June 27, 2008
Archived - Government of Canada Eases Tax Compliance Burden for Internationally-Engaged Canadian Businesses
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The Honourable Jim Flaherty, Minister of Finance, today proposed changes to the Income Tax Act for Canadian businesses with foreign affiliates and those that report earnings in a foreign currency.
"Our government is committed to creating a corporate tax system that is both fair and internationally competitive," said Minister Flaherty. "The proposals I am announcing today will improve the tax system and will assist Canadian businesses in complying with the tax law."
Bill C-28, the second Budget 2007 implementation bill, provided substantial tax relief for Canadian businesses, including the historic corporate income tax rate reductions announced in the 2007 Economic Statement. In addition, the bill, which received Royal Assent on December 14, 2007, implemented a number of amendments to the Income Tax Act relating to foreign affiliates.
Included in the bill were provisions which allow taxpayers to elect retroactive application of some of these foreign affiliate amendments. However, in response to concerns that the deadline for filing these elections is too tight-for example, a taxpayer with a December 31, 2007 year-end must file these elections by June 30, 2008-the Government is proposing to extend the filing deadline for these elections by 18 months. These proposals are set out in more detail in the attached annex.
Functional Currency Tax Reporting
Bill C-28 also included amendments to the Act that implemented the Budget 2006 proposal to introduce functional currency tax reporting rules. In response to representations from stakeholders concerning the amended rules, the Government is proposing several technical revisions. The revisions, which are described in detail in the attached annex, include:
- Extending the deadline to elect functional currency tax reporting to October 31, 2008;
- Amending the definition of "functional currency" to address concerns about its practical application to the situations of certain taxpayers; and
- Introducing symmetry in foreign exchange rate calculations used in the reporting of assets and debt obligations.
Minister Flaherty indicated that the Government will introduce legislation at an early opportunity to implement these proposed technical changes to the Income Tax Act.
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The following provides further detail on income tax proposals announced by the Honourable Jim Flaherty, Minister of Finance, on June 27, 2008.
Bill C-28, which received Royal Assent on December 14, 2007, included a number of amendments to the Income Tax Act that implement various foreign affiliate proposals announced in Budget 2007 as well as related foreign affiliate proposals announced on February 27, 2004.
In this context, Bill C-28 contains a one-time election (commonly referred to as the "Global Election") which allows taxpayers to elect retroactive application of a block of foreign affiliate amendments. In addition to the Global Election, there are various other foreign affiliate amendments in Bill C-28 that allow for separate one-time elections. In the case of both of the Global Election and the separate elections, the elections apply to all foreign affiliates of the particular taxpayer.
As enacted, Bill C-28 requires that a taxpayer wishing to make the Global Election or a separate election must do so by filing the election with the Minister of National Revenue on or before the taxpayer's filing-due date for the taxpayer's taxation year that includes the day on which the bill received Royal Assent. Since corporate filing-due dates are generally six months after year-end, this means that a taxpayer with a December 31, 2007 year-end must file these elections by June 30, 2008.
The Government has received comments from stakeholders, in respect of both the Global Election and the separate elections, expressing concern with the current election deadline. To address these concerns, it is proposed that the filing deadline for both the Global Election and the separate elections be extended by 18 months.
Functional Currency Tax Reporting
Bill C-28, as enacted, also included amendments to the Act that implement the proposal first announced in Budget 2006 to introduce functional currency tax reporting rules. Those amendments are set out in new section 261 of the Act.
