the purposes of determining the eligible amount of a gift under subsection 248(30), deemed to be the lesser of the actual fair market value of the property and its cost to the donor. This rule applies if the property was acquired in contemplation of its donation or less than three years before the time of donation, unless the donation is made as a consequence of the donor's death. This rule also applies if the property was acquired by the donor as part of a gifting arrangement. For more information on gifting arrangements, refer to the commentary for subsection 237.1(1) of the Act.

Non-application of Subsection (35)

ITA
248(36)

New subsection 248(36) of the Act provides exceptions to the application of subsection 248(35) of the Act where the property that is the subject of a gift is an ecological gift, inventory, real property situated in Canada, publicly-traded securities or cultural property, the value of which is certified by the Cultural Property Export Review Board.

Artificial Transactions

ITA
248(37)

New subsection 248(37) of the Act, which applies in respect of gifts made after 6:00 p.m. (EST), December 5, 2003, prevents a donor from avoiding the application of subsection 248(35) by disposing and reacquiring a property before donating it to a qualified donee. If this is the purpose of any transaction or series of transactions that includes a disposition or acquisition of a property, the cost of the property to the donor for the purpose of subsection 248(35) is deemed to be the lowest cost incurred by the taxpayer at any time to acquire that property or an identical property.

Substantive Gift

ITA
248(38)

New subsection 248(38) of the Act, which applies in respect of gifts made after Announcement Date, prevents a donor from avoiding the application of subsection 248(35) by disposing a property (the "substantive gift") to a qualified donee and donating the proceeds, rather than donating the property itself. The provision applies similarly in respect of political contributions. The fair market value of the gift or contribution of the proceeds, for the purpose of determining its eligible amount under subsection 248(30), is deemed to be the lesser of the fair market value of the property sold and its cost. Subsection 248(38) does not apply if subsection 248(35) would not have applied to a gift by the taxpayer of that property.

 

Clause 121

Acquisition of Control of a Corporation

Acquiring Control

ITA
256(7)(a)

Paragraph 256(7)(a) of the Act describes the circumstances where control of a corporation (or a corporation controlled by the corporation) is considered not to have been acquired for the purposes of certain provisions of the Act. That paragraph is amended in two ways.

First, subparagraph 256(7)(a)(i) is amended effective with respect to the acquisition of shares after 2000 to add clause (E) which precludes an acquisition of control of a corporation on a distribution (within the meaning assigned by subsection 55(1) of the Act) by a specified corporation (within the meaning assigned by that subsection) if a dividend is received in the course of a spin-off distribution in which no portion of the dividend is treated as a capital gain by the anti-avoidance rule in subsection 55(2) of the Act because of the application of the exception for certain reorganizations under paragraph 55(3)(b) of the Act.

Second, new subparagraph 256(7)(a)(iii), which applies to the acquisition of shares after 2000, provides that, where there is an acquisition of any shares of a corporation, there is no acquisition of control of the corporation by a related group of persons if each member of each group of persons that controls the corporation was related to the corporation immediately before the change of control.

 

Clause 123

Securities Lending Arrangements

ITA
260

Section 260 of the Act sets out special rules that apply to securities lending arrangements.

Definitions

ITA
260(1)

Subsection 260(1) of the Act provides definitions that apply for the purposes of the special rules for securities lending arrangements. The existing definitions are modified, and additional definitions are added, as follows:

"qualified security"

The securities lending arrangement rules apply only to securities that are qualified securities. A new paragraph (e) is added to the definition "qualified security" to include a qualified trust unit.

This new definition applies to securities lending arrangements made after 2001.

"qualified trust unit"

A "qualified trust unit" is defined to mean a unit of a mutual fund trust that is listed on a prescribed stock exchange.

This new definition applies to securities lending arrangements made after 2001.

"securities lending arrangement"

There are three amendments to the definition "securities lending arrangement".

Paragraph (a) of the existing definition provides that in order for there to be a securities lending arrangement, the lender and the borrower of a security must be dealing at arm's length. The amendment to paragraph (a) extends the definition to include an arrangement entered into by non-arm's length parties. New paragraph (e) provides that where the lender and borrower do not deal with each other at arm's length, the arrangement must be of a term not exceeding 270 days and must not be part of a series of securities lending arrangements, loans or other transactions intended to be in effect for more than 270 days.

Paragraph (c) of the existing definition provides that where a borrowed security is a share, the borrower must be obligated to pay to the lender a dividend compensation payment in order for the transaction to be a securities lending arrangement. This paragraph is amended to apply a comparable requirement in respect of all arrangements. This recognizes and codifies the commercial reality that compensation payments are required to be made by the borrower to the lender in all securities lending arrangements, and not just those arrangements involving shares.

