Archived - Explanatory Notes to Legislative Proposals Relating to Income Tax: 2

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Foreign Investment Entities – Mark-to-market

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94.2

New section 94.2 of the Act sets out new rules for the taxation of interests in FIEs where subsections 94.1(4) and 94.3(3) do not apply.

Except as otherwise indicated, section 94.2 applies to taxation years that begin after 2002.

Definitions

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94.2(1)

New subsection 94.2(1) of the Act sets out a number of definitions and provides that those definitions and the definitions in subsection 94.1(1) apply for the purposes of section 94.2.

"deferral amount"

The deferral amount of a taxpayer generally represents the gain or loss (in the event that the interest was capital property, one half of the gain or loss) in respect of the interest accrued to the time when the interest first became subject to the rules in section 94.2. The expression "deferral amount " in respect of a participating interest of a taxpayer in an entity applies principally for the purpose of determining the value of D in the "mark-to-market formula" (as defined in subsection 94.2(1)) for a taxation year of the taxpayer in respect of the participating interest. That formula applies in determining, under subsection 94.2(4), a taxpayer’s income or loss (or capital gain or capital loss) from the participating interest for a taxation year. Subsection 94.2(4) generally provides for the recognition of a deferral amount in respect of a participating interest on the disposition of the interest. Because of paragraph 94.1(2)(u), identical participating interests are considered to be disposed of in the order in which they were acquired.

For a participating interest, in a non-resident entity, acquired after the beginning of the taxpayer’s first taxation year that began after 2002, the deferral amount will be nil in the typical cases where the rules in section 94.2 apply to the interest for the year in which the interests were acquired.

The deferral amount is calculated, in conjunction with subsections 94.2(5) and subsection 128.1(4), so that gains and losses accruing while a taxpayer is not resident in Canada are ignored for the purposes of section 94.2, except in the unusual case where an interest in a FIE is taxable Canadian property.

Additional rules affecting the calculation of the deferral amount are contained in subsections 94.2(6) and (14) to (18), as described in the commentary below.

"gross-up factor"

The definition "gross-up factor" for a particular deferral amount is 1, except where the 1/2 factor is relevant in computing the deferral amount because the property is capital property. In the latter case, the "gross-up factor" is 2 (i.e., the reciprocal of the 1/2 factor). For more information on the relevance of this definition, see the commentary on subsection 94.2(12).

"mark-to-market formula"

The definition "mark-to-market formula" provides a formula that applies, for a taxation year of a taxpayer in respect of a participating interest of the taxpayer, in determining, under subsection 94.2(4), a taxpayer’s income or loss (or, where subsection 94.2(20) applies in respect of the participating interest, the capital gain or capital loss) from the participating interest for a taxation year.

The amount determined under the formula for a taxpayer's taxation year in respect of a participating interest in a non-resident entity is computed as follows:

Ignoring the descriptions of D and G, the mark-to-market formula in effect determines the net increase or decrease in the fair market value of a taxpayer's participating interest in a non-resident entity for a taxation year.

The value of D represents a taxpayer's accrued gain or loss when a participating interest first becomes subject to section 94.2. The amount of this accrued gain or loss (or one half of it, in the event so provided in paragraph (b) of the definition "deferral amount" in subsection 94.2(1)) is included in computing income under the description of D, but only for the taxation year in which the interest is disposed of unless the taxpayer elects for earlier recognition of a positive deferral amount. (An earlier recognition of a positive deferral amount may be beneficial for a taxpayer, particularly where section 94.4 applies.) Where the taxpayer is a trust, a disposition may occur as a consequence of the application of the 21-year deemed disposition rule. See, in this regard, new subsection 104(4.1).

For more detail, see the commentary on subsections 94.2(3) and (4) and the definitions "deferral amount" and "gross-up factor" in subsection 94.2(1).

"readily obtainable fair market value"

The definition "readily obtainable fair market value" is relevant in determining whether a taxpayer may elect to have subsection 94.2(3) (and, as a result, subsection 94.2(4)) apply for a taxation year in respect of a particular participating interest (as defined in subsection 94.1(1)) of the taxpayer in a non-resident entity (as defined in subsection 94.1(1)).

In general terms, the readily obtainable fair market value of a particular participating interest is, if one of two sets of conditions is met, its fair market value.

The first set of conditions requires, in respect of the particular participating interest that:

Note that, under paragraph 94.2(2)(b), where the identical participating interests are listed on more than one prescribed stock exchange, the taxpayer may generally elect which of the exchanges will be used in applying the definition "readily obtainable fair market value". For more information, see the commentary on paragraph 94.2(2)(b).

Where the first set of conditions is not met, the second set of conditions requires that the identical participating interests have, throughout the period, in the taxpayer’s taxation year that includes that time, during which the taxpayer held the particular participating interest, conditions attached that require the non-resident entity to accept at the demand of the holders of the participating interests (or that require the holders of the participating interests to accept, at the demand of the non-resident entity), at a price ("the redemption price") determined and payable in accordance with the conditions, the surrender in whole or in part of the participating interests. In addition, the second set of conditions requires that the redemption price be determined by reference to the fair market value, at the time the participating interest is surrendered, of the property of the non-resident entity, and be a price that would have been acceptable to entities dealing at arm's length with one another.

"reconciliation amount"

The reconciliation amount in respect of a participating interest of a taxpayer is relevant in determining what adjustments, if any, to the cost of the interest may be required under subsection 94.2(12) and what amounts, generally, may be included or deductible, under subsection 94.2(21), by the taxpayer in computing the taxpayer’s income for a taxation year in which the interest is disposed of. For more detail, see the commentary on subsections 94.2(12) and (21).

The reconciliation amount at a particular time in a taxation year of a taxpayer in respect of a participating interest of the taxpayer, means, in very general terms the amount (including a negative amount) that is the difference between the taxpayer’s economic loss in respect of the interest (while the taxpayer held the interest and subsection 94.2(4) applied to it) and the taxpayer’s deductions, in computing income, under sections 94.2 or 94.4 (net of income inclusions under section 94.2)) in respect of the interest.

More specifically, the reconciliation amount at a particular time in a taxation year in respect of a participating interest is the amount (including a negative amount) determined by the formula "A – B".

Under the formula, "A" is the positive amount (for more detail, see section 257 of the Act) determined by subtracting from the cost of the participating interest to the taxpayer (determined without reference to section 94.2), the proceeds of disposition from the last disposition in the taxation year by the taxpayer of the participating interest (or, if paragraph 94.2(12)(a) deemed the taxpayer to have acquired the participating interest in the taxation year, the cost to the taxpayer of the participating interest).

Variable "B" is the positive amount determined by

For this purpose, a specified year means, if paragraph 94.2(12)(a) deems the taxpayer to have acquired the participating interest at a time in the taxation year, a preceding taxation year, and in any other case, the taxation year that includes the particular time or a preceding taxation year.

For more detail, see the commentary on subsections 94.2(4), (12) and (21) and 94.4(2).

"tracking entity"

The definition "tracking entity" is relevant in determining whether subsections 94.1(4) and 94.2(4) will apply for a taxation year of a taxpayer in respect of a participating interest, held by the taxpayer at the end of the year, in a non-resident entity. If the non-resident entity is, at the end of a taxation year of the non-resident entity that ends in the taxpayer’s year, a tracking entity, and the other conditions described in subsection 94.2(9) are met, such that subsection 94.2(9) applies, then either of subsections 94.1(4) or 94.2(4) would generally apply for the year. Subsection 94.3(4) will not apply for the year in respect of the interest.

A particular non-resident entity is a tracking entity in respect of a particular participating interest of a taxpayer in the non-resident entity if either of paragraph (a) or (b) of the definition applies.

Under paragraph (a) of the definition, the particular non-resident entity is a tracking entity if

Under paragraph (b) of the definition, the particular non-resident entity will be a tracking entity if

Note that an election under paragraph 94.1(2)(j) is relevant only in determining whether an entity is a "foreign investment entity" (and where stipulated, a "qualifying entity"), as those expressions are defined in subsection 94.1(1). Thus the determination of whether property is owned or not by an entity is made, for the purposes of the definition "tracking entity", without regard to that election.

Note also that the exclusion of "exempt property" from being treated as "investment property" (as those expressions are defined in subsection 94.1(1)) does not apply for the purposes of the definition "tracking entity".

For more information on the application of this definition, see the commentary on subsections 94.1(4) and 94.2(3) and (9). For more information on paragraph 94.2(1)(j) and the definitions "exempt property" and "investment property in subsection 94.1(1), see the commentary on those provisions.

"trading day"

The definition "trading day" is relevant in applying paragraph (a) of the definition "readily obtainable fair market value" in subsection 94.2(1). A trading day of a participating interest on a prescribed stock exchange, means a day on which the participating interest trades on that stock exchange.

Rules of Application

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94.2(2)

New subsection 94.2(2) of the Act provides rules of application for the purpose of section 94.2.

Application

Paragraph 94.2(2)(a) provides that the rules in subsection 94.1(2) also apply for the purposes of section 94.2.

Readily Obtainable Fair Market Value

Paragraph 94.2(2)(b) applies for the purpose of paragraph (a) of the definition "readily obtainable fair market value" in subsection 94.2(1), referred to in the commentary above, in respect of a particular participating interest in a non-resident entity held by a taxpayer in a taxation year. Where participating interests in the non-resident entity that are identical to the particular participating interest are listed on more than one prescribed stock exchange, the references in that definition to a prescribed stock exchange shall be read as a reference to the prescribed stock exchange in respect of which the taxpayer files an election with the Minister of National Revenue.

If the taxpayer does not so elect or participating interests that are identical to the particular participating interest are no longer listed on the stock exchange identified in the taxpayer’s election referred, the references in that definition to a prescribed stock exchange shall be read as a reference to the prescribed stock exchange chosen by the Minister of National Revenue.

Restrictions on Application of Mark-to-market Rules

Paragraph 94.2(2)(c) provides that the mark-to-market regime in subsection 94.2(4) will not apply to a taxpayer in respect of certain participating interests of the taxpayer. The rule applies if the taxpayer has been subject to subsection 94.2(4) in respect of a participating interest because of an election in respect of the interest where the interest has a readily obtainable fair market value and subsection 94.2(3) ceases to apply. For example, paragraph 94.2(2)(c) would apply where the interest (other than a foreign insurance policy) ceases to have a readily obtainable fair market value or the Minister fails to receive, in response to a demand under paragraph 94.2(2)(d), information satisfactory to make a determination of whether the interest has a readily obtainable fair market value.

Where paragraph 94.2(2)(c) applies the taxpayer will become subject to 94.1(4) in respect of the participating interest if 94.1(3) continues to apply to the taxpayer in respect of the participating interest.

Note that if, subsection 94.2(4) applies to a taxpayer for a taxation year in respect of a participating interest in a tracking entity and in the immediately following year the interest ceases to be an interest in a tracking entity and becomes subject to subsection 94.1(3), then the taxpayer may elect to have subsection 94.2(4) apply for that immediately following year. In this regard, see the commentary on clause 94.2(3)(b)(ii)(B).

Paragraph 94.2(2)(d) provides that paragraph 94.2(3)(b) does not apply to a taxpayer for a particular taxation year in respect of a participating interest held in the particular taxation year by the taxpayer in a non-resident entity if the Minister sends a written demand to the taxpayer requesting additional information for the purpose of enabling the Minister to determine whether the participating interest has a readily obtainable fair market value and information satisfactory to the Minister to make the determination is not received by the Minister within 60 days (or within such longer period as is acceptable to the Minister) after the Minister sends the demand.

Characterization of Income from FIE Interest

Paragraphs 94.2(2)(e) and (f) provide special rules for determining whether a taxpayer’s income for a taxation year from the application of subsection 94.2(4) will be treated as income from a source outside Canada. Paragraph 94.2(2)(e) provides that in applying subparagraph 94.2(4)(a)(i) to a taxpayer (that is a trust) for a particular taxation year of the taxpayer and in respect of a participating interest of the taxpayer in a non-resident entity, the reference in that paragraph to "as income from property that is the participating interest" shall be read as a reference to "as income from property that is a source outside Canada that is the participating interest". However, this special rule applies only if the portion of the net accounting income of the non-resident entity, from sources outside Canada, for its last taxation year that ends in the particular taxation exceeds 90% of the total net accounting income of the non-resident entity for that last taxation year.

Paragraph 94.2(2)(f) provides that in applying subparagraph 94.2(4)(b)(i) to a taxpayer (that is a trust) for a particular taxation year of the taxpayer and in respect of a participating interest of the taxpayer in a non-resident entity, the reference in that paragraph to "a capital gain for the year" shall be read as a reference to "a capital gain for the year from a source outside Canada and". However, this special rule applies only if the portion of the net accounting income of the non-resident entity, from sources outside Canada, for its last taxation year that ends in the particular taxation year exceeds 90% of the total net accounting income of the non-resident entity for that last taxation year.

The application of paragraphs 94.2(2)(e) and (f) (and a related rule in paragraph 94.1(2)(d)) in respect of a participating interest of a taxpayer will not be relevant in determining a taxpayer’s eligibility for a foreign tax credit under section 126 of the Act. In this regard, see the commentary below on subsections 94.3(2) and 126(1.2). Rather, paragraph 94.2(2)(e) and (f) provide relief to trusts resident in Canada that hold participating interests in a FIE and that make payable to their non-resident beneficiaries all or part of the trusts’ incomes arising under subsection 94.2(4). Where paragraph 94.2(2)(e) or (f) applies and the terms of the trust permit amounts of deemed income of the trust to be made payable to beneficiaries, the amounts of such trust income arising under subsection 94.2(4) that become payable to non-resident beneficiaries of the trust may qualify for reduced withholding if the non-resident beneficiary is resident in a country with which Canada has entered a tax treaty and the tax treaty contains a provision permitting such a reduction in withholding.

Where paragraphs 94.2(2)(e) and (f) do not apply, income and capital gains arising under subsection 94.2(4) are from a source inside Canada.

Mark-to-market

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94.2(3) and (4)

Subsection 94.2(3) of the Act sets out those circumstances where, subject to paragraphs 94.2(2)(c) and (d) and 94.2(5)(b), subsection 94.2(4) applies to a taxpayer in respect of a participating interest in a non-resident entity. For the mark-to-market regime in subsection 94.2(4) to apply for a taxation year, subsection 94.2(3) must apply for the year.

Except as described above, subsection 94.2(3) will apply to a taxpayer for a particular taxation year in respect of a participating interest, in a non-resident entity, held by the taxpayer in the year if either:

  • the taxpayer elects, generally in the first taxation year of the taxpayer in which the taxpayer is subject to subsection 94.1(3) or 94.2(9) in respect of the participating interest (or an identical interest), to have subsection 94.3(3) apply to the participating interest or identical interest, or
  • subsection 94.2(3) applied in respect of an identical participating interest that was held by the taxpayer at any time when the taxpayer held the participating interest.

In effect, where a taxpayer has validly elected for the mark-to-market regime to apply to a participating interest for a taxation year, that regime will continue to apply to the interest and to any identical interests that are held by the taxpayer in that taxation year or a future taxation year until either all of the interests are no longer held by the taxpayer or any one of the conditions for applying subsection 94.2(3) to the interests is not met (e.g., subsection 94.1(3) and 94.2(9) no longer apply in respect of the interests or the interests no longer have a readily obtainable fair market value).

Example

1. Libby acquires 101 shares of the capital stock of ABC Inc. in 2004. At all times ABC is a FIE (and not a tracking entity) and shares of its capital stock are participating interests that do not qualify as exempt interests. ABC’s taxation years end on December 30. ABC has issued only one class of shares, the shares of which are identical to each other. Libby is not an exempt taxpayer.

2. Subsection 94.1(3) applies to Libby in respect of her ABC shares for each of her taxation years at the end of which she holds the shares. Assume that the shares have a readily obtainable FMV. In her return of income for her 2004 taxation year, Libby elects under clause 94.2(3)(b)(iii)(B) to have the rules in section 94.2 apply to the shares. Assume that subsection 94.2(20) does not apply in respect of the ABC shares at any time.

3. In February 2005, Libby sells 100 of her ABC shares and continues to hold the remaining 1 share on December 30, 2005.

4. In January 2006, Libby acquires another 200 shares of the capital stock of ABC.

5. In November 2007, Libby disposes of all (i.e., 201) of her ABC shares and holds no ABC shares on December 30, 2007.

6. In July 2008, Libby buys 1000 shares of the capital stock of ABC. Libby continues to hold the shares on December 30, 2008.

Results

1. For her 2004 taxation year, Libby reports as income from property the amount determined under subsection 94.2(4) for the year in respect of her 100 ABC shares.

2. For her 2005 taxation year, clause 94.2(3)(b)(iii)(A) applies in respect of her remaining ABC share and Libby must report as income from property the amount determined under subsection 94.2(4) for the year in respect of that share.

3. For her 2006 taxation year, clause 94.2(3)(b)(iii)(A) applies in respect of Libby’s 201 ABC shares and she reports as income from property the amount determined under subsection 94.2(4) for the year in respect of those shares.

4. For her 2007 taxation year, subsection 94.2(3) does not apply to Libby (because Libby holds no shares in ABC at ABC’s taxation year-end that ends in Libby’s 2007 taxation year) in respect of the shares that she sold in November 2007. Subsection 94.2(12) will apply to Libby in determining the amount of her gain or loss from the sale of the shares.