The Government has received comments from stakeholders in respect of the functional currency tax reporting rules. Those comments have pointed out certain technical deficiencies and practical difficulties with the rules. In response to these comments, the following changes are proposed:
- The definition of "functional currency" in subsection 261(1) of the Act would be amended to address concerns that have been raised by stakeholders about the practical application of paragraphs (b) and (c) of that definition to taxpayers' situations: e.g., the interpretation of the expressions "more often than any other currency" and "principal business activities" and the application of the definition in cases where the taxpayer (as a subsidiary) may not otherwise be required to prepare financial statements. Specifically, paragraphs (b) and (c) of that definition would be replaced with a new paragraph (b) that refers to the primary currency in which the taxpayer maintains its records and books of account for financial reporting purposes. As a consequence, the definitions "consolidated financial statements", "generally accepted accounting principles" and "legal-entity financial statements" in subsection 261(1) would be repealed;
- Because the changes referred to above to the definition of "functional currency" would open the application of section 261 to holding corporations, a rule would be introduced to protect against potential abuses of the functional currency tax reporting rules. That rule would apply where the taxpayer has amounts owing to or from, or other financial transactions with, directly or indirectly, a corporation resident in Canada that is related to the taxpayer and that, for the related corporation's taxation year ending in the calendar year in which the taxpayer's taxation year ends, reports its Canadian tax results in a different currency from that of the taxpayer. Where this is the case, any loss in respect of such amounts owing, or other financial transactions, would be denied to the taxpayer or the related corporation, as the case may be, to the extent that such loss would not have been available had the two corporations reported their Canadian tax results using Canadian currency;
- Section 261 would be amended in connection with the exchange rates that are required to be used for various calculations involving different currencies. Among other things, stakeholders have noted that, on electing into the functional currency rules, the existing provisions require that the current (or spot) foreign exchange rate on the last day of the last Canadian currency year be used in respect of debt obligations, while the "transitional exchange rate" (based on a 12-month average) is required to be used in respect of assets. This means that accrued foreign exchange gains and losses in respect of debt obligations are measured differently from those in respect of assets. This lack of symmetry can in some circumstances produce adverse results. Further, it has been noted that the use of the transitional exchange rate in these circumstances can produce anomalies in the calculation of foreign exchange gains and losses in respect of assets in cases where the asset is disposed of early in the initial functional currency year. Consequently, the 12-month average exchange rate concept would be replaced with the current (spot) rate concept for all purposes of section 261. As a result, the definitions "currency exchange rate", "reversionary exchange rate" and "transitional exchange rate" in subsection 261(1) would be repealed and references in section 261 to those definitions would be replaced with references to the Bank of Canada noon rate for the relevant date;
- The deadline for making an election to enter the functional currency tax reporting regime would be extended. Specifically, any such election that would otherwise be due on a date before October 31, 2008 would instead be due on October 31, 2008;
- Subsection 261(3) would be amended to remove the requirement in paragraph 261(3)(c) that the taxpayer continue to have the foreign currency qualify as its functional currency in all years subsequent to the election year. If the taxpayer is eligible and makes the functional currency election in subsection 261(3), then, subject to the provisions of subsections 261(11) to (18) which may otherwise require a reversion to Canadian currency tax reporting, it will continue to file under the functional currency regime in all future years using that same functional currency unless it elects out of functional currency tax reporting. An election out of functional currency tax reporting would be due six months before the end of its last functional currency year and would cause the taxpayer to revert to Canadian currency tax reporting. Furthermore, subsection 261(9), which applies where a taxpayer reverts to Canadian currency tax reporting, would be amended so that all conversions under that subsection from a functional currency to Canadian currency, whether in respect of events occurring in a Canadian currency year or a functional currency year, would be made using the Bank of Canada noon rate for the last day of the taxpayer's last functional currency year. A similar amendment would be made to subsection 261(10);
- The definition "qualifying currency" in subsection 261(1) would be amended to include the currency of Australia;
- Section 261 would be amended to specify that the filing deadline for the election to use functional currency tax reporting for the first taxation year of a corporation formed by an amalgamation to which subsection 87(1) applies be the filing-due date for the taxation year, of each predecessor corporation, that is deemed to have ended immediately before the amalgamation;
- The definition "Canadian tax results" in subsection 261(1) would be amended to include the amount of a taxpayer's "taxable income earned in Canada". This amendment would be applicable for all taxation years; and
- The reference in paragraph 261(4)(g) to "the references in section 95 and the references in regulations made for the purposes of that section" would be amended to refer to "the references in section 95 and the references in regulations made for the purposes of that section or section 113".
Except where otherwise indicated, it is proposed that these amendments to section 261 of the Act be applicable in respect of taxation years that begin after December 13, 2007 (which is generally the period of application of new section 261). However, where a taxpayer has, before today, validly made an election under subsection 261(3), the taxpayer may choose to have the current rules in subsections 261(5) and (6) apply in respect of that election. Furthermore, the rule described above in respect of related party loans and other financial transactions would, for taxpayers validly electing before today, apply only for taxation years beginning after today.