The amendment to paragraph (c) applies to arrangements made after 2001. The amendments to paragraphs (a) and (e) apply to arrangements made after 2002.

"security distribution"

"Security distribution" is a newly-defined term, introduced not to effect any substantive change to the relevant rules but only for simplicity and clarity. A security distribution is an amount, in respect of a borrowed security, that is either paid by the issuer of the security (for example as a dividend or a trust distribution) or received as a compensation payment.

This definition applies to securities lending arrangements made after 2001.

Deemed Compensation Payment

ITA
260(5) and (5.1)

Subsection 260(5) of the Act, in its current form, treats dividend compensation payments that are received under specified circumstances as dividends. The subsection also, however, denies this dividend treatment where the amount is received by a corporation and one of the main reasons for the corporation entering into the arrangement was to enable it to receive an amount that would be treated as a dividend by the subsection.

Subsection 260(5) is reorganized into two subsections. New subsection 260(5) describes the circumstances under which the compensation payment deeming rule, now found in new subsection 260(5.1), applies. The deeming rule applies where an amount is received under a securities lending arrangement under one of these circumstances: from a person resident in Canada, from a person not resident in Canada where the amount was paid in the course of carrying on business in Canada through a permanent establishment, or from or by a registered securities dealer. These are essentially the same as the circumstances specified prior to the amendment.

Also, the anti-avoidance rule in this subsection - which currently addresses only the case of an amount that would otherwise be received by a corporation as a dividend - is amended to include all otherwise non-taxable amounts that may be received under a securities lending arrangement, by any person. This amendment recognizes that with the introduction of qualified trust units as "qualified securities," a person may be treated as having received any of several kinds of non-taxable amounts.

New subsection 260(5.1) of the Act treats a given compensation payment as one of three things: a dividend, an amount paid by a trust and having the same characteristics, source and purpose as the "underlying payment" amount paid by the trust directly, or interest. The overall effect of the provision is, in addition to replicating the former dividend deeming rule, to deem compensation payments in respect of payments from a trust to have the same characteristics, source and purpose as if the amounts were paid by the trust.

These amendments apply to securities lending arrangements made after 2001.

Deductible Compensation Payment Amount

ITA
260(6)

Subsection 260(6) of the Act limits the extent to which a person who makes a dividend compensation payment under a securities lending arrangement may deduct the payment in computing income from a business or property. In brief, the subsection denies a deduction for any dividend compensation payment made by persons other than registered securities dealers, and provides that registered securities dealers may deduct up to 2/3 of the dividend compensation payments they make.

Amended subsection 260(6) retains this 2/3 dividend compensation payment deduction for registered securities dealers. It also allows any taxpayer - including but not limited to registered securities dealers - a deduction in respect of compensation amounts that are not dividend compensation payments. The amount of this new deduction is computed differently depending on the actions of the taxpayer in question (the one who made the payment and seeks to deduct it). If the taxpayer has disposed of the borrowed security and has included any resulting gain or loss in computing business income, the compensation amount is fully deductible. In any other case, new subsection 260(6) allows a deduction to the extent of the lesser of (i) the compensation amount and (ii) the amount included in the taxable income of the taxpayer or persons related to it.

Amended subsection 260(6) applies to securities lending arrangements made after 2001.

Deduction - Compensation Payments

ITA
260(6.1)(a)

Subsection 260(6.1) of the Act provides a deduction for dividend compensation payments made pursuant to certain dividend rental arrangements. The amount deductible is the lesser of the amount the corporation is obligated to pay as compensation under the arrangement and the amount of the dividends received by the corporation under the arrangement that were identified in its return of income as amounts which are not deductible because of subsection 112(2.3) of the Act.

Paragraph 260(6.1)(a) of the Act is amended to clarify that the amount described in that paragraph is the total of all amounts that the corporation becomes obligated in the taxation year to pay to another person as compensation under certain dividend rental arrangements.

Also, paragraph 260(6.1)(a) of the English version of the Act is amended, as a consequence of the amendments to the definition "dividend rental arrangement" in subsection 248(1) of the Act, by replacing the reference to "paragraphs (c) and (d)" of that definition to a reference to "paragraph (b)" of that definition.

This amendment applies to dividend rental arrangements made after December 20, 2002 and, if the parties jointly elect within 90 days after this Act has been assented to, it also applies to dividend rental arrangements made after November 2, 1998 and on or before December 21, 2002, except that before 2002 the reference to "subsection 260(5.1)" should be read as "subsection 260(5)".