5. For her 2008 taxation year, clause 94.2(3)(b)(iii)(A) will not apply in respect of any of the 1000 ABC shares she acquired in 2008. Libby must elect under clause 94.2(3)(b)(iii)(B) if she wishes to have the mark-to-market regime apply in respect of the shares.

Note that under subclause 94.2(3)(b)(iii)(B)(II) a taxpayer may elect, to have subsection 94.2(3) apply, in a year other than the first taxation year in which subsection 94.1(3) or 94.2(9) applies to the taxpayer in respect of the participating interest or an identical interest, if the election is made in the taxpayer’s return of income for a taxation year in which subsection 94.1(3) applies and that taxation year immediately follows a taxation year for which the interest is subject to subsection 94.2(9) (i.e., an interest of the taxpayer in a tracking entity).

Where subsection 94.2(3) applies (and subsection 94.2(20) does not apply) to a taxpayer’s participating interest in a non-resident entity, subparagraph 94.2(4)(a)(i) requires the taxpayer to include in computing income as income from property (in this regard, see the commentary on paragraph 94.2(2)(e)) from a property that is the participating interest the positive amount resulting from the operation of the mark-to-market formula for the taxation year in respect of the participating interest. Under subparagraph 94.2(4)(a)(ii), the absolute value of any negative amount resulting from the operation of the same formula may be deducted in computing the taxpayer's income as a loss from property from a property that is the participating interest. (Note, however, that losses in respect of foreign insurance polices are denied because of clause 94.2(4)(a)(ii)(A). Instead, as described in the commentary to the definition "mark-to-market formula" in subsection 94.2(1), the denied losses are carried forward to offset later income inclusions.)

Where both subsections 94.2(3) and 94.2(20) apply to a taxpayer’s participating interest in a non-resident entity, subparagraph 94.2(4)(b)(i) deems the taxpayer to have a capital gain for the year from the disposition of capital property (in this regard, see the commentary on paragraph 94.2(2)(f)), that is the participating interest, in the taxation year equal to the positive amount determined under the mark-to-market formula for the taxation year in respect of the participating interest plus or minus the positive or negative deferral amount included in "D" in that same formula in respect of the participating interest for the year. Subparagraph 94.2(4)(b)(ii) deems the taxpayer to have capital losses in the year equal to the negative amount determined under the market formula for the taxation year in respect of the participating interest plus or minus the negative or positive deferral amount included in "D" in that same formula in respect of the participating interest for the year.

The example below illustrates the operation of subsection 94.2(4) and the mark-to-market formula for a taxation year in respect of a participating interest.

Example

1. Leonard acquires a 1% interest in ABC Inc. in 1999 for $500. On December 31, 2000, it is capital property to Leonard. ABC is not a FIE in respect of the taxpayer at any time before 2004. Subsection 94.2(20) does not apply at any time in respect of the interest. ABC’s taxation year end is June 30.

2. ABC becomes a FIE in April 2004 and remains a FIE at all subsequent times. Leonard elects under subparagraph 94.2(3)(b)(iii) to have the rules in section 94.2 apply. Leonard's interest in ABC does not qualify as an "exempt interest".

3. The fair market values of Leonard's participating interest at the beginning and at the end of 2004 are $800 and $1,000 respectively.

4. Leonard disposes of his shares on December 15, 2005 for $1,200. ABC does not make any distributions to Leonard during his period of ownership.

Results

1. No amount is included in Leonard's income for 2003 under any of sections 94.1 to 94.3. For 2004, Leonard is required to include $200 in income under subparagraph 94.2(4)(a)(i).

2. The $200 inclusion is determined under the mark-to-market formula and subparagraph 94.2(4)(a)(i) as follows:

3. Although Leonard's participating interest has appreciated by $500 since the time of its acquisition, only $200 is required to be included in income under section 94.2 for 2004.

4. For 2005, the amount included in income under the mark-to-market formula and subparagraph 94.2(4)(a)(i) is $350, computed as follows:

Non-resident Periods Excluded

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94.2(5)

New subsection 94.2(5) of the Act provides special rules dealing with the application of section 94.2 for a taxation year to persons who are not resident in Canada throughout the year.

Under paragraph 94.2(5)(a), the amounts determined under section 94.2 are generally determined as if the taxation year of the taxpayer excludes the period in the year during which the taxpayer is not resident in Canada. This rule, in conjunction with section 128.1, generally ensures that the increases and decreases in fair market values that are relevant in determining income inclusions and deductions under section 94.2 are the increases and decreases occurring while the taxpayer is resident in Canada. However, this rule does not affect the calculation of the taxpayer's deferral amount: paragraph (b) of the definition "deferral amount" in subsection 94.2(1) (in conjunction with subsection 128.1(1)) already ensures that gains or losses accruing prior to becoming resident in Canada are not taken into account for the purposes of computing a taxpayer's deferral amount in respect of a participating interest in a FIE, except in the unusual case where the FIE interest is taxable Canadian property.

Paragraph 94.2(5)(a) also ensures that subsection 94.2(4) does not apply to a taxpayer for a taxation year throughout which the taxpayer is not resident in Canada.

Under paragraph 94.2(5)(b), subsection 94.2(3) generally does not apply to a taxpayer at a particular time if the taxpayer is not resident in Canada at the particular time. This has relevance for the purposes of a number of new provisions, including subparagraph 39(1)(a)(ii.3). This subparagraph has the effect of excluding, from a taxpayer's capital property, a property in respect of which subsection 94.2(3) applies (and subsection 94.2(20) does not apply). Paragraph 94.2(5)(b) ensures that a non-resident taxpayer cannot claim that a taxable Canadian property consisting of a FIE interest is not capital property on the basis of subparagraph 39(1)(a)(ii.3). (Note: non-resident taxpayers are generally subject to Canadian income tax on taxable capital gains from their dispositions of taxable Canadian properties.)

Paragraph 94.2(5)(c) applies in the unusual case where an individual changes his or her Canadian residence status more than once in the same calendar year. For example, an individual might cease to be resident in Canada near the beginning of a calendar year but become resident in Canada later in the same year. In the event that such an individual is considered not to reside in Canada during a period in the calendar year, the individual's period of non-residence would be included within the individual's taxation year and the rule in paragraph 94.2(5)(a) would have no effect. In order to not tax gains accrued while an individual was non-resident and to not provide relief for losses accrued during the same period, paragraph 94.2(5)(c) provides that:

  • there is to be deducted the increase in the fair market value of an interest in a FIE to which subsection 94.2(4) applies during the non-resident period (this fair market value appreciation would be reflected in the amount determined under the mark-to-market formula (as defined in subsection 94.1(1)) in respect of the interest in computing the taxpayer's income), and
  • there is to be added the decline in the fair market value of an interest in a FIE to which subsection 94.2(4) applies that accrued during the non-resident period (this fair market value decline would be reflected in the amount determined under the mark-to-market formula in respect of the interest in computing the taxpayer's income).

The example below illustrates the operation of paragraph 94.2(5)(c).

Example

Bernard emigrates from Canada on February 1, 2003 in order to start permanent employment elsewhere. Due to unexpected changes in circumstances, he returns to Canada on December 1, 2003. Bernard owns an interest in a FIE to which section 94.2 applies. The fair market value of the interest in 2003 increases from $100 (January 1, 2003), to $105 (February 1, 2003), to $108 (December 1, 2003) and to $107 (December 31, 2003). It is assumed that Bernard establishes that he did not reside in Canada from February 1, 2003 to December 1, 2003.

Results

1. Under section 94.2(4), the amount included in computing Bernard's income for 2003 is equal to $7 (B = 107, F = 100).

2. Paragraph 94.2(5)(c) permits a deduction for the purposes of paragraph 114(a) equal to $3 (i.e., $108 - $105) equal to the appreciation in the fair market value of the interest while Bernard was not resident in Canada. As a consequence, Bernard's taxable income in respect of the FIE interest for 2003 is $4 (i.e., $7 minus $3).

Foreign Partnerships – Change of Residence of Member

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94.2(6) to (8)

New subsections 94.2(6) to (8) of the Act provide special rules for partnerships having non-resident members. These subsections are analogous to rules in existing subsections 96(8) and (9) and are designed, in general terms, to prevent partnership losses that accrue while no partnership member is resident in Canada from being used in Canada. A further rule for partnership members is set out in new subsection 96(1.9).

More specifically, subsection 94.2(6) applies where a partnership begins to have members who reside in Canada. Under subsection 94.2(7), a corresponding rule applies in a similar fashion where a partnership ceases to have members who reside in Canada. In either case, for the purposes of determining amounts under section 94.2 portions of the fiscal period of the partnership in which no member is resident in Canada will generally be disregarded.

Where subsection 94.2(6) applies to a partnership at any time, the deferral amount for a FIE interest held by the partnership immediately before that time is computed with reference to the fair market value and the cost amount of the interest. However, if a negative deferral amount is otherwise determined with respect to the interest, the deferral amount is deemed to be nil.

As a consequence of subsections 94.2(6) and (7), amounts added or deductible under subsection 94.2(4) for a partnership in respect of a FIE interest will generally reflect increases or decreases in fair market value while the partnership has members resident in Canada. However, once the interest is disposed of, an amount reflecting gains accruing before any member became resident in Canada will be recognized because of the application of subsection 94.2(4).

Subsection 94.2(8) contains an anti-avoidance rule, which is aimed at preventing the insertion of nominal Canadian resident partners for tax planning purposes. This rule is parallel to the rule in existing subsection 96(9).

Subsection 94.2(8) also contains a "look-through" rule. It allows for the "look-through" of one or more tiers of partnerships for the purposes of determining whether a person is a member of a partnership.

Participating Interests in a Tracking Entity

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94.2(9)

New subsection 94.2(9) of the Act is an anti-avoidance rule intended to prevent the circumvention of subsection 94.1(3) through the use of a participating interest in a "tracking entity" (as defined in subsection 94.1(1)). Where subsection 94.2(9) applies with regard to an interest in a tracking entity for a taxation year, subsection 94.1(4) will apply to the taxpayer for that year unless subsection 94.2(3) applies for that year in respect of the interest.

Subsection 94.2(9) applies to a taxpayer (other than an exempt taxpayer, as defined in subsection 94.1(1)) for a particular taxation year of the taxpayer in respect of a particular participating interest of the taxpayer in a non-resident entity (and any participating interests of the taxpayer in the non-resident entity that are identical to the particular participating interest) if

  • production from the property, use of the property, gains from the disposition of the property, profits from the disposition of the property, fair market value of the property,
  • income from the property, profits from the property, revenue from the property, cash flow from the property, or
  • any other criterion similar to any of the above criteria; and
  • that is a share or shares of the capital stock of a corporation that is at that time a particular foreign affiliate of the taxpayer that if held at that time by the taxpayer would be a qualifying interest (within the meaning assigned by paragraph 95(2)(m)) of the taxpayer in the particular foreign affiliate of the taxpayer, and a participating interest of the taxpayer in a qualifying entity, and
  • that is not at that time tracked property in respect of a participating interest in a non-resident entity of an entity that is not related to the taxpayer.

It should be noted that tracked properties can include any property, whether owned by the non-resident entity or not. For example, if the fair market value of shares issued by a non-resident entity were tracked to the worldwide price of gold bullion, the tracked properties in question would be the worldwide supply of gold bullion. Whether subsection 94.2(9) applies in this case or not would typically depend on whether the non-resident entity is a tracking entity, as defined in subsection 94.2(1).

Treatment of Foreign Insurance Policies

ITA
94.2(10) and (11)

New subsection 94.2(10) of the Act applies if a taxpayer (other than an exempt taxpayer, as defined in subsection 94.1(1)) holds, at any time in a particular taxation year of the taxpayer, an interest in a foreign insurance policy. For this purpose, a foreign insurance policy is one that is not issued by an insurer in the course of carrying on in Canada a business the income from which is subject to tax under Part I.

Subsection 94.2(11) sets out the treatment under section 94.2 of an interest in the foreign insurance policy. Where subsection 94.2(10) applies, paragraph 94.2(11)(a) provides, subject to paragraph 94.2(11)(c), that

Paragraph 94.2(11)(b) generally provides that, where a taxpayer (other than an exempt taxpayer) holds an interest in a foreign insurance policy, for the purposes of subsections 94.2(1) to (4) (and a corresponding foreign property reporting rule in subsection 233.3(1)) the particular interest is deemed to be a participating interest in a non-resident entity. However, the mark-to-market regime under subsection 94.2(4) applies differently to insurance policies in three respects:

Paragraph 94.2(11)(b) applies to treat an interest in an insurance policy as a participating interest only for the limited purposes identified in that paragraph (i.e., subsections 94.2(1) to (4) and the corresponding foreign property reporting rule in subsection 233.3(1)). For example, the interest will not be a participating interest for the purpose of subsection 94.2(19) or, as mentioned above, for the purpose of 94.2(20).

Paragraph 94.2(11)(c) provides that paragraphs 94.2(11)(a) and (b) do not apply to a taxpayer in respect of an insurance policy in the following situations:

  • the interest in the policy was, on the anniversary day (as defined in subsection 12.2(11)) of the policy that occurs in the taxation year, an exempt policy (as defined in subsection 12.2(11)) or a prescribed annuity contract (as defined in section 304 of the Income Tax Regulations – in this regard, it is intended that amendments be proposed to section 304 of the Regulations to reflect this change), or
  • an appropriate amount of income has been included in the taxpayer's income under section 12.2 in respect of the policy or that the interest in the policy is an interest in an exempt policy for the purpose of that section.

In the event that new paragraphs 94.2(11)(a) and (b) do not apply to a taxpayer in respect of an interest in an insurance policy in a particular year but apply to that taxpayer in respect of that interest in the following year, paragraph 94.2(11)(d) provides that the taxpayer is deemed to have acquired the interest in the insurance policy, at its fair market value at the end of the particular year (determined with reference to paragraph 94.2(11)(f)), immediately after the beginning of the following taxation year.

In the event that paragraphs 94.2(11)(a) and (b) do not apply to a taxpayer in respect of an interest in an insurance policy for a taxation year but did apply in the preceding taxation year, paragraph 94.2(11)(e) provides that the taxpayer is deemed to have disposed of the interest in the insurance policy immediately before the end of the preceding taxation year for proceeds equal to its fair market value at that time.

Paragraph 94.2(11)(f) provides that the fair market value of an interest in an insurance policy and amounts of proceeds of disposition of an interest in an insurance policy and payments in respect of interests in insurance policy are determined without reference to benefits paid, payable or anticipated to be payable under the policy only as a consequence of the occurrence of the risks insured under the policy.

Paragraph 94.2(11)(g) provides that, where a taxpayer makes a premium or a policy loan payment in respect of an insurance policy in a taxation year, an interest in the insurance policy is deemed to have been acquired in the year. The cost of the interest is the total of the premiums paid, the payments of the principal amount of policy loans to the extent the loans were included in proceeds of disposition of the interest in prior years, and any amount paid by the taxpayer, to an entity or individual other than the insurer that issued the policy, to acquire the interest from the entity or individual.

Paragraph 94.2(11)(h) provides rules permitting additions to the deemed cost of an interest in a policy otherwise determined for a year where the actual costs exceed the fair market value of interest at the beginning of the first taxation year in which subsection 94.2(4) applies to the taxpayer in respect of these interests. The amount that may be added is the amount, if any, by which the qualifying premiums paid at or before that time in respect of the interest in the policy exceeds the fair market value of the interest at that time.

Paragraph 94.2(11)(i) provides rules adding to a taxpayer's proceeds of disposition otherwise determined of an interest in an insurance policy for the year in which it is disposed of, the amount by which the fair market value of the interest at the beginning of the first taxation year in which subsection 94.2(4) applies to the taxpayer in respect of the interest exceeds the cost of the interest at that time.

In the event that paragraphs 94.2(11)(a) and (b) do not apply to a taxpayer in respect of an interest in an insurance policy for one taxation year and did apply in the preceding year, paragraph 94.2(11)(j) deems the taxpayer to have acquired the interest at the beginning of the taxation year and provides that the cost of the interest is equal to the amount if any by which the total of the fair market value and the amount that would be determined under subparagraph 94.2(4)(a)(ii) (read without reference to its clause (A)) in respect of the interest at the end of the preceding taxation year exceeds the amount determined under paragraph 94.2(11)(i) in respect of the interest in respect of the taxpayer.

Subsections 94.2(10) and (11) apply for taxation years that begin after 2002.

Example

Assume that David, a long-term resident of Canada, pays premiums of $10,000 to an offshore insurer for a life insurance policy in 2000. The policy's fair market value is $9,000 and $10,700 at the end of 2003 and 2004 (respectively).

Results

1. For 2003, no income amount is determined under paragraph 94.2(4)(a) because the cost of the policy exceeds the fair market value at the end of 2003. The cost to David of the policy is deemed to be $10,000 ($9000 + $1000).

2. The loss for the year 2003 is $1000. ($9000 – $10,000). No claim in respect of the loss is permitted under paragraph 94.2(4)(b) of the Act. The amount of the denied loss is equal to $1,000 and is included under G in the formula in paragraph 94.2(4)(a) in year 2004.

3. For 2004, the amount included in income under paragraph 94.2(4)(a) is $700 (= $10,700 ("B"), minus $9,000 ("F"), minus $1,000 ("G")).

It is possible that the cash surrender value of a policy may be less than its fair market value.

Change of Status

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94.2(12)

New subsection 94.2(12) of the Act sets out rules that apply where a taxpayer holds a participating interest in a non-resident entity at a time that is the beginning of a particular taxation year and subsection 94.2(4) applied for the purpose of computing the taxpayer's income for the preceding taxation year in respect of the participating interest, but does not apply for the particular taxation year (otherwise than because the taxpayer ceased to reside in Canada or became an exempt taxpayer as defined in subsection 94.1(1)).

Where subsection 94.2(12) applies, the taxpayer is deemed to have acquired the particular interest at the beginning of the following taxation year at a cost equal to the fair market value of the particular interest at that time.

This subsection could apply, for example, where a taxpayer’s interest in a foreign investment entity ceases to have a readily obtainable fair market value (as defined in subsection 94.2(1)) or where the entity ceases to be a foreign investment entity (as defined in subsection 94.1(1).

Since the taxpayer is deemed to have acquired the property at its fair market value at the beginning of the following year, all increases and decreases in the value of the interest from the time of its acquisition are reflected in the taxpayer's cost of the interest for tax purposes. However, only the gain or loss accruing while it was subject to subsection 94.2(4) has been brought into income. Because of the rules in respect of deferral amounts, the gain or loss in value for the period from the time of acquisition to the time it became subject to subsection 94.2(4) would not generally have been taken into consideration for tax purposes.

Accordingly, paragraph 94.2(12)(b) provides for a negative or positive adjustment to the adjusted cost base (ACB) of a participating interest held as capital property. Any positive "deferral amount" (as defined in subsection 94.2(1)) in respect of the interest is deducted in computing the ACB of the interest, but the deduction is grossed-up by a factor of two in the event that the deferral amount was calculated with reference to one-half of the accrued gains. The ACB deduction does not, however, apply in the event that a positive deferral amount has already been taken into account because of an election under the description of D in the mark-to-market formula (as defined in subsection 94.2(1)) for the taxation year in respect of the participating interest. The ACB is also reduced by the amount of any negative "reconciliation amount" (as defined in subsection 94.2(1)) in respect of the participating interest.

The absolute value of any negative deferral amount (or twice the amount if the 1/2 factor was used in computing the negative deferral amount) is added in computing the ACB of the interest. There is also added any positive reconciliation amount in respect of the participating interest.

Where capital property is not involved, a corresponding decrease or increase in cost (rather than adjusted cost basis) is provided under paragraph 94.2(12)(c). To the extent that the decrease in respect of the positive or negative deferral amount would otherwise result in a negative cost, the decrease is brought into the taxpayer's income under subparagraph 94.2(12)(c)(ii).

For more detail, see the commentary on paragraphs 53(1)(m.1) and 53(2)(w), the definitions "deferral amount", "mark-to-market formula" and "reconciliation amount" in subsection 94.2(1), and subsection 94.2(4).

Cost of Participating Interest

ITA
94.2(13)

New subsection 94.2(13) of the Act provides a rule for determining the cost at a particular time of a participating interest in an entity for a taxation year in the event that the interest is disposed of by the taxpayer in the year.

The cost to the taxpayer immediately before the disposition of the property is deemed to be its fair market value at the beginning of the taxpayer's taxation year. In the event that the property was not held by the taxpayer at that time, its cost immediately before the disposition is its cost determined without reference to section 94.2. In identifying property for these purposes, identical properties of a taxpayer are considered to be disposed of on a "first in, first out" basis, as a consequence of the application of paragraph 94.1(2)(u).

Under new paragraph (c.2) of the definition "cost amount" in subsection 248(1), the cost determined at a particular time for a property under subsection 94.2 (13) is also the "cost amount" of the property at the particular time.

Deferral Amount where Same Interest Reacquired

ITA
94.2(14)

New subsection 94.2(14) of the Act generally provides that a "deferral amount" in respect of a property of a taxpayer is deemed to be nil, after the property has been disposed of by the taxpayer at a time when the mark-to-market rules in subsection 94.2(4) applied to the property. This is of relevance to property that is reacquired by a taxpayer. However, subsection 94.2(14) is subject to the rules in subsections 94.2(15) to (18).

It should be noted that identical properties of a taxpayer are considered to be disposed of on a "first in, first out" basis as a consequence of the application of paragraph 94.1(2)(u).

Fresh-start re Change of Status of Entity

ITA
94.2(15)

New subsection 94.2(15) of the Act applies where a taxpayer's participating interest in an entity was initially subject to the rules in subsection 94.2(4) and ceases to be subject to those rules (otherwise than because of the taxpayer having become an "exempt taxpayer"). For example, subsection 94.2(15) could apply where an entity ceases to be a FIE.

In these circumstances, the deferral amount in respect of the participating interest is determined without reference to previous applications of subsections 94.2(4) and (14). This rule is relevant only in the event that the same participating interest of the taxpayer again becomes subject to the rules in subsection 94.2(4).

Parallel "fresh-start" rules are contained in subsection 94.2(16) and (17). All of these "fresh-start" rules are expected to be only rarely involved, given that more than one change in status of an investment or a taxpayer is required for the rules to become relevant. For more information on the "deferral amount" defined in subsection 94.2(1), see the commentary on that definition.

Fresh-start after Emigration of Taxpayer

ITA
94.2(16)

New subsection 94.2(16) of the Act affects the calculation of the "deferral amount" in respect of a participating interest in an entity for a taxpayer who has ceased to reside in Canada. It is relevant in the event that, at a subsequent time, the taxpayer becomes resident in Canada again.

In these circumstances, the deferral amounts in respect of the taxpayer's FIE interests are determined without reference to the previous application of subsections 94.2(4) and (14).

For further detail, see the commentary on the related fresh-start rule in subsection 94.2(15).

Fresh-start re Change of Status of Tax-exempt Entity

ITA
94.2(17)

New subsection 94.2(17) of the Act affects the calculation of the "deferral amount" in respect of an interest in an entity for a taxpayer that initially was not an "exempt taxpayer" under paragraph (a) or (b) of that definition in subsection 94.1(1) and then subsequently obtains that status.

In these circumstances, the deferral amounts in respect of the FIE interests of the taxpayer are determined without reference to previous applications of subsections 94.2(4) and (14).

For further context, see the commentary on the related fresh-start rule in subsection 94.2(15). In addition, it should be noted that amended subsection 149(10) applies to changes of tax-exempt status for taxpayers that are corporations. Where subsection 149(10) applies, the rules in subsection 94.2(17) do not apply.

Superficial Dispositions

ITA
94.2(18)

New subsection 94.2(18) of the Act applies where a taxpayer disposes of a participating interest in an entity in respect of which a negative amount is determined under the description of D in the formula in subsection 94.2(4). This would be the case where there is a negative deferral amount associated with the interest. In these circumstances, the deferral amount is instead generally deemed to be nil if, during the period beginning 30 days before the disposition and ending 30 days after the disposition, identical property is acquired by the taxpayer or certain related persons.

Subsection 94.2(18) operates in a manner similar to the "superficial loss" rules for capital properties and is intended to prevent the premature realization of losses in respect of a property in which a taxpayer effectively retains an economic interest. "Superficial loss" has the same meaning as assigned in section 54, except that the definition for the purposes of subsection 94.2(18) does not contain the exception for transactions covered by subsection 40(3.4).

Property substituted for the particular property is, in these circumstances, considered to have the deferral amount associated with the property disposed of.

Determination of Capital Dividend Account

ITA
94.2(19)

New subsection 94.2(19) provides rules that deem a positive or negative deferral amount in respect of a disposition of what would, but for section 94.2, be a capital property of a taxpayer that is a corporation resident in Canada, to be a taxable capital gain or an allowable capital loss, as the case may be, and twice such an amount to be a capital gain or capital loss of the corporation, as the case may be, for the purposes of computing the capital dividend account of the corporation. This rule ensures that 1/2 of a capital gain or a capital loss that is attributable to a deferral amount is reflected in the capital dividend account of a corporation.

Application of Paragraph 94.3(4)(b)

ITA
94.2(20)

New subsection 94.2(20) of the Act provides a special rule that requires a taxpayer to report, as capital gains or losses under paragraph 94.2(4)(b) rather than as income or losses from property under paragraph 94.2(4)(a), amounts determined under the "mark-to-market formula" for a particular year in respect of a participating interest of the taxpayer in a non-resident entity.

This rule applies where two conditions are met. The first condition is that the participating interest of the taxpayer would, if the Act were read without reference to section 94.2, be a capital property of the taxpayer at the last time in the particular taxation year at which the taxpayer held the participating interest.

The second condition is that all or substantially all of the amount required to be added or deducted under the mark-to-market formula for the taxation year in respect of the participating interest, in a particular non-resident entity, can be attributed to

In the event that any entity in a chain or tier of entities holds capital properties that are particular participating interests in foreign investment entities, changes in value of the particular participating interests and gains or losses from the disposition of those interests are ignored in applying the "all or substantially all" requirement. Instead, the requirement would be computed with regard to gains or losses from the disposition of, or changes in value in, capital properties of the foreign investment entities. This is intended to prevent the use of intermediary entities, contrary to the intent of subsection 94.2(20), as a means of triggering the application of paragraph 94.2(4)(b).

Reconciliation

ITA
94.2(21)

New subsection 94.2(21) applies where a taxpayer disposes of an interest in a non-resident entity at a particular time in a particular taxation year. If subsection 94.2(4) applies for the purpose of computing the taxpayer's income for the particular taxation year in respect of the participating interest, in computing that income the taxpayer may be required to include an amount of income (or to have capital gains) or may be permitted to deduct as a loss (or to have capital losses) determined with regard to the reconciliation amount (as defined in subsection 94.1(1)) at that time in respect of the participating interest.

More specifically, under paragraph 94.2(21)(a), where paragraph 94.2(4)(a) applies for the particular taxation year, and subsection 94.2(20) has never applied for a preceding taxation year, in respect of the participating interest,

In any other case where subsection 94.2(4) applies for the purpose of computing the taxpayer's income for the particular taxation year in respect of the participating interest, paragraph 94.2(21)(b) provides that

Where a taxpayer disposes of a participating interest in a taxation year of the taxpayer and subsection 94.2(21) does not apply (i.e., because subsection 94.2(4) does not apply for the purpose of computing the taxpayer's income for the particular taxation year in respect of the participating interest), subsection 94.2(12) may apply to adjust, with reference to the reconciliation amount in respect of the interest, the taxpayer’s adjusted cost base (or cost) of the interest.

For more detail, see the commentary on subsection 94.2(12) and the definition "reconciliation amount" in subsection 94.2(1).

Foreign Investment Entities – Accrual

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94.3

New section 94.3 of the Act sets out new rules for the taxation of interests in FIEs where subsections 94.1(4) and 94.2(3) do not apply.

Section 94.3 applies to taxation years that begin after 2002.

Definitions

ITA
94.3(1)

New subsection 94.3(1) of the Act sets out a number of definitions and provides that those definitions and the definitions in subsections 94.1(1) and 94.2(1) apply for the purposes of section 94.2.

"fresh-start year"

The definition "fresh-start year" is relevant to calculating a taxpayer's "income allocation" (as defined in subsection 94.3(1)) in respect of a non-resident entity. In general terms, a fresh-start year of an entity in respect of a taxpayer that holds a participating interest in the entity means a taxation year of the entity at the end of which it becomes an entity in respect of which subsection 94.1(3) may apply to the taxpayer in respect of the participating interest.

For more detail, see the commentary on subsection 94.3(4) and on the definition "income allocation" in subsection 94.3(1).

"income allocation"

The definition "income allocation" applies in determining the amount to be included, under "A" of the formula in subsection 94.3(4), in computing a taxpayer’s income or loss for the taxpayer’s taxation year in respect of a property that is a participating interest of the taxpayer in a non-resident entity.

A taxpayer's income allocation (in respect of a participating interest in a non-resident entity held by the taxpayer at the end of a particular taxation year of the non-resident entity that ends in a taxation year of the taxpayer) is determined by the formula set out in that definition. In general terms, the taxpayer’s income allocation is the proportion of the non-resident entity 's income for the particular taxation year ("A" in the formula) that the fair market value of the interest ("B" in the formula) is of the fair market value of all participating interests in the non-resident entity ("C" in the formula). (Note that subsection 94.3(4) is unavailable in respect of a particular interest that would not be a participating interest if the definition "participating interest" in subsection 94.1(1) were read without reference to its paragraph (d).)

The calculation of a taxpayer's income allocation in respect of a non-resident entity depends on a calculation of income for the non-resident entity in accordance with rules set out in paragraphs (a) to (l) of "A" in the formula. This permits taxpayers to make independent calculations of a non-resident entity 's income for the purpose of determining income allocations under section 94.3 for the non-resident entity’s "fresh-start year" (as defined in subsection 94.3(1)) in respect of the taxpayer and subsequent years.

The special rules that apply in calculating a non-resident entity’s income in respect of a taxpayer that is a participating interest holder for the non-resident entity’s fresh-start year and subsequent years are as follows:

(a) Subject to three exceptions, the non-resident entity is generally treated as having been a taxpayer resident of Canada throughout its existence. First, this rule does not apply for the purposes of subsection 107.4(1) and paragraph (f) of the definition "disposition" in subsection 248(1), with the result that where the non-resident entity is a trust, property that is transferred to the non-resident entity is considered to have been transferred to the non-resident entity under subsection 69(1) at its fair market value. Second, this rule does not apply for the purpose of section 91, with the result that the non-resident entity will not itself be required to include an amount in respect of foreign accrual property income in computing the non-resident entity’s income under the "income allocation" definition. It should be noted, however, that the non-resident entity will not be able to rely on subparagraph (a)(i) of the definition "exempt interest" in section 94.1 as a basis for an exemption from the FIE regime for a participating interest of the non-resident entity in a controlled foreign affiliate of it or of the investor taxpayer. Thus the non-resident entity will have FIE income for purposes of the "income allocation" definition in respect of its participating interest in the controlled foreign affiliate. Third, this rule does not apply for the purpose of subparagraph 94.3(2)(b)(ii) with the result that subsection 94.1(4) or 94.2(4) (rather than section 94.3) potentially applies in computing its income in the event that the non-resident entity owns a participating interest in another non-resident entity that is a FIE.

(b) Each property held by the non-resident entity at the beginning of the fresh-start year is deemed to have been disposed of for its fair market value immediately before that time and reacquired for the same amount at that time.

(c) Each discretionary deduction permitted in computing the non-resident entity's income for its fresh-start year and subsequent taxation years is deemed to have been claimed to the extent designated by the investor taxpayer. Thus, in calculating an income allocation in respect of the non-resident entity, the investor taxpayer will be permitted to claim deductions such as capital cost allowance.

(d) The non-resident entity is assumed to have deducted the greatest amounts permissible, for its taxation year preceding the fresh-start year, under sections 20, 138 and 140. These amounts are added in computing the non-resident entity's income for the fresh-start year, but appropriate deductions under these sections can be claimed for the fresh-start year and subsequent taxation years. In the context of the reserve for life insurers under subsection 138(3), it is intended that paragraph (c) of the definition "reported reserve" in subsection 1408(1) of the Regulations be amended so that the non-resident entity can have a "reported reserve".

(e) The non-resident entity is deemed not to have been in existence before the fresh-start year for the purposes of sections 37, 65 to 66.4 and 66.7. As a consequence, the scientific research and resource expenditure pools to which these sections refer are ignored, to the extent that these pools were generated before the fresh-start year.

(f) The non-resident entity is not permitted to deduct any amount under subsection 20(11) or (12) in respect of its foreign tax. However, foreign tax will be taken into account because the non-resident entity's specified tax allocation (as defined under subsection 94.3(1)) can offset amounts otherwise included in income under subsection 94.3(4). Further, if the non-resident entity is a trust, no amount is considered deductible under subsection 104(6) in determining its income for the year. Double taxation for the investor taxpayer is avoided through the application of new section 94.4. In addition, no deemed disposition day under subsection 104(4) is determined in respect of the trust, whether the non-resident entity falls outside the restricted meaning of "trust" for this purpose under subsection 108(1) or not.

(f.1) For taxation years that begin on or before Announcement Date, if the investor taxpayer is a corporation resident in Canada and the non-resident entity is a foreign affiliate of the taxpayer, any dividends received by the non-resident entity from a foreign affiliate of the taxpayer in respect of which the taxpayer has a qualifying interest (as determined under paragraph 95(2)(m)) are not included in the non-resident entity 's income. Note, that this rule does not apply in the event that the non-resident entity's interest in the foreign affiliate is subject to the mark-to-market regime in section 94.2. However, an income inclusion resulting from the application of subsection 94.2(4) for the non-resident entity can, in some cases, be offset by the deduction provided under new subsection 94.4(2).

(g) Where the non-resident entity has an interest in another non-resident entity, there is no "deferral amount" taken into account in computing the non-resident entity 's income pursuant to new subsection 94.2(4). (The fresh-start rule described above eliminates the need for a "deferral amount".)

(h) Participating interests in controlled foreign affiliates of the investor taxpayer or of the non-resident entity are not treated as "exempt interests" of the non-resident entity. As a result, the FIE rules and not the FAPI rules apply in respect of such interests in computing the non-resident’s income under the income allocation rules.