For arrangements made after 2001 and before December 21, 2002 that are not the subject of the election described in the previous paragraph, the definition "dividend rental arrangement" in effect before December 21, 2002 is applicable, except that the reference to "subsection 260(5)" in that definition should be read as "subsection 260(5.1)".

Dividend Refund

ITA
260(7)

Subsection 260(7) of the Act provides that, where a corporation makes a payment which is deemed by the former subsection 260(5) to be a taxable dividend, the corporation will also be entitled to treat the amount as the payment of a dividend for the purposes of section 129 of the Act.

The postamble of the English version of subsection 260(7) is amended to replace the reference "subsection 260(5)" with "subsection 260(5.1)".

This amendment applies to securities lending arrangements made after 2001.

Non-resident Withholding Tax

ITA
260(8), (8.1) and (8.2)

Subsection 260(8) of the Act applies special rules, for the purposes of Part XIII of the Act, to payments made under securities lending arrangements. The subsection has two main aspects: rules that ensure the appropriate treatment for Part XIII purposes of compensation payments; and a rule that in certain circumstances will treat a borrower as having paid to a lender a "borrow fee".

The subsection is rearranged into three separate subsections. Amended subsection 260(8) retains the previous rules for compensation payments relating to interest and dividends, confining them to amounts paid on a security that is not a qualified trust unit. Subsection 260(8) also provides for compensation payments made in respect of a borrowed qualified trust unit: these are treated as payments from a trust and as having the same character and composition as the trust payments for which they compensate.

New subsection 260(8.1) provides for a deemed borrow fee, on the same basis as the existing paragraph 260(8)(b). New subsection 260(8.2) similarly preserves the effect of the existing postamble to subsection 260(8) in relation to tax treaties.

These subsections apply to securities lending arrangements made after 2001.

Partnerships

ITA
260(10), (11), and (12)

A "securities lending arrangement" (SLA) is defined in subsection 260(1) of the Act as a particular transaction between two persons: the "lender" and the "borrower" of a security. A partnership - which for most purposes of the Act is not a person - can be a party to a transaction that would be an SLA if the partnership were a person. In such a case, it is appropriate in policy terms for the arrangement to be treated as an SLA. New subsections (10), (11) and (12) are added to section 260 to bring partnerships within the SLA rules.

New subsection 260(10) provides that, for the purposes of section 260, a person includes a partnership. This allows a partnership to be either the borrower or the lender in respect of an SLA. The subsection also treats a partnership as a registered securities dealer, if all of its members are themselves registered securities dealers.

A transaction's status as an SLA is relevant to, among other things, the tax treatment of amounts paid and received in compensation for dividends or interest on the security that is transferred or lent. New subsections 260(11) and (12) are added to ensure the appropriate treatment of these amounts in a case where a corporation or an individual is a member of a partnership that has entered into an SLA.

• Under new paragraph 260(11)(a), a corporation that is a member of a partnership is treated for the purpose of subsection 260(5) as having received its "specified proportion" (now defined in subsection 248(1) of the Act) of each compensation payment or amount in respect of proceeds of disposition that is described in subsection 260(5) and was received by the partnership. It is also treated as being the same person as the partnership, thus ensuring that the partnership's reasons for entering into the arrangement (which are relevant to the applicability of the subsection) are attributed to the corporation.

• New paragraph 260(11)(b) treats the corporation as being obligated to pay its specified proportion of each dividend compensation payment described in paragraph 260(6.1)(a).

• New paragraph 260(11)(c) treats the corporation, for the purpose of applying the dividend refund rules in section 129 of the Act, as having paid its specified proportion of each non-deductible dividend compensation payment made by the partnership.

• New paragraph 260(12)(a) performs for individuals who are members of a partnership the same functions as new paragraph 260(11)(a) does for corporations that are partners.

• New paragraph 260(12)(b) treats an individual partner as having paid, for the purpose of clause 82(1)(a)(ii)(B) of the Act, the individual's specified proportion of each dividend compensation payment paid by the partnership that is deemed by new subsection 260(5.1) to have been received by another person as a taxable dividend.

These amendments apply to SLAs made after December 20, 2002 and, if the parties jointly elect within 90 days after this Act has been assented to, they also apply to SLAs made after November 2, 1998 and on or before December 20, 2002, except that before 2002, the reference to "subsection 260(5.1)" should be read as "subsection 260(5)".

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¹ Subparagraph 142.6(1)(b)(i). [Return]

² Subparagraph 142.6(1)(b)(ii).[Return]

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