(i) Where the non-resident entity has net capital gains for the particular taxation year, the amount to be included in computing the non-resident entity’s income in respect of the capital gains is the amount, if any, by which the amount determined under subparagraph 3(b)(i) exceeds the amount determined under subparagraph 3(b)(ii) in respect of the non-resident entity for the year.

(j) Where the non-resident entity has net capital losses for the particular taxation year the amount deductible in computing the non-resident entity’s income in respect of capital losses (other business investment losses) is the amount, if any, by which the amount determined under subparagraph 3(b)(ii) exceeds the amount determined under subparagraph 3(b)(i) in respect of the non-resident entity for the year.

(k) Where the non-resident entity has business investment losses for the year the amount deducted in computing the non-resident entity's income for the year in respect of business investment losses is the amount of its allowable business investment losses for the year.

For further details, see the related commentary on the definitions "foreign investment entity", "non-resident entity" and "exempt interest" in subsection 94.1(1) and "loss allocation" and "specified tax allocation" in subsection 94.3(1).

"loss allocation"

The definition "loss allocation" applies in determining the amount to be included, under "B" of the formula in subsection 94.3(4), in computing a taxpayer’s income or loss for the taxpayer’s taxation year in respect of a property that is a participating interest of the taxpayer in a non-resident entity. A taxpayer is entitled, under the formula in subsection 94.3(4), to deduct the taxpayer’s loss allocation in respect the participating interest.

In general, a taxpayer's loss allocation in respect of a participating interest, in a non-resident entity, held by the taxpayer at the end of a particular taxation year of the non-resident entity that ends in a taxation year of the taxpayer, is the proportion of the non-resident entity 's net loss for the particular taxation year that the fair market value of the taxpayer's participating interest in the non-resident entity is of the fair market value of all participating interests in the non-resident entity. More specifically, a taxpayer's loss allocation is determined as follows:

The determination of a taxpayer's loss allocation is subject to the same special rules that apply for the purposes of computing a taxpayer's "income allocation" (as defined in subsection 94.3(1)). For more detail, see the commentary on the definition "income allocation".

"specified tax allocation"

The definition "specified tax allocation" applies in determining the amount to be included, under "C" of the formula in subsection 94.3(4), in computing a taxpayer’s income or loss for the taxpayer’s taxation year in respect of a property that is a participating interest of the taxpayer in a non-resident entity. A taxpayer is entitled to deduct, under C of the formula in subsection 94.3(4), the taxpayer's specified tax allocation in respect of the participating interest

A taxpayer's specified tax allocation in respect of a participating interest, in a non-resident entity, held by the taxpayer at the end of a particular taxation year of the non-resident entity that ends in a taxation year of the taxpayer, means the total of all amounts each of which is the amount determined, in respect of the particular taxation year, by the formula set out in the definition.

More specifically, the taxpayer's specified tax allocation is the product obtained by the following:

Income or profits tax is normally expected to be tax that is paid by an entity to a foreign government. However, it could also include income tax paid to the government of Canada or a province with respect to income earned by the entity from Canadian sources. In each case, only income or profits tax payable for taxation years of entities that end in a taxation year of a taxpayer that begins after 2002 is taken into account.

Rules of Application

ITA
94.3(2)

New subsection 94.3(2) of the Act sets out rules that apply in applying section 94.3 of the Act.

Paragraph 94.3(2)(a) provides that the rules of application in subsection 94.1(2) apply in section 94.3.

Paragraph 94.3(2)(b) identifies a number of circumstances in which subsection 94.3(3) (and hence subsection 94.3(4)) is not available, even though the conditions in paragraphs 94.3(3)(a) to (e) may be met, for a particular taxation year of a taxpayer in respect of a particular participating interest, in a non-resident entity, held in the particular taxation year by the taxpayer. More specifically those circumstances are:

Accrual

ITA
94.3(3) and (4)

Subsection 94.3(3) provides that the accrual regime is available, subject to the limitations set out in paragraph 94.3(2)(b), to a taxpayer for a particular taxation year of the taxpayer in respect of a particular participating interest, in a non-resident entity, held in the particular taxation year by the taxpayer if

  • subsection 94.3(3) applied in respect of an identical participating interest that was held by the taxpayer at any time when the taxpayer held the particular participating interest, or
  • the taxpayer has elected that subsection 94.3(3) apply in respect of the particular participating interest, by notifying the Minister in writing in the taxpayer’s return of income filed on or before the taxpayer’s filing-due date for the first taxation year of the taxpayer for which
  • subsection 94.1(3) applies to the taxpayer in respect of the particular participating interest, or
  • subsection 94.2(9) does not apply to the taxpayer in respect of the particular participating interest and that immediately follows a taxation year for which subsection 94.2(9) applied to the taxpayer in respect of the particular participating interest;

If subsection (3) applies to a taxpayer resident in Canada for a particular taxation year of the taxpayer in respect of a participating interest in a non-resident entity, in computing the taxpayer’s income for the particular taxation year, subsection 94.3(4) will apply in computing the taxpayer’s income or loss for the particular taxation year from property from a property that is the participating interest. More specifically, under paragraph 94.3(4)(a), the taxpayer’s income from property from a property that is the participating interest, is the positive amount, if any, determined as follows:

Where a negative amount results in applying the formula under paragraph 94.3(4)(a), paragraph 94.3(4)(b) may permit a deduction of the negative amount, as a loss from property from a property that is the participating interest, in computing the taxpayer's income for the particular taxation year. However, the deduction is limited by net cumulative positive balance determined under subparagraph 94.3(4)(b)(ii) in respect of the taxpayer for such property in respect of preceding taxation years of the non-resident entity.

An unused loss allocation is treated as a loss from property and is carried forward to offset the total amount otherwise required to be included in computing the taxpayer's income from property under subsection 94.3(4) for a subsequent taxation year of the non-resident entity. For more detail, see the commentary on the definition "loss allocation" in subsection 94.3(1).

The following examples illustrate the operation of subsection 94.3(4).

Example 1

Canco owns shares in the capital stock of FIE-1, which like Canco has a calendar taxation year. Canco's income (loss) allocations for, 2003, 2004, 2005, 2006 and 2007 are ($100), $25, $90, ($20) and $50, respectively. FIE-1 pays no income or profits taxes.

Results

1. The amount included under paragraph 94.3(4)(a) in Canco's income for 2003 is nil (B = $100). The amount determined under paragraph 94.3(4)(b) for 2002 is $100, which can be carried forward to 2004.

2. The amount included under paragraph 94.3(4)(a) in Canco's income for 2004 is nil (A = $25, D = $100). The amount determined under paragraph 94.3(4)(b) for 2004 is $75, which can be carried forward to 2005.

3. The amount included under paragraph 94.3(4)(a) in Canco's income for 2005 is $15 (A = $90, D = $75). The amount determined under paragraph 94.3(4)(b) for 2005 is nil.

4. The amount included under paragraph 94.3(4)(a) in Canco's income for 2006 is nil (B = $20, D = $0). The amount deductible under paragraph 94.3(4)(b) is $15 (= the lesser of $20 and $15). The remaining $5 unused loss allocation can be carried forward to 2007.

5. The amount included under paragraph 94.3(4)(a) in Canco's income for 2007 is $45 (A = $50, D = $5).

Example 2

Canco owns shares in the capital stock of FIE-1, which like Canco has a calendar taxation year. Canco's income (loss) allocations for, 2003, 2004, 2005, 2006 and 2007 are: ($100), ($125), ($175), $300 and $150. FIE-1 pays no income or profits taxes.

Results

1. The amount included under paragraph 94.3(4)(a) in Canco's income for 2003 is nil (B = $100). The amount determined under subparagraph 94.3(4)(b)(i) for 2002 is $100 (= B), which can be carried forward to 2004.

2. The amount included under paragraph 94.3(4)(a) in Canco's income for 2004 is nil (B = $125, D = $100). The amount determined under subparagraph 94.3(4)(b)(i) for 2004 is $225 (= B+D), which can be carried forward to 2005.

3. The amount included under paragraph 94.3(4)(a) in Canco's income for 2005 is nil (B = $175, D = $225). The amount determined under subparagraph 94.3(4)(b)(i) for 2005 is $400 (= B+D).

4. The amount included under paragraph 94.3(4)(a) in Canco's income for 2006 is nil (A = $300, D = $400). The amount deductible under paragraph 94.3(4)(b) is nil (= the lesser of $100 and nil). The remaining $100 unused loss allocation (= D - A) can be carried forward to 2007.

5. The amount included under paragraph 94.3(4)(a) in Canco's income for 2007 is $50 (A = $150, D = $100).

Example 3

1. Canco, FIE-1 and ABC Inc. each have taxation years that coincide with calendar years and each issue only one class of shares.

2. Canco is a corporation resident in Canada that holds 20% of the shares of the capital stock of FIE-1.

3. FIE-1 owns 75% of the shares of the capital stock of ABC Inc.

4. ABC Inc. is not a FIE, but would be a controlled foreign affiliate of FIE-1 if FIE-1 were resident in Canada. Although ABC Inc. is a foreign affiliate of Canco, it is not a controlled foreign affiliate of Canco.

5. FIE-1 earns $5,000 in interest income in 2003. It also receives a dividend of $1,000 from ABC Inc. FIE-1 pays no income or profits taxes.

6. The fair market value of FIE-1's shares in ABC Inc. increases by $6,500 in 2003.

Results

1. Under the definition "income allocation" in subsection 94.3(1), Canco is required to compute its share of FIE-1’s income. For this purpose, FIE-1's income is generally computed as if FIE-1 were resident in Canada. Canco is required, under "A" of the formula in paragraph 94.3(4)(a), to include in computing income its income allocation in respect of its shares in the capital stock of FIE-1.

2. FIE-1's income, in computing Canco’s income allocation, includes the $5,000 of interest income (as per paragraph 12(1)(c)). However, the $1,000 dividend from ABC Inc. is disregarded because of paragraph (g) of "A" in the definition "income allocation".

3. Section 91 of the Act is not applicable in computing Canco’s income allocation in respect of its shares in FIE-1 because of paragraph (a) of "A" in the definition "income allocation".

4. Since ABC Inc. is not a FIE, sections 94.1 to 94.4 are not applicable to FIE-1’s interest in ABC Inc. in computing Canco’s income allocation in respect of is shares in FIE-1.

5. Canco’s income allocation, therefore, is $1,000 (i.e., 20% x $5,000). This amount is included under "A" of the formula in paragraph 94.3(4)(a).

Example 4

Same facts as in example 3, except that ABC Inc. is itself a FIE.

Results

1. Because of subparagraph 94.3(2)(b)(ii), the accrual regime will not apply in the calculation of FIE-1's income in respect of its interest in ABC Inc. Instead, FIE-1 may rely upon subsections 94.2(3) and (4), and if not applicable, subsection 94.1(4). Assume that FIE-1 qualifies, and so elects, to have subsection 94.2(3) apply to it in respect of its interest in ABC Inc. Thus, the mark-to-market regime under subsection 94.2(4) will apply to determine its FIE income from the interest.

2. For the purpose of computing Canco's income allocation in respect of its shares in FIE-1, FIE-1's income would include the $5,000 of interest (as per example 3), but not include any share of foreign accrual property income (as per example 3). However, FIE-1's income would include the $1,000 dividend paid in addition to its gain determined under subsection 94.2(4) in respect of its participating interest in ABC Inc. This gain so determined is $7,500, which is equal to the $6,500 increase in the value of shares plus the $1,000 dividend paid. However, for the purposes of computing Canco's income allocation, a deduction for the $1,000 dividend is permitted for FIE-1 because section 94.4 would have permitted the deduction if FIE-1 had been resident in Canada.

3. Consequently, Canco's income allocation in respect of its shares of the capital stock of FIE-1 is equal to $2,500 [i.e., ($5,000 + $7,500 + $1,000 - $1,000) x 20%)]. This amount is required to be included in computing Canco's income under subsection 94.3(4).

Example 5

In 1999, Mireille (a resident of Canada) purchased a 30% participating interest in an entity (FIE-1) that is a FIE. The rate of foreign tax applicable to FIE-1's income is 20%. FIE-1's taxation years coincide with calendar years. For the purposes of computing Mireille's income or loss in respect of the interest under subsection 94.3(4), the income (loss) and the foreign tax of FIE-1 for taxation years 2003 to 2006 are as follows:

 

Year 2003 2004 2005 2006 Total

Income (loss) $100,000 ($120,000)** $95,000 $130,000 $205,000
Foreign tax paid* $20,000 Nil Nil $21,000 $41,000

* Assume foreign tax paid in the same taxation year as liability arose.

** Assume that an equivalent amount is carried forward under the laws of the relevant foreign jurisdiction to reduce FIE-1's tax liabilities after 2004.

Results

Mireille's income allocations, loss allocations and specified tax allocations are shown in the table below, as are the resulting income inclusions and deductions under subsection 94.3(4). The specified tax allocations in the table below are obtained by multiplying the related figures in the above table by 30% (Mireille's percentage interest) and 2.2 (specified tax factor for Mireille). For example, for 2003 Mireille's specified tax allocation is $13,200 ($20,000 x 30% x 2.2).

 

Year 2003 2004 2005 2006

A. Income/Loss allocation $30,000 ($36,000) $28,500 $39,000
B. Specified tax allocation ($13,200) nil nil ($13,800)
C. Loss allocation (used) nil ($16,800) nil nil
D. Carry-forward offset used nil nil ($19,200) nil
E. Loss allocation/ tax allocation to carry-forward nil ($19,200) nil nil

Amount included in income under subsection 94.3(4)

(A - B - C - D)

$16,800 nil $9,300 $25,200

Amount deducted in computing income under subsection 94.3(4)

(D + C + B - A)

nil ($16,800) nil nil

Adjusted Cost Base

ITA
94.3(5)

New subsection 94.3(5) of the Act provides for adjustments to the adjusted cost base (ACB) of a participating interest in an entity held by a taxpayer.

Paragraph 94.3(5)(a) provides for an addition to the ACB of a taxpayer of a participating interest, in a non-resident entity, at any time of the amount that is the total of the amount included in computing the taxpayer's income under paragraph 94.3(4)(a) for a taxation year of the taxpayer that ended before that time and the product obtained when the amount determined under paragraph (i) of the description of "A" in the definition "income allocation" in subsection 94.3(1) (taxable capital gains of the non-resident entity) in respect of the taxpayer and the participating interest for a particular taxation year of the non-resident entity that ended in a taxation year of the taxpayer that ended before that time and at the end of which particular taxation year the taxpayer held the participating interest is multiplied by the percentage that the fair market value of the interest represents of the fair market value of all participating interests in the entity.

Conversely, paragraph 94.3(5)(b) provides for a reduction to the ACB of a taxpayer of a participating interest, in a non-resident entity, at any time, of the total of three amounts. The first is the amount deducted, as a loss from a property that is the participating interest, under paragraph (4)(b) in computing the taxpayer's income for a taxation year of the taxpayer that ended before that time. The second and third amounts are the product obtained when the amount determined under paragraph (j) or (k), as the case may be, of the description of A in the definition "income allocation" (allowable capital losses of the non-resident entity and allowable business investment losses of the non-resident entity) in respect of the taxpayer and the participating interest for a particular taxation year of the non-resident entity that ended in a taxation year of the taxpayer that ended before that time and at the end of which particular taxation year the taxpayer held the participating interest is multiplied by the percentage that the fair market value of the interest represents of the fair market value of all participating interests in the entity.

For more information, see the commentary on new paragraphs 53(1)(m.1) and 53(2)(w).

Prevention of Double Taxation

ITA
94.4

New section 94.4 provides rules to eliminate double taxation of income where an amount of income of a non-resident entity, in respect of which any of sections 94.1 to 94.3 has applied in calculating the income for a year of a holder of an interest in the non-resident entity, becomes payable (determined by reference to paragraph 94.1(2)(o)) to that interest holder.

Subsection 94.4(1) provides that the definitions in subsections 94.1(1), and the rules of application in subsection 94.1(2), apply in section 94.4.

Under subsection 94.4(2), where an amount becomes payable (at a particular time in a particular taxation year of a taxpayer that begins after 2002 or in a preceding taxation year of the taxpayer that begins after 2002) to the taxpayer from a non-resident entity in respect of a participating interest in the entity held by the taxpayer (otherwise than as consideration for the disposition of the interest), and the taxpayer is resident in Canada at the particular time, a deduction is permitted to offset (against any income included in respect of the interest under subsection 94.1(4), 94.2(4) or 94.3(4)) any net income inclusion resulting from the amount payable.

The permitted deduction under subsection 94.4(2) for the taxpayer’s taxation year is equal to the lesser of two amounts. The first amount is the amount, if any, by which the total of those amounts payable that are included in computing the taxpayer's income for any of those years, exceeds the total of all amounts each of which

As a result, in computing the portion of the amounts payable that may be used in computing a deduction under subsection 94.4(2), an adjustment is made to account for the extent to which the accrual system under the FIE regime has already recognized a possible incidence of taxation at Canadian-equivalent rates in the non-resident entity.

The second amount is the amount, if any, by which the total of

exceeds the total of all amounts each of which is an amount, in respect of the participating interest,

The amount deducted from income under paragraph 94.4(2)(a) in respect of the interest must also be deducted in computing after the particular time the adjusted cost base of the interest. For more information, see the commentary on new paragraph 53(2)(w).

The example below illustrates the operation of subsection 94.4(2).

Example

1. A taxpayer resident in Canada, Canco, purchases a 20% interest in Foreignco, a non-resident corporation. Foreignco is a FIE. Participating interests in Foreignco do not qualify as "exempt interests". Both Canco and Foreignco have taxation years that coincide with calendar years. Subsection 94.1(4) applies to Canco in respect of the interest.

2. Canco's income under subsection 94.1(4) in respect of its participating interest in Foreignco for 2003 is $100,000. Foreignco pays a dividend of $50,000 to Canco in 2003. Canco includes the dividend in income pursuant to section 90 and claims a deduction of $20,000 in computing its taxable income pursuant to subsection 113(1). No foreign withholding taxes were paid by Canco on the $50,000 dividend.

Results

1. Canco's deduction from income under subsection 94.4(2) is equal to $50,000, being the lesser of the income inclusion as a result of the payment (= $50,000) and the amount of the income inclusion under subsection 94.1(4) ($100,000).

2. The result would generally be the same if the $50,000 dividend were instead paid in a subsequent year.

Subsection 94.4(3) is designed to provide relief in circumstances where – because of having made, in computing its income for a taxation year, a deduction under subsection 94.4(2) in respect of a distribution from a FIE – a taxpayer does not have sufficient Part I tax payable for the year against which to claim a foreign tax credit under subsection 126(1) in respect of taxes paid to the government of a foreign country on that amount distributed from the FIE. Subsection 94.4(3) is applicable if

Where these conditions are met, subsection 94.4(3) provides that the taxpayer may deduct in computing the taxpayer's income for the taxation year the amount of the product determined by the formula "A x B" set out in subsection 94.4(3).

Under the formula, A will generally be the taxpayer’s relevant tax factor (as defined by subsection 95(1)) for the taxation year. However, A is nil where the taxpayer is a corporation and the particular amounts are income from a share of the capital stock of a foreign affiliate of the taxpayer; in effect, the deduction under subsection 94.4(3) is not available in these circumstances, as the extent of any relief available to the taxpayer is not otherwise determined under section 126, but rather section 113.

Variable B in the formula is the lesser of two amounts. The first amount is 15% of the total of all amounts, if any, determined under subparagraph (2)(a)(ii) in computing the amount deductible by the taxpayer, in respect of the particular participating interest and the particular amounts, under subsection (2) in computing the taxpayer’s income for the taxation year. In general terms, this will be the amount by which, in respect of the participating interest, income inclusions under the FIE regime for the taxation year exceed deductions from income made under the FIE regime for the taxation year. The second amount is the portion of the foreign tax paid in respect of the particular amounts that would - if the taxpayer had not made a deduction under subsection 94.4(2) - otherwise have been creditable by the taxpayer under subsection 126(1) for the taxation year.

Subsection 94.4(3) is relevant where a FIE distribution is made in respect of a taxpayer’s participating interest and the distribution is subject to non-business income tax imposed by the government of a country in which the FIE is resident. Because of new subsection 126(1.2) of the Act, described in the commentary below, a taxpayer is not entitled to a tax credit under subsection 126(1) in respect of non-business income tax paid by a taxpayer in respect of the distribution if the taxpayer made a deduction under subsection 94.4(3) in respect of the amount distributed.

Clause 19

Foreign Affiliates

ITA
95

Section 95 of the Act defines a number of terms and provides certain rules relating to the taxation of resident shareholders of foreign affiliates.

Definitions

ITA
95(1)

Subsection 95(1) of the Act sets out definitions that are relevant for the purposes of sections 90 to 95.

Subsection 95(1) is amended so that these definitions do not apply for the purposes of sections 94 to 94.4, except where the definition applies for the purposes of the Act as a whole because of subsection 248(1). This amendment applies to taxation years that begin after 2002.

As set out below, various definitions in subsection 95(1) are also being amended.

"controlled foreign affiliate"

In computing the income for a taxation year of a taxpayer resident in Canada, subsection 91(1) of the Act requires the inclusion of a specified percentage of the foreign accrual property income (FAPI) of any controlled foreign affiliate of the taxpayer. In order to eliminate overlap between the FAPI rules and the rules for foreign investment entities in sections 94.1 to 94.4, the latter rules generally do not apply in respect of a taxpayer's interest in a controlled foreign affiliate of a taxpayer resident in Canada. An election is provided under new paragraph 94.1(2)(h) under which a foreign affiliate of a taxpayer can be treated as the taxpayer’s controlled foreign affiliate.

The definition "controlled foreign affiliate" is amended to refer to foreign affiliates that are deemed by paragraph 94.1(2)(h) to be controlled foreign affiliates.

This amendment applies to taxation years that begin after 2002.

"foreign accrual property income"

The FAPI of a controlled foreign affiliate of a taxpayer resident in Canada must be allocated to the taxpayer in accordance with subsection 91(1) of the Act. Under its definition in subsection 95(1), FAPI includes certain amounts that would be included in the affiliate’s income under existing subsection 94.1(1) if that subsection were read in the manner specified in the description of C of the definition.

Existing section 94.1 is being repealed. Accordingly, the description of C in the definition "foreign accrual property income" is also repealed. There are, however, special rules in new paragraph 95(2)(g.3) with regard to the application of sections 94.1 to 94.4 to a foreign affiliate. Amounts determined under paragraph 95(2)(g.3) will be included in FAPI under the description of "A" in the definition "foreign accrual property income". For detail on paragraph 95(2)(g.3), see the commentary on that paragraph.

This amendment applies to taxation years that begin after 2002.

"relevant tax factor"

The definition "relevant tax factor" in subsection 95(1) of the Act is used in determining the Canadian tax relief provided in respect of foreign taxes imposed on the earnings of a foreign affiliate of a taxpayer or a foreign investment entity in which the taxpayer has a "participating interest" (as defined in subsection 94.1(1)). The existing definition provides that the relevant tax factor for a corporation (or a partnership all the resident members of which are corporations) is the reciprocal of the basic corporate tax rate (i.e., 1/.38, or 2.63). The factor for individuals and other partnerships is 2.

As part of a series of amendments reflecting recent and planned reductions in income tax rates, the definition "relevant tax factor" is amended. The relevant tax factor for a corporation (or a partnership all the resident members of which are corporations) will take account of the "general rate reduction percentage" provided in section 123.4 of the Act. For example, if a corporation’s taxation year is the calendar year, its relevant tax factor for 2003 will be 1/(.38 – .05), or 3.03.

Similarly, to take account of decreasing personal income tax rates, the relevant tax factor for individuals and other partnerships is increased to 2.2.

These amendments apply to the 2002 and subsequent taxation years.

Foreign Investment Entities

ITA
95(2)

Subsection 95(2) of the Act provides rules for determining the income of a foreign affiliate of a taxpayer resident in Canada. Subsection 95(2) is amended to clarify that these rules do not apply in applying sections 94 to 94.4 of the Act.

New paragraph 95(2)(g.3) applies to a particular foreign affiliate of a particular taxpayer for a particular taxation year of the particular foreign affiliate, in respect of a property that is a participating interest, in a particular non-resident entity held by the particular foreign affiliate in the particular taxation year. In this case, the amount required under sections 94.1 to 94.4 to be included (or that may be deducted) in computing the particular foreign affiliate’s income from a property that is the participating interest, is to be computed as if

  • the particular foreign affiliate is a controlled foreign affiliate of the particular taxpayer and the particular non-resident entity is a controlled foreign affiliate of both the particular taxpayer and the particular foreign affiliate, or
  • where the particular taxpayer is a partnership, the particular foreign affiliate is a controlled foreign affiliate of the partnership, the particular non-resident entity is a controlled foreign affiliate of the partnership, and the particular non-resident entity is a controlled foreign affiliate of each taxpayer resident in Canada

1. that has, directly or indirectly, a partnership interest in the partnership, or

2. a controlled foreign affiliate of which is a member of the partnership;

This amendment applies to taxation years that begin after 2002.

Application Rules - Foreign Affiliates

ITA
95(5), (6) and (7)

Subsections 95(5) to (7) of the Act contain special rules of application that apply for purposes of the foreign affiliate and controlled foreign affiliate regimes.

These subsections are amended so that they do not apply for purposes of the non-resident trust and foreign investment entity regimes in new sections 94 to 94.4.

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

Clause 20

Partnerships and their Members

ITA
96

Section 96 of the Act provides general rules for determining the income or loss of a partnership and its members.

Computing Partnership Income

ITA
96(1)(d)

Under subsection 96(1), the income earned and losses incurred by a partnership are generally calculated at the partnership level and attributed to partners in accordance with their respective interests in the partnership.

Paragraph 96(1)(d) is amended so that, where at any time in a particular taxation year of the partnership the partnership’s property includes a participating interest in a particular non-resident entity, sections 94.1 to 94.4 apply to the partnership for the particular taxation year in respect of the participating interest as if

  • the taxpayer (i.e. the member of the partnership) is a foreign affiliate of another taxpayer resident in Canada, the particular non-resident entity is a controlled foreign affiliate of the other taxpayer and would be a controlled foreign affiliate of the first taxpayer if the first taxpayer were resident in Canada, or
  • where the taxpayer (i.e., the member of the partnership) is not a foreign affiliate of another taxpayer resident in Canada, the particular non-resident entity is a controlled foreign affiliate of the taxpayer;
  • all of the members of the partnership that were resident in Canada would have qualifying interests (as defined in paragraph 95(2)(m)) in the foreign affiliate based on certain assumptions,
  • an entity that was at any time a member of the partnership has not made in respect of the partnership any other election under paragraph 94.1(2)(h) in respect of the non-resident entity, and
  • none of the members of the partnership is a partnership;

This amendment applies to fiscal periods that begin after 2002.

Application of sections 94.1 and 94.2

ITA
96(1.9)

New subsection 96(1.9) of the Act is relevant where an "exempt taxpayer" (in general, an individual who has been resident in Canada for fewer than 60 months or certain persons exempted by subsection 149(1) from tax on their taxable incomes) is a member of a partnership and the partnership invests in a foreign investment entity. In these circumstances, the exempt taxpayer's share of the partnership's income or loss is computed without regard to sections 94.1 to 94.4. For further details on the application of section 94.2 to partnerships, see the commentary on new subsections 94.2(6) to (8).

This amendment applies to fiscal periods of partnerships that begin after 2002.

Agreement or Election of Partnership Members

ITA
96(3)

Subsection 96(3) of the Act provides rules that apply if a member of a partnership makes an election under certain provisions of the Act for a purpose that is relevant to the computation of the member's income from the partnership. In such a case, the election will be valid only if it is made on behalf of all the members of the partnership and the member had authority to act for the partnership.

Subsection 96(3) is amended, generally for taxation years that end after February 27, 2000, to apply for the purposes of an election under subsections 14(1.01) and (1.02) of the Act in respect of the disposition of an eligible capital property.

Subsection 96(3) is also amended so that

Application of Foreign Partnership Rule

ITA
96(9)

Subsection 96(8) of the Act provides rules that apply where, at a particular time, a Canadian resident becomes a member of a partnership, or a person who is a member of such a partnership becomes a resident of Canada. Where, immediately before the particular time no member of the partnership was resident in Canada, these rules apply in computing the income of the partnership for fiscal periods ending after the particular time. In general terms, the rules in subsection 96(8) are designed to prevent losses accrued while a partnership had no Canadian resident partners from being used to reduce Canadian income tax liabilities.

Subsection 96(9) provides that, where one of the main reasons that there is a member of the partnership who is resident in Canada is to avoid the application of subsection 96(8), that member will, for the purpose of applying subsection 96(8), be considered not to be resident in Canada.

Subsection 96(9) is amended to provide an explicit look-through rule for the purposes of subsection 96(8) so that members of partnerships may be identified through one or more tiers of partnerships that are members of other partnerships. Amended subsection 96(9) is consistent with new subsection 94.2(8).

This amendment applies to partnership fiscal periods that begin after June 22, 2000.

Clause 21

Contributions of Property to a Partnership

ITA
97(2)

Subsection 97(2) of the Act provides rules that allow a person to transfer certain types of property on a tax-deferred "rollover" basis to a partnership.

Subsection 97(2) is amended so that it does not apply to a transfer of property that is a specified participating interest. The concept of a specified participating interest is generally relevant in the context of the foreign investment entity rules in sections 94.1 to 94.4. For more information on the definition "specified participating interest" in subsection 248(1), see the commentary on that definition.

This amendment applies to dispositions that occur in taxation years that begin after 2002.

Clause 22

Disposition of Partnership Property

ITA
98

Section 98 provides rules relating to the taxation of partnership properties and partnership interests where the partnership has ceased to exist.

ITA
98(7)

New subsection 98(7) of the Act applies if at a particular time a partnership ceases to exist. In this case, the partnership is, at a time (the "disposition time") that is three instants before the particular time, deemed

This amendment applies to fiscal periods that begin after 2002.

Clause 23

Trusts and their Beneficiaries

ITA
104

Section 104 of the Act provides rules governing the tax treatment of trusts and their beneficiaries.

ITA
104(4)(a), (a.5) and (c)

Subsection 104(4) of the Act sets out what is generally referred to as the "21-year deemed realization rule" for trusts. The purpose of subsection 104(4) is to prevent the use of trusts to defer indefinitely the recognition for tax purposes of gains accruing on capital property. Subsection 104(4) generally treats capital property of a trust (other than certain trusts for the benefit of a spouse or common-law partner) as having been disposed of and reacquired by the trust every 21 years at the property's fair market value.

Subparagraph 104(4)(a)(i.1) is amended to apply to a trust to which property is transferred in circumstances to which paragraph 70(5.2)(c) applied. It is also amended to ensure that it continues to apply to a trust to which property was transferred in circumstances to which paragraph 70(5.2)(b) or (d) applied as those paragraphs read in their application to taxation years that began before 2003.

Paragraph 104(4)(a.5) is introduced to provide for a deemed disposition day for a trust that is deemed by subsection 94(3) to be resident in Canada for a taxation year for the purpose of computing the trust's income for the year. The deemed disposition day is the day (in that taxation year) on which, because a "contributor" (as defined in subsection 94(1) of the Act) to the trust either ceases to be resident in Canada or ceases to be a contributor to the trust because of the application at any time of paragraph 94(2)(t), there is no resident contributor to the trust (or the only resident contributors to the trust are entities each of which is an entity the maximum amount recoverable from which under the provisions referred to in paragraph 94(3)(d) is limited to the entities’ recovery limits determined under subsection 94(8)). However, no deemed disposition will occur under paragraph 104(4)(a.5) if subsection 94(5) applies in respect of the contributor ceasing on that day to be a resident contributor of the trust. For more information on section 94, see the commentary on that section.

Paragraph 104(4)(c) is amended so that there is not a deemed disposition day for a trust 21 years after any day determined under new paragraph 104(4)(a.5). In effect, the time from which 21 years is counted under paragraph 104(4)(c) is determined without regard to days determined without regard to days determined under any of paragraphs 104 (4)(a) to (a.5)

These amendments apply to trust taxation years that begin after 2002. They also apply to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming into-force provision for new section 94 of the Act.

ITA
104(4.1)

New subsection 104(4.1) of the Act provides that, for the purposes of the deemed disposition rule in subsection 104(4), a property's status as capital property is determined without reference to new subparagraph 39(1)(a)(ii.3). As a result, if subsection 94.2(3) applies for a taxation year to a taxpayer that is a trust in respect of a participating interest of the trust and the trust is deemed to have disposed of the interest because of the application of subsection 104(4), there is a recognition of the "deferral amount" in applying subsection 94.2(4).

This amendment applies to trust taxation years that begin after 2002.

ITA
104(6)

Subsection 104(6) of the Act generally permits a trust to deduct, in computing income for a taxation year, any income payable to a beneficiary under the trust.

Subsection 104(6) is amended so that it is expressly subject to subsections 104(7) to 104(7.1).

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

ITA
104(7.01)

Subsection 104(6) generally permits a trust to deduct, in computing income for a taxation year, an amount not exceeding the portion of its income for the year that becomes payable in the year to a beneficiary under the trust. Because of subsection 104(24), trust income is deemed not to have become payable in the year to a beneficiary unless it is paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of the amount.

New subsection 104(7.01) of the Act restricts the amount that a trust, that is deemed by subsection 94(3) to be resident in Canada (referred to in this commentary as a "subsection 94(3) trust"), can deduct under subsection 104(6) in computing its income in the event that the trust has Canadian-source income and makes distributions to beneficiaries not resident in Canada.

In effect, subsection 104(7.01) acts as a proxy for taxes under Parts XII.2 and XIII of the Act in connection with Canadian-source income earned by a subsection 94(3) trust that has become payable by the trust to its non-resident beneficiaries.

New subsection 94(3) deems a trust to which it applies to be resident in Canada for certain purposes, not including Part XII.2. Accordingly, a trust that is resident in Canada solely because of the deeming provision in subsection 94(3) would generally be non-resident for purposes of Part XII.2. Because of an existing exemption for non-resident trusts in Part XII.2, a tax under that Part does not apply to such a trust.

A subsection 94(3) trust is also exempt from Part XIII withholding obligations on Canadian-source income earned by it that becomes payable by it in the year to non-resident persons.

However, to ensure that subsection 94(3) trusts are not inappropriately used to distribute Canadian-source income free of tax to non-resident beneficiaries, subsection 104(7.01) limits the amount of any trust deduction under subsection 104(6) for such distributions, thereby ensuring the income is subject to Part I tax in the trust.

(It should also be noted that persons that pay or credit an amount to a subsection 94(3) trust are still liable for a withholding obligation under section 215 of the Act notwithstanding that the trust itself is exempt from Part XIII tax. This is because new paragraph 94(4)(b) provides that the deemed Canadian residence under subsection 94(3) does not apply for the purposes of determining withholding obligations under section 215. The Canada Revenue Agency will hold the withholding taxes paid and apply them on account of the trust's Part I tax liability. The existing provisions of the Act do not expressly give a Part XIII exemption in this regard to trusts that are subject to existing subsection 94(1). Instead, existing subparagraph 94(1)(c)(ii) allows a tax credit to be claimed by those trusts under section 126 in connection with Part XIII tax on payments made to those trusts.)

As mentioned above, subsection 104(7.01) reduces the maximum deduction under subsection 104(6). More specifically, the amount by which the maximum deduction under subsection 104(6) for a taxation year is reduced under subsection 104(7.01) is equal to the total of:

The specified factor in respect of each particular amount described in the second paragraph above is 0.35, if the trust can establish to the satisfaction of the Minister of National Revenue that the non-resident beneficiary to whom the particular amount is payable is resident in a country with which Canada has a tax treaty under which the income tax that Canada may impose on the beneficiary in respect of the amount is limited. In any other case, the specified factor is 0.6.

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

The example below illustrates the operation of new subsection 104(7.01).

Example

1. Trust X is an offshore trust established by Stefan, a long-term resident of Canada. The primary beneficiaries under the trust are Linda (a resident of Canada), Tim (a resident of non-Treatyland) and Bart (a resident of the United States).

2. Trust X receives $1,600 of income in its 2003 taxation year. This income consists of $400 of taxable dividends received from a taxable Canadian corporation. The remaining $1,200 of income is from other sources, none of which is "designated income" (as defined in Part XII.2) of the trust.

3. $1,050 of Trust X's income for 2003 is made payable in the year to Bart. Of this amount, $100 represents the taxable dividends. Trust X makes payable $200 of its income to Tim. Of this amount, $200 represents the taxable dividends. The remaining $350 of the trust's income is made payable in the year to Linda. Of this amount, $100 represents the taxable dividends.

4. Trust X is assumed to have designated the $400 of taxable dividends under subsection 104(19). (Where a designation under subsection 104(19) is available and the designation is made, the designated portion of the dividend income of the trust will, for the purposes of the Act (other than Part XIII), maintain its character, as dividend income, in the hands of the beneficiary.)

Results

1. Because Trust X has a resident contributor at the end of its 2003 taxation year, the trust is deemed by new subsection 94(3) to be resident in Canada for the purposes of computing its income.

2. Before taking into account any deduction under subsection 104(6), Trust X's income is $1,600. Note that the $400 in dividends is included in computing the trust's income.

3. Before taking into account new subsection 104(7.01), the maximum deduction under subsection 104(6) is also $1,600.

4. Because of subsection 104(7.01), the maximum deduction under subsection 104(6) is reduced to $1,445 (i.e., $1,600 minus the total of: nil + ((.60 x $200) and (0.35 x $100))).

5. Assuming that the trust claims a deduction of $1,445 under subsection 104(6), the trust would consequently have income of $155. If a tax rate of 42.92% were assumed (i.e., combined federal rates of 29% (because of subsections 122(1) and 117(2) and 13.92% (because of subsection 120(1)), the trust would be liable for Canadian income tax of approximately $67. Note that the trust is exempt from having to collect a Part XIII tax in respect of the amounts made payable to Bart and Tim that are referred to in paragraph 104(7.01)(b) in respect of the trust for the particular taxation year, because these are exempt amounts for the purposes of subparagraph 94(3)(a)(ix). Disregarding this exemption, the Part XIII tax that would have had to have been collected by the trust in respect of the amounts made payable to Bart and Tim would have been $65 (i.e., 25% of $200 and 15% of $100).

ITA
104(21.3)

Subsection 104(21.3) of the Act defines the expression "net taxable capital gains". The expression is used in subsections 104(21) and (21.2), which permit a trust to flow through its taxable capital gains realized in a year to a beneficiary to whom an amount of the trust's income for the year has been made payable. The trust can flow through its taxable capital gains to beneficiaries only to the extent of its net taxable capital gains for the year.

Under subsection 104(21.3), the amount of a trust’s net taxable capital gains for a taxation year equals the amount, if any, by which its total taxable capital gains for the year exceeds the total of two amounts:

Subsection 104(21.3) is amended so that allowable business investment losses (ABILs) are disregarded for the purpose of the first of the two amounts. Accordingly, ABILs will not result in a reduction of taxable capital gains that may be flowed through to beneficiaries under trusts and against which allowable capital losses can be claimed.

This amendment applies to trust taxation years that begin after 2000.

ITA
104(24)

The determination of when an amount becomes payable in a taxation year is relevant for a number of purposes, including the determination of the amount deductible under subsection 104(6) of the Act. Under subsection 104(24), an amount is deemed not to have become payable in the year to a beneficiary unless it was paid in the year to the beneficiary or the beneficiary was entitled in the year to enforce payment of the amount.

Subsection 104(24) is amended so that it also applies for the purposes of paragraph (c) of the definition "specified charity" in subsection 94(1), subsection 94(8) and subsection 104(7.01). For more information, see the commentary on those provisions.

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 24

Cost of Capital Interest

ITA
107(1.1)

Subsection 107(1.1) of the Act provides rules for computing the cost to a taxpayer of a capital interest in a personal trust or a prescribed trust. Paragraph 107(1.1)(b) provides that the cost is nil, except where certain conditions apply.

Paragraph 107(1.1)(b) is amended so that if a capital interest in a personal trust or prescribed trust is a participating interest in a foreign investment entity, the cost of the capital interest will not be deemed by that paragraph to be nil. For more details, see the commentary on new sections 94.1 to 94.4.

This amendment applies to taxation years that begin after 2002.

ITA
107(4.01)

New subsection 107(4.01) of the Act provides that subsection 107(2.1) applies (and subsection 107(2) does not apply) to a distribution to a beneficiary by a trust of a property that is a specified participating interest. The concept of a specified participating interest is generally relevant in the context of the foreign investment entity rules in sections 94.1 to 94.4. For more information on the definition "specified participating interest" in subsection 248(1), see the commentary on that definition.

This amendment applies to distributions that occur in taxation years that begin after 2002.

Clause 25

Qualifying Disposition

ITA
107.4(1)(k)

Subsection 107.4(1) of the Act defines a qualifying disposition of property to a trust to be a disposition of property to the 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. Under subsection 107.4(3), a qualifying disposition generally qualifies for a tax-deferred "rollover" of the property to the trust.

New paragraph 107.4(1)(k) provides that a disposition of property to a trust does not include a disposition of property that is, immediately before the disposition, a specified participating interest.

This amendment applies to dispositions that occur in taxation years that begin after 2002.

Clause 26

Trusts

ITA
108

Section 108 of the Act sets out certain definitions and rules that apply for the purposes of subdivision k, which deals with the taxation of trusts and their beneficiaries.

Definitions

ITA
108(1)

"cost amount"

The definition "cost amount" in subsection 108(1) of the Act applies, for the purposes of sections 104 to 108 (except section 107.4), in determining the cost amount to a taxpayer of the taxpayer’s capital interest (and any part of it relevant in the circumstances) in a trust. However, where the trust is a foreign affiliate of the taxpayer this definition of "cost amount" does not apply. (A trust may be a foreign affiliate of a taxpayer because of the operation of paragraph 94(1)(d) of the Act, which can deem a trust to be in certain circumstances a non-resident corporation in which the taxpayer own shares.)

The definition "cost amount" in subsection 108(1) of the Act is amended to reflect the repeal of paragraph 94(1)(d).

Note that, while the cost amount to a taxpayer of its capital interest in a trust may be relevant in applying sections 94.1 to 94.4 to the taxpayer where the trust is a "foreign investment entity" (as defined in new subsection 94.1(1)) in which the taxpayer’s capital interest is a "participating interest" (as defined in new subsection 94.1(1)), the definition cost amount in subsection 108(1) does not apply for these purposes.

This amendment applies after 2001.

"income interest"

Subsection 108(1) of the Act contains the definition "income interest". It is defined as a right of a taxpayer as a beneficiary under a personal trust to, or to receive, all or any part of the income of the trust and after 1999 includes a right (other than a right acquired before 2000 and disposed of before March 2000) to enforce payment by the trust that arises as a consequence of a right that is an income interest.

Under subsection 108(3), "income" for this purpose is determined without reference to the provisions of the Act.

The definition "income interest" is amended to provide that it does not include a participating interest in a foreign investment entity. For more details on foreign investment entities, see the commentary on sections 94.1 to 94.4.

This amendment applies to trust taxation years that begin after 2002.

"trust"

Subsection 108(1) of the Act defines "trust", for the purposes of the 21-year deemed disposition rule and other specified measures, to exclude certain listed trusts.

Paragraph (a.1) of that definition is amended to clarify that its intended application should be limited to health and welfare trusts.

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Income of a Trust in Certain Provisions

ITA
108(3)

Subsection 108(3) of the Act provides that, for the purposes of the definition "income interest" in subsection 108(1), the income of a trust is its income computed without reference to the provisions of the Act.

Subsection 108(3) is amended so that the rule described above also applies for the purposes of the definitions "life-time benefit trust" in subsection 60.011(1) and "exempt foreign trust" in new subsection 94(1).

This amendment applies to trust taxation years that begin after 2000.

Interests Acquired for Consideration

ITA
108(7)

Subsection 108(7) of the Act contains a rule that, in general terms, provides that a person (or two or more related persons) can make a contribution to a trust and retain an interest under the trust without the interest being considered to have been acquired for consideration. This rule applies for the purposes of paragraph 53(2)(h), subsection 107(1), paragraph (j) of the definition "excluded right or interest" in subsection 128.1(10) and the definition "personal trust" in subsection 248(1).

Subsection 108(7) is amended so that it also applies for the purpose of paragraph (b) of the definition "exempt amount" in subsection 94(1). For more detail on that definition, see the commentary above.

This amendment applies in determining after 2003 whether an interest in a trust has been acquired for consideration.

Clause 27

Deduction in Respect of Dividend Received from Foreign Affiliate

ITA
113

Subsection 113(1) of the Act permits a resident corporation to deduct specified amounts in respect of dividends received from a foreign affiliate out of the exempt, taxable and pre-acquisition surplus of the foreign affiliate. The amounts so deductible are determined largely with reference to Part LIX of the Income Tax Regulations. The deductions under paragraphs 113(1)(b) and (c) with regard to dividends out of taxable surplus are also determined with reference to the resident corporation's "relevant tax factor".

Subsection 113(1) is amended to explicitly link the "relevant tax factor" to the resident corporation receiving the dividends and the taxation year in which the dividends are received.

This amendment applies after 2000.

Clause 28

Part-year Residents

ITA
114

Section 114 of the Act provides rules for computing the taxable income of an individual who is resident in Canada for a period or periods in a taxation year, and is non-resident for the rest of the year.

Section 114 is amended so that it is subject to paragraph 94.2(5)(c), a rule that applies in connection with a participating interest, in a foreign investment entity, in respect of which the mark-to-market regime under section 94.2 applies to a taxpayer. Paragraph 94.2(5)(c) is, however, only relevant to an individual who ceases to be, and later becomes, resident in Canada in the same taxation year. For further information, see the commentary on new subsection 94.2(5).

This amendment applies to taxation years that begin after 2002.

Clause 29

Taxable Income Earned in Canada

ITA
115(1)

Section 115 of the Act determines the amount of a non-resident person's income that is subject to tax under Part I of the Act. This amount is referred to as the non-resident's "taxable income earned in Canada". Subsection 115(1) provides general rules to be applied in calculating a non-resident's "taxable income earned in Canada". Paragraphs 115(1)(a) to (c) set out special assumptions that are applied in computing the taxable income earned in Canada of a non-resident taxpayer. Subparagraph 115(1)(a)(vii) includes in the taxable income earned in Canada of an authorized foreign bank the amount claimed by the bank to the extent that the inclusion increases the bank's usable foreign tax credit under subsection 126(1) but does not increase any amount deductible by the bank under section 127.

Subparagraph 115(1)(a)(vii) of the Act is amended so that, in computing the taxable income earned in Canada of an authorized foreign bank, there must also be included amounts (not otherwise included in computing its taxable income earned in Canada) that are required by paragraph 12(1)(k) to be included in computing the bank’s income, but only to the extent that the income is earned in its Canadian banking business.

This amendment is made in conjunction with paragraph 94.2(2)(t), which ensures that an authorized foreign bank is subject to the FIE rules in respect of participating interests held by it in a FIE.

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

Clause 30

Tax Payable by Inter Vivos Trust

ITA
122(2)(d.1)

Subsection 122(1) of the Act provides that, instead of graduated income tax rates, inter vivos trusts are generally subject to top marginal rates of income tax on their undistributed income. Subsection 122(2) which does not apply to mutual fund trusts, permits graduated income tax rates for certain inter vivos trusts established before June 18, 1971. One of the conditions for an inter vivos trust continuing to qualify for graduated income tax rates is that it not receive any gifts after June 18, 1971.

The opening words of subsection 122(2) are amended to modernize the language and to clarify its intended scope.

Paragraph 122(2)(d.1) is introduced so that the graduated income tax rates cease to apply to a trust in the event that, after June 22, 2000, a "contribution" is made to the trust. For this purpose, the expression "contribution" is defined in new section 94.

This amendment applies to trust taxation years that begin after 2002.

Clause 31

Foreign Tax Credit

ITA
126

Section 126 of the Act provides rules under which taxpayers may deduct, from tax otherwise payable, amounts they have paid in respect of foreign taxes.

ITA
126(1)(a) and (1.2)

Subsection 126(1) of the Act provides a tax credit to a taxpayer in respect of foreign non-business income tax – that is, foreign taxes levied on investment and other non-business income of the taxpayer. However, paragraph 126(1)(a) provides an exception to the effect that no tax credit is available if the taxpayer is a corporation and the foreign taxes paid by the taxpayer are in respect of income from a share of the capital stock of a foreign affiliate of the taxpayer.

Paragraph 126(1)(a) is amended to remove the reference to the exception for taxes paid in respect of income from a share of a foreign affiliate. This exception is now found in subsection 126(1.2).

New subsection 126(1.2) describes circumstances in which subsection 126(1) does not apply. More specifically, it provides that subsection 126(1):

These amendments apply to taxation years that begin after 2002.

Clause 32

Changes in Residence

ITA
128.1

Section 128.1 sets out the income tax effects of becoming or ceasing to be resident in Canada.

ITA
128.1(1.1)

Subsection 128.1(1) sets out rules that apply where a taxpayer becomes resident in Canada. Paragraph 128.1(1)(b) treats a taxpayer who becomes resident in Canada as having disposed of the taxpayer’s property, with certain exceptions, for proceeds equal to the property’s fair market value.

New subsection 128.1(1.1) identifies a set of circumstances in which paragraph 128.1(1)(b) does not apply to a taxpayer that is a trust.

Under subsection 128.1(1.1), paragraph 128.1(1)(b) will not apply, at a time in a particular taxation year of a trust, to the trust if the trust is resident in Canada because of new paragraph 94(3)(a) for the particular taxation year for the purpose of computing its income.

This rule applies to ensure that a deemed disposition does not occur solely because the basis for a trust’s residency in Canada changes from paragraph 94(3)(a) to some other basis.

For more detail on subsections 94(3) and (4), see the commentary on those provisions.

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 33

Exempt Corporations

ITA
149(10)(c)

Subsection 149(10) of the Act applies where, at a particular time, a corporation becomes or ceases to be exempt from tax under Part I on its taxable income (otherwise than by reason of the exemption for certain insurers in paragraph 149(1)(t)). A new taxation year is considered to start at the particular time and the corporation's properties are deemed to have been disposed of at fair market value and reacquired at the particular time for the same amount.

Paragraph 149(10)(c) provides that the corporation is, for specified purposes in the Act, treated as a new corporation. One of the specified purposes is with regard to the investment tax credit regime set out in subsections 127(5) to (26).

Paragraph 149(10)(c) is amended so that it is also relevant in applying

These amendments apply to corporations that, after 2002, become or cease to be exempt from tax on their taxable income under Part I of the Act.

Clause 34

Assessment and Reassessment

ITA
152(4)(b)(vi)

In general terms, subsection 152(4) of the Act provides that the Minister of National Revenue may not reassess tax payable by a taxpayer for a taxation year after the normal reassessment period for the taxpayer in respect of the year unless certain conditions described in paragraph 152(4)(a) or (b) have been met. Subparagraph 152(4)(b)(vi) allows the Minister to reassess a taxpayer within 3 years after the end of the normal reassessment period for the taxpayer in respect of the year where the reassessment is made in order to give effect to the application of subsection 118.1(15) or (16) of the Act.

Subparagraph 152(4)(b)(vi) is amended to also allow the Minister to reassess a taxpayer within three years after the end of the normal reassessment period where the reassessment is made in order to give effect to the application of subsection 94(9) or (10). For more information on subsections 94(9) and (10), see the commentary on those subsections.

This amendment applies after 2002.

Clause 35

Tax Liability – Non-arm's Length Transfers of Property

ITA
160

Section 160 contains rules regarding the joint and several liability of a taxpayer for the income tax liability of another person who, when not dealing at arm’s length with the taxpayer, transferred property to the taxpayer for consideration less than its fair market value.

Assessment

ITA
160(2.1)

New subsection 160(2.1) of the Act allows the Minister of National Revenue to assess a taxpayer at any time in respect of any amount payable because of paragraph 94(3)(d) or (e). Such an assessment has the same effect as if it had been made under section 152 of the Act and is subject to interest. For more information on paragraphs 94(3)(d) and (e), see the commentary on those provisions.

This amendment applies to assessments made after 2002.

Discharge of Liability

ITA
160(3)

Subsection 160(3) of the Act provides that, where a taxpayer becomes jointly and severally liable with another taxpayer under subsection 160(1) or (1.1) with respect to a tax liability of the other person, a payment by the particular taxpayer on account of the particular taxpayer’s tax liability will discharge the joint liability to the extent of the payment.

Subsection 160(3) is amended so that it also applies where the particular taxpayer has become jointly and severally, or solidarily, liable with another taxpayer under because of paragraph 94(3)(d) or (e) in respect of part or all of a liability under this Act of the other taxpayer. (The expression "solidarily " is added to ensure that the Act appropriately reflects both the civil law of the province of Quebec and the law of other provinces.) For more information on paragraphs 94(3)(d) and (e), see the commentary on those provisions.

This amendment applies to assessments made after 2002.

Clauses 36 and 37

Penalties

ITA
162 and 163

Subsections 162 and 163 of the Act impose penalties for infractions such as failing to provide certain information on a return, failing to file a return for a taxation year, and making false statements on a return.

ITA
162(10.1) and (10.11)

Subsection 162(10.1) of the Act imposes a penalty on any person or partnership that is more than 24 months late in filing an information return that the person or partnership was required to file under any of sections 233.1 to 233.4. (This penalty applies in addition to the penalties imposed under subsections 162(7) and (10).)

The penalty imposed under subsection 162(10.1) with respect to a particular information return is equal to a specified amount less the amount of the penalties imposed under subsections 162(7) and (10) with respect to the return. The specified amount with respect to an information return for a trust required to be filed by a person or partnership under section 233.2 is equal to 5% of the total fair market value of any property transferred or loaned to the trust that, if no other loan or transfer were taken into account, would have imposed an obligation on the person or partnership to file the return.

Subsection 162(10.1) is amended, as a consequence of amendments made to section 233.2, by changing the manner in which the specified amount is determined. The specified amount is now to be determined with reference to the fair market value of "contributions" made by the person or partnership to the trust.

New subsection 162(10.11) provides that, for the purpose of the calculation in subsection 162(10.1), the definitions and rules in subsections 94(1), (2) and (9) generally apply. Subsection 162(10.11) is similar to amended subsection 233.2(2), described in greater detail in the commentary below.

These amendments apply to returns in respect of taxation years that begin after 2002. They also apply to returns in respect of taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

ITA
162(10.3), 162(10.4), 163(2.6) and 163(2.91)

Existing paragraph 94(1)(d) of the Act provides for non-resident trusts to be treated as foreign affiliates. It is being repealed as a consequence of the introduction of new rules for non-resident trusts in section 94. Subsections 162(10.3) and (10.4) are rules that affect the calculation of penalty tax in respect of a person's or partnership's failure to file a return in respect of a foreign affiliate.

Subsections 163(2.6) and (2.91) are similar provisions that affect the calculation of penalty tax in respect of false statements and omissions in such a return.

Subsections 162(10.3) and 163(2.6) are amended to reflect the changes to section 94 under which non-resident trusts are no longer treated as foreign affiliates. Subsections 162(10.4) and 163(2.91) are repealed for the same reason.

These amendments apply to returns in respect of taxation years that begin after 2002. They also apply to returns in respect of taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

ITA
163(2.4)(b) and (2.41)

Subsection 163(2.4) of the Act imposes a penalty on any person or partnership that, knowingly or under circumstances amounting to gross negligence, has made or has participated in, assented to, or acquiesced in, the making of a false statement or omission in a return required to be filed under any of sections 233.1 to 233.6. The penalty under paragraph 163(2.4)(b) relates to a return required to be filed under section 233.2. The existing penalty is the greater of $24,000 and 5% of the total fair market value of the property that the person or partnership loaned or transferred to the trust that gave rise to the obligation to file.

Paragraph 163(2.4)(b) is amended as a consequence of changes made to the non-resident trust rules in section 94 and the annual reporting requirement in respect of non-resident trusts under section 233.2. Under amended section 233.2, a person is subject to the annual reporting requirement where the person makes a "contribution" to the trust.

Accordingly, amended paragraph 163(2.4)(b) provides for a penalty for a person equal the greater of $24,000 and a specified amount in respect of the return. The specified amount for a person is essentially equal to 5% of the fair market value of "contributions" made by the person. The specified amount is calculated in the same way as the specified amount under amended subsection 162(10.1) in respect of late-filed returns. Under new subsection 163(2.41), the definitions and rules in subsections 94(1), (2) and (9) generally apply. Subsection 163(2.41) is similar to amended subsection 233.2(2), described in greater detail in the commentary below.

These amendments apply to returns in respect of taxation years that begin after 2002. They also apply to returns in respect of taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 38

Withholding and Remittance of Tax

ITA
215

Section 215 sets out rules governing when a person paying or crediting an amount to a non-resident must withhold a portion of the amount paid or credited.

ITA
215(1)

Subsection 215(1) provides that, where a resident of Canada pays or is deemed to pay an amount to a non-resident person in respect of which the non-resident person is liable for withholding tax under Part XIII, the payer is required to withhold the tax from the amount and remit it to the Receiver General on behalf of the non-resident.

Subsection 215(1) is amended to ensure that, where an amount is paid or credited (or deemed to be paid or credited) to a trust that is deemed, by paragraph 94(3)(a), to be resident in Canada for the purpose of determining the trust’s liability for tax under Part XIII, the payer is required to withhold the tax that would otherwise be payable by the trust and to remit it to the Receiver General.

For more detail on the application of Part XIII to trusts deemed, under paragraph 94(3)(a), to be resident in Canada, and to payers of amounts to such trusts, see the commentary on subsection 94(3) and (4) and subsections 216(4.1).

This amendment applies to trust taxation years that begin after 2002. It also applies to trust taxation years that begin

Clause 39

Deduction and Payment of Tax

ITA
216

Section 216 of the Act provides certain rules relating to non-residents who elect to be taxed under Part I in respect of certain rental and timber royalty income rather than under Part XIII, which would normally apply in such circumstances.

Rents and Timber Royalties –Optional Method of Payment

ITA
216(4.1)

In general, Part XIII of the Act imposes a withholding tax of 25% on rental payments made by Canadians to non-resident owners of Canadian real property. An exception to this general rule exists where a non-resident chooses, under subsection 216(4) of the Act, to file a Canadian income tax return in respect of the rental income and timber royalty income and pay tax on the net amount of such income. Where the conditions of subsection 216(4) are satisfied, the rule requiring a Canadian payer (or agent of the payee pursuant to s. 215(3)) to remit 25% of the gross payment to the CCRA does not apply; instead, only 25% of the net amount of income received by the non-resident’s agent need be remitted.

Although an otherwise non-resident trust to which paragraph 94(3)(a) of the Act applies is deemed resident in Canada for the purposes of determining the trust’s liability under Part XIII on amounts paid or credited to the trust, for the purpose of determining the liability of a Canadian payer on amounts paid or credited to the trust, the trust is effectively treated as resident in Canada (see paragraph 94(4)(c) and section 215).

Subsection 216(4.1) is introduced to provide a measure of relief in these circumstances. Under that subsection, if a trust is deemed by subsection 94(3) to be resident in Canada for a taxation year for the purpose of computing the trust's income for the year, a person who is otherwise required by subsection 215(3) to remit in the year, in respect of the trust, an amount to the Receiver General in payment of tax on rent on real property or on a timber royalty may elect in prescribed form filed with the Minister under this subsection not to remit under subsection 215(3) in respect of amounts received after the election is made. Under paragraphs 216(4.1)(a) and (b), if that election is made, the elector shall,

This amendment applies to trust taxation years that begin after 2002.

Clause 40

Foreign Reporting Requirements

ITA
233.2

Existing section 233.2 of the Act requires certain persons who have made transfers or loans to a "specified foreign trust", or to a non-resident corporation that is a controlled foreign affiliate of such a trust, to file annual information returns with respect to the trust. A "specified foreign trust", as defined in subsection 233.2, includes a trust with a "specified beneficiary" resident in Canada. As defined in subsection 233.2(1), a "specified beneficiary" is generally any beneficiary under the trust with the exception of persons listed in subparagraphs (a)(i) to (x) of the definition. For a return to be required to be filed as a consequence of a transfer or loan, it is necessary to have a "non-arm's length indicator", as set out in subsection 233.2(2), apply in respect of the transfer or loan. One of the cases where a "non-arm's length indicator" applies in respect of a transfer to a trust is where the transferor is a "specified beneficiary" under the trust. Subsection 233.2(3) provides a look-through rule so that, where a partnership transfers property, it is considered to have been transferred by members of the partnership.

New section 94 sets out new rules governing the taxation of non-resident trusts. In order to be consistent with the new rules:

Under amended subsection 233.2(4), reporting will generally be required for a taxation year of a person if the person is a "contributor", "connected contributor" or "resident contributor" to a trust that is non-resident at a "specified time" in the taxation year, of the trust, that ends in that taxation year of the taxpayer. Because of amended subsection 233.2(2), the expressions "contributor", "contribution", "connected contributor", "resident contributor" and "specified time" generally carry the same meaning as in new section 94 (including by reference to deeming rules such as, for example, 94(12) and (13)), with most of the same exceptions for "arm's length transfers" contained in the definition of that expression in subsection 94(1). However, the exception in that definition against transfers of "restricted property" (as defined in subsection 94(1)) is extended to apply to most transfers described in paragraph 94(2)(g) (unless the transfer involves, generally, an issuance of a unit or share from a mutual fund trust, a mutual fund corporation or a corporation other than a closely-held corporation, as the case may be), with the result that such transfers do not give rise to an exception to the obligations for reporting under subsection 233.2(4). It should be noted that amended subsection 233.2(2) also applies for the purpose of new paragraph 233.5(c.1).

New subparagraph 233.2(4)(c)(ii) sets out a list of persons for whom reporting obligations are not imposed. This list is consistent with the list of beneficiaries who are not treated as "specified beneficiaries" under the existing rules in section 233.2.

Amended subsection 233.2(4) of the Act also exempts contributors from filing information returns with regard to trusts described in paragraphs (c) to (h) of the new definition "exempt foreign trust" in subsection 94(1). For more information in this regard, see the commentary on that definition.

These amendments generally apply to returns in respect of trust taxation years that begin after 2002. They also apply to returns in respect of trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

ITA
233.2(4.1)

New subsection 94(3) of the Act provides that, where a non-resident trust has a resident contributor or resident beneficiary at the end of the trust's taxation year, the trust is generally taxed on its income in Canada for the year as if the trust were resident in Canada. However, the deeming provisions in subsection 94(3) apply only to arrangements that are considered to be trusts for Canadian income tax purposes. In some cases, there may be doubt as to whether a given arrangement is a trust for Canadian income tax purposes.

New subsection 233.2(4.1), in combination with subsection 233.2(4), imposes a filing obligation on contributors to certain entities or arrangements in respect of which reporting is not otherwise required. One of the key objectives of subsection 233.2(4.1) is to ensure that claims that section 94 does not apply can be reviewed by the CCRA.

More specifically, new subsection 233.2(4.1) applies where property has, directly or indirectly, been transferred or loaned by a person to be held

The person must, where certain additional conditions are satisfied, file the information return referred to in amended subsection 233.2(4).

New subsection 233.2(4.1) provides that, except as the Minister of National Revenue otherwise permits in writing, the person has obligations under amended subsection 233.2(4) if all of the following conditions are satisfied:

(i) an exempt foreign trust (as defined in subsection 94(1)),

(ii) foreign affiliate in respect of which the person is a reporting entity (as defined in subsection 233.4(1)), or

(iii) an exempt trust (as defined in subsection 233.2(1)).

Where the above conditions are satisfied, the person's obligations under subsection 233.2(4) and related provisions are determined as if:

These amendments apply to returns in respect of trust taxation years that begin after 2002. They also apply to returns in respect of trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 41

Returns in Respect of Foreign Property

ITA
233.3

Section 233.3 of the Act provides reporting requirements in respect of foreign property. In general terms, it provides that certain taxpayers resident in Canada and certain partnerships must file an information return with respect to their "specified foreign property" if the total cost amount of such property exceeds $100,000. For this purpose, "specified foreign property" (as defined in subsection 233.3(1)) includes an interest in a non-resident trust or a trust that would be non-resident were it not for section 94. It does not include an interest in a non-resident trust that was not acquired for consideration by the person or partnership.

Paragraph (d) of the definition "specified foreign property" is amended by eliminating the reference to section 94. Under new subparagraph 94(3)(a)(vi), a trust is deemed to be resident in Canada only for the purpose of determining its obligation to file a return under section 233.3. As a result, the trust will be treated as a specified Canadian entity and reporting entity for purposes of section 233.3. In respect of the obligations of a person or partnership that has an interest in the trust, paragraph 94(3)(a) does not apply to deem the trust to be resident in Canada. This amendment is consequential on amendments to section 94. As a result, an interest in a trust, otherwise deemed to be resident in Canada will be considered a specified foreign property, unless otherwise expressly excluded.

Paragraph (d.1) of the definition is introduced so that specified foreign property includes an interest in an insurance policy issued by a non-resident insurer, if the mark-to-market regime in section 94.2 applies in respect of the interest. New paragraph (d.1) of the definition applies to returns for taxation years that begin after 2002. For further information in this regard, see the commentary on new subsection 94.2(11).

Paragraph (l) of the definition is repealed to eliminate a reference to trusts that are treated as foreign affiliates. This reference is no longer necessary in light of new subsection 94(1), under which non-resident trusts are no longer treated as foreign affiliates.

Except as indicated above, these amendments generally apply to returns in respect of trust taxation years that begin after 2002. In addition, amended paragraphs (d) of the definition "specified foreign property" and the repeal of paragraph (l) of that definition apply to returns in respect of trust taxation years that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 42

Returns Respecting Foreign Affiliates

ITA
233.4(1) and (2)

Section 233.4 of the Act provides reporting requirements in respect of foreign affiliates. In general terms, it provides that taxpayers resident in Canada (or certain partnerships) of which a non-resident corporation or non-resident trust is a foreign affiliate must file an information return in respect of the affiliate.

Subsections 233.4(1) and (2) are amended to eliminate references to foreign affiliates that are non-resident trusts. These references are no longer necessary in light of new subsection 94(1), under which non-resident trusts are no longer treated as foreign affiliates.

These amendments apply to taxation years and fiscal periods that begin after 2002. They apply to taxation years and fiscal periods that begin after 2000, or after 2001, if the trust makes the appropriate election under the coming-into-force provision for new section 94 of the Act.

Clause 43

Due Diligence Exception

ITA
233.5

Section 233.5 of the Act provides that, where specified conditions set out in paragraphs 233.5(a) to (d) are met, information required in a return filed under section 233.2 or 233.4 does not include information that is not available to the person or partnership required to file the return. In the case of a return required to be filed by a person or partnership under section 233.2, paragraph 233.5(c) provides that it must be reasonable for the person or partnership to expect, at the time of each transaction entered into by the person or partnership after March 5, 1996 that either gives rise to the requirement to file the return or that affects the information to be reported in the return, that sufficient information would be available to the person or partnership to comply with section 233.2.

Paragraph 233.5(c) is amended so that it applies only in connection with transactions entered into before June 23, 2000 that gave rise to the requirement to file a return for a taxation year of the trust that began before 2003. In connection with trust returns required to be filed for trust taxation years that began before 2003, it must be reasonable for the person or partnership to expect that sufficient information would have been available to the person or partnership to comply with section 233.2 if the proposed amendments to section 94 were not taken into account.

Paragraph 223.5(c) is also amended so that it does not apply to returns required to be filed under section 233.4. It is replaced in this respect by new paragraph 233.5(c.2), without any change in the specified conditions for such returns.

Paragraph 233.5(c.1) is introduced in connection with returns required to be filed under section 233.2 by a person or partnership for a taxation year of the trust that begins after 2002. Where "contributions" (determined with reference to subsection 233.2(2), referred to in the commentary above) are made after June 22, 2000, relief under section 233.5 is available only if it was reasonable for the person or partnership to expect, at the time of each such contribution that either gives rise to the requirement to file the return or that affects the information to be reported in the return, that sufficient information would be available to the person or partnership to comply with section 233.2.

This amendment applies to returns in respect of taxation years that begin after 2002. It also applies to returns in respect of taxation years that begin

Clause 44

Interpretation and Certain Arrangements under Civil Law

ITA
248(1)

Section 248 of the Act defines a number of terms that apply for the purposes of the Act, and sets out various rules relating to the interpretation and application of various provisions of the Act.

"amount"

The expression "amount" is defined in subsection 248(1) of the Act to mean money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing. A number of special definitions, that apply in limited circumstances, of "amount" are set out in paragraphs (a) to (c) of the definition.

The definition "amount" is amended to add new paragraph (b.1). New paragraph (b.1) of that definition provides that in the case of a stock dividend paid by a non-resident corporation, the amountof any stock dividend is, except where subsection 95(7) applies to the dividend, the greater of two amounts. The first is the amount by which the paid-up capital of the corporation that paid the dividend is increased by reason of the payment of the dividend. The second is the fair market value of the share or shares paid as a stock dividend at the time of payment.

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

"controlled foreign affiliate"

The expression "controlled foreign affiliate" is defined to have the meaning assigned by subsection 95(1).

This definition is amended so that it applies except as expressly otherwise provided in the Act. See, for example, the definition "controlled foreign affiliate" in subsection 17(15).

This amendment applies to taxation years that begin after 2002.

"cost amount"

This definition is used throughout the Act, particularly in provisions relating to the transfer of properties to and from corporations, trusts and partnerships.

New paragraph (c.2) of the definition provides that, where a cost of property to a taxpayer is determined as of any time under new subsection 94.2(13), that cost is also the "cost amount", under subsection 248(1), of the property to the taxpayer at that time.

This amendment applies to taxation years that begin after 2002.

"inventory"

A taxpayer's "inventory" is generally described in subsection 248(1) of the Act as a description of property the cost or value of which is relevant in computing a taxpayer's income from a business for a taxation year. Rules for "inventory" in section 10 and elsewhere in the Act affect the calculation of a taxpayer's income from business.

The definition "inventory" is amended to exclude property of a taxpayer that is subject to the application of subsection 94.1(4) or 94.2(3) of the Act in respect of the taxpayer.

This amendment applies to fiscal periods that begin after 2002.

"share"

The definition "share" is amended so that it applies except as the context otherwise requires. For example, if the context requires that the expression "share" refer to a portion of an amount or thing, then it would not carry the meaning otherwise assigned by subsection 248(1).

This amendment applies to taxation years that begin after 2002.

"foreign accrual property income"

The definition "foreign accrual property income" is included in subsection 248(1) so that the definition of this expression in section 95 of the Act applies for the purposes of the Act.

This amendment applies to taxation years that begin after 2002.

"foreign investment entity"

The definition "foreign investment entity" is included in subsection 248(1) so that the definition of this expression in subsection 94.1(1) of the Act applies for the purposes of the Act.

This amendment applies to taxation years that begin after 2002.

"participating interest"

The definition "participating interest" is included in subsection 248(1) so that the definition of this expression in subsection 94.1(1) of the Act applies for the purposes of the Act.

This amendment applies to taxation years that begin after 2002.

"specified participating interest"

This definition is used throughout the Act, particularly in provisions relating to the transfer of properties to and from corporations, trusts, partnerships, spouses or common-law partners. In general, a transfer of property that is a specified participating interest will not qualify for special rules in the Act that would otherwise allow the transferor of the property to defer recognition, for income tax purposes, of any accrued gains or losses in respect of the property.

A specified participating interest at any time means a property of a taxpayer that at that time is a "participating interest" (e.g., a share of a non-resident corporation, or a beneficial interest in a non-resident trust) of the taxpayer in a "foreign investment entity" (as those expressions are defined in subsection 94.1(1)). However, if the interest is at that time an "exempt interest" (as defined in subsection 94.1(1)) of the taxpayer in the foreign investment entity, it will not be at that time a specified participating interest.

A specified participating interest at any time also means a property of a taxpayer that at that time is a participating interest of the taxpayer in a "tracking entity" (as defined in subsection 94.2(1)). However, if the interest is at that time an exempt interest of the taxpayer in the tracking entity, it will not be at that time a specified participating interest, unless the tracking entity is a controlled foreign affiliate of the taxpayer or is a qualifying entity that is a foreign affiliate of the taxpayer in respect of which the taxpayer has a qualifying interest (within the meaning assigned by paragraph 95(2)(m) of the Act). In addition, if the interest is at that time an interest, of the taxpayer in the tracking entity, that is a participating interest in respect of which subsection 94.2(9) does not apply to the taxpayer solely because of paragraph 94.2(9)(e), it will not be at that time a specified participating interest.

For more detail on the definitions "participating interest", "tracking entity", "exempt interest", and "foreign investment entity", see the commentary on those definitions.

This amendment applies to taxation years that begin after 2002.

Civil Law

ITA
248(3)

Subsection 248(3) of the Act provides a number of rules that apply for the purposes of applying the Act in relation to the Province of Quebec.

Paragraphs 248(3)(a) to (d) deem certain institutions or arrangements created under the laws of the Province of Quebec to be trusts for those purposes. Paragraph 248(3)(e) clarifies that a person is deemed to be beneficially interested in a trust if the person has any right to receive the income or the capital in respect of property that is deemed, under any of paragraphs 248(3)(a) to (d), to be held in trust. Paragraph 248(3)(f) provides that a person beneficially owns property, even if there is a servitude in respect of the property, in relation to which the person has the rights described in any of subparagraphs 238(3)(f)(i) to (iii).

Subsection 248(3) is amended so that it applies generally for the purposes of the Act.

The rules found in paragraphs 248(3)(a) to (c) of the Act are now found in new paragraph 248(3)(a), which sets out the treatment as a trust of certain civil law institutions.

New paragraph 248(3)(b) ensures that the rules in the Act that apply to trusts (including the rules in new sections 94 to 94.4) also apply to foundations. Where property is at any time property of a foundation (and the foundation is not otherwise treated as a trust or corporation for purposes of the Act), the foundation is deemed under paragraph 248(3)(b) to be at that timea trust, and where the foundation is created by will, to be a trust created by will. Such property is deemed to have been acquired (at the time it first became property of the foundation) by the trust from the person that transferred the property to the foundation, and the property is deemed to be, throughout the period in which it is property of the foundation, held by the trust, and not otherwise.

The provisions of paragraph 248(3)(d) are now found in paragraph 248(3)(c). However, note that new paragraph 248(3)(c) clarifies that it is intended to apply only in respect of arrangements that are neither partnerships nor trusts determined without reference to paragraph 248(3)(c). In addition, new paragraph 248(3)(c) applies only to an arrangement established before October 31, 2003. This recognizes that amendments to the Civil Code of Quebec have rendered unnecessary the provision’s original purpose i.e., to allow for the characterization, in the Province of Quebec, of certain entities as trusts under the Act even though they may not technically constitute trusts under the civil law of Quebec.

The provisions of paragraphs 248(3)(e) and (f) are found in new paragraphs 248(3)(d) and (e), respectively. In the latter, the obsolete terms "lessee under an emphyteutic lease" / droit de preneur dans un bail emphytéotique are replaced with "lessee under an emphyteusis" / droit d’emphytéote, the new terminology used in the Civil Code of Québec.

These amendments apply to taxation years that begin after October 30, 2003.

Technical Amendments to the Income Tax Amendments Act, 2000

Clause 45

Inter Vivos

Transfer of Property by an Individual

S.C. 2001

, C.17
53(2)(a)

Income Tax Act

73(1)

Subsection 73(1) of the Income Tax Act generally provides for a tax-free disposition of capital property if it is transferred by an individual to the individual's spouse, common-law partner or a trust for the exclusive benefit of the spouse or common-law partner during the lifetime of the spouse or common-law partner. For subsection 73(1) to apply, the transferor and transferee must both be resident in Canada at the time of the transfer. Where the transferee is a trust, in respect of transfers that occur in 2000 or 2001, the residency requirement is determined without reference to subsection 94(1) as it read before 2002.

This amendment to the Income Tax Amendments Act, 2000, ensures that, in applying subsection 73(1) in respect of transfers that occur in 2000, 2001 or 2002, the residence of a transferee will be determined without reference to section 94 of the Act, as it reads in its application to taxation years that began before 2003.

This amendment is deemed to come into force on June 14, 2001.

Clause 46

Disposition by Taxpayer of Capital Interest

S.C. 2001

, C.17
80(19)

Income Tax Act

107(1)

Paragraph 107(1)(a) of the Income Tax Act applies for the purpose of computing a taxpayer's taxable capital gain from the disposition of a capital interest in a personal trust (or a prescribed trust described in section 4800.1 of the Income Tax Regulations), except where the interest was an interest in a non-resident inter vivos trust purchased by the taxpayer and the disposition was not by way of a distribution to which subsection 107(2) applies. For this purpose the residency of the trust is to be determined without reference to section 94 as it read before 2002.

This amendment to the Income Tax Amendments Act, 2000, ensures that, in applying subsection 107(1) in respect of transfers that occur in 2000, 2001 or 2002, the residence of a transferee trust will be determined without reference to section 94 of the Act, as it reads in its application to taxation years that began before 2003.

This amendment is deemed to come into force on June 14, 2001.

Part 2 - General Amendments

Clause 47

Income or Loss from a Source or from Sources in a Place – Deductions Applicable

ITA
4(3)(a)

Subsection 4(2) of the Income Tax Act provides that, in determining the income or loss from a source, no deductions are permitted under sections 60 to 64 of the Act. Subsection 4(3) provides that this rule does not apply, with the exception of certain deductions, in determining the foreign source income designated by a trust to a beneficiary under subsections 104(22) and 104(22.1), in determining a taxpayer’s taxable income earned in Canada under section 115 and in determining a taxpayer’s foreign tax credit under section 126 of the Act. The exceptions are for deductions permitted by paragraphs 60(b) to (o), (p), (r) and (v) to (w).

Paragraph 4(3)(a) is amended to expand the list of exceptions to include deductions permitted by paragraph 60(x) (e.g., repayment of Canada Education Savings Grants).

This amendment applies to the 2002 and subsequent taxation years.

Clause 48

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

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.

Forgiven Amount

ITA
6(15.1)

Subsection 6(15) of the Act provides that, for the purpose of paragraph 6(1)(a), the value of the benefit derived from the forgiveness of a debt is the forgiven amount in respect of the obligation. Subsection 6(15.1) of the Act provides that, for the purpose of subsection 6(15), the expression "forgiven amount" in respect of an obligation has the meaning that would be assigned by subsection 80(1) of the Act if certain assumptions were made.

Subsection 6(15.1) of the French version of the Act refers to conditions that must be met in order for the provision to apply. This statement could be interpreted as requiring that the obligation referred to in the preamble of subsection 6(15.1) be a commercial obligation. In order to avoid this interpretation, the French version of subsection 6(15.1) is amended to clarify that the statements made in paragraphs (a) to (d) are assumptions and not conditions.

This amendment applies to taxation years that end after February 21, 1994.

Clause 49

Employee Security Options – Definitions

ITA
7(7)

Section 7 of the Act deals with agreements (generally referred to as stock options) under which employees of a corporation or mutual fund trust acquire rights to acquire securities of the employer (or a person with whom the employer does not deal at arm’s length).

Subsection 7(7) of the Act defines the expressions "qualifying person" and "security" for the purposes of section 7 and certain other provisions of the Act relating to those agreements. "Qualifying person" is defined as a corporation or a mutual fund trust. "Security" is defined as a share issued by a corporation or a unit of a mutual fund trust.

Subsection 7(7) is amended to have these definitions also apply for the purposes of new subsections 110(1.7) and (1.8) of the Act. New subsection 110(1.7) ensures that a reduction in the exercise price under an employee security option will not disqualify the employee from claiming the security option deduction under paragraph 110(1)(d) of the Act, provided certain conditions are met. New subsection 110(1.8) sets out the conditions that must be met in order for new subsection 110(1.7) to apply.

This amendment, which applies after 1998, is consequential to the enactment of new subsections 110(1.7) and (1.8). For additional information, see the commentary to those subsections.

Clause 50

Income from Office or Employment – Deductions

ITA
8

Section 8 of the Act provides for the deduction of various amounts in computing income from an office or employment.

Legal Expenses of Employee

ITA
8(1)(b)

Paragraph 8(1)(b) of the Act allows the deduction of amounts paid by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the taxpayer’s employer or former employer.

Concern has been expressed that where an amount is not owed to the employee directly by the employer, any legal expenses incurred by the taxpayer would not be deductible under paragraph 8(1)(b), even though the amount, when received, would be taxable as employment income. This would be the case, for example, with respect to legal fees incurred by a taxpayer to collect insurance benefits under a sickness or accident insurance policy provided through an employer.

Paragraph 8(1)(b) is amended, effective for amounts paid after 2000, to allow a deduction for legal expenses incurred by a taxpayer to collect, or establish a right to collect, an amount that, if received, would be included in computing the taxpayer’s employment income.

Dues and Other Expenses of Performing Duties

ITA
8(1)(i)

Paragraph 8(1)(i) of the Act permits an employee to deduct certain dues and other employment expenses that are paid by the employee. Paragraph 8(1)(i) is amended, applicable on Royal Assent, to clarify that an expense described in that paragraph that is paid on an employee’s behalf is deductible by the employee if the amount paid is required to be included in computing the employee’s income.

Clause 51

Income Inclusions

ITA
12

Section 12 of the Act provides for the inclusion of various amounts in computing the income of a taxpayer from a business or property.

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.

No Deferral of Section 9 Under Paragraph (1)(g)

ITA
12(2.01)

New subsection 12(2.01) of the Act, which comes into force on Royal Assent, provides that paragraph 12(1)(g) of the Act does not defer the inclusion in a taxpayer's income of an amount that would otherwise be so included at an earlier time in accordance with section 9 of the Act. Accordingly, where an amount based on production or use would be included in computing a taxpayer’s income from a business or property (if section 12 were read without reference to paragraph 12(1)(g)) at a time when the amount is accrued but not yet received, subsection 12(2.01) clarifies that paragraph 12(1)(g) does not apply to defer the inclusion of the amount in income until the time of receipt.

Clause 52

Depreciable Property

ITA
13

Section 13 of the Act provides a number of special rules related to the treatment of depreciable property. Generally, these rules apply for the purposes of sections 13 and 20 of the Act and the capital cost allowance regulations.

Recaptured Depreciation

ITA
13(1)

Subsection 13(1) of the Act provides for the inclusion in a taxpayer’s income of recaptured capital cost allowance when the taxpayer’s proceeds of disposition of depreciable property of a prescribed class exceeds the undepreciated capital cost (UCC) of the property.

Subsection 13(1) is amended to add a reference to new descriptions D.1 and K of the definition "undepreciated capital cost" in subsection 13(21). Those descriptions provide for an addition to the UCC of a class of certain countervailing duties paid in respect of property of the class ("D.1") and a corresponding reduction for any refunds of those amounts ("K").

This amendment applies to taxation years that end after February 23, 1998, and corrects a technical deficiency.

Exchanges of Property

ITA
13(4)(c)(ii)

Subsection 13(4) of the Act allows a taxpayer, who is required under subsection 13(1) to include in income recaptured depreciation resulting from the disposition of certain depreciable property, to elect to defer tax on the recapture to the extent that the taxpayer reinvests the proceeds of disposition in a replacement property within a certain period of time, namely

Subparagraph 13(4)(c)(ii) is amended to accommodate taxation years that are shorter than 12 months, by providing that the periods for acquiring replacement property end at the later of the times mentioned above and

These amendments apply, in the case of involuntary dispositions, in respect of dispositions that occur in taxation years that end on or after December 20, 2000, and in any other case, in respect of dispositions that occur in taxation years that end on or after December 20, 2001.

Election – Limited Period Franchise, Concession or License

ITA
13(4.2) and (4.3)

Subsection 14(6) of the Act permits a taxpayer to defer tax otherwise arising on the disposition of an eligible capital property, to the extent that the taxpayer reinvests the proceeds of disposition in a replacement property within a certain period of time. A franchise, concession or license with an indefinite term may be such an eligible capital property. However, such a property with a defined term will generally be a depreciable property included in Class 14 of Schedule II of the Regulations and will not be eligible for similar replacement treatment under subsection 13(4) of the Act because such a property is not a "former business property" as defined in subsection 248(1) of the Act. Further, the replacement property provisions for depreciable property generally apply only to immoveable property.

New subsections 13(4.2) and (4.3) of the Act are added, concurrent with the amendment of the definition "former business property", to allow a taxpayer (the "transferor") to use the replacement property rules under subsection 13(4) in respect of the disposition or termination of a property that is the subject of a joint election with the purchaser (the "transferee") of the property.

New subsection 13(4.2) describes the circumstances under which the transferor and the transferee may make a joint election. Property eligible for the election is a "former property" described in subsection 13(4) that is a franchise, concession or license for a limited period that is wholly attributable to the carrying on of a business at a fixed place. The election may be made where the property is disposed of directly by the transferor to the transferee or where the property of the transferor is terminated and the transferee acquires a similar property in respect of the same fixed place from another person. Both parties must elect in their returns of income for their respective taxation years that include the year of the disposition or termination.

New subsection 13(4.3) provides rules that apply when an election has been made under subsection 13(4.2). If the transferee acquires the property disposed of by the transferor (the "former property"), the transferee is deemed to own that property until such time as the transferee owns neither the former property nor a similar property in respect of the same fixed place to which the former property related. If the transferee instead acquires a similar property in respect of the same fixed place (i.e., the life of the former property was terminated), the transferee is deemed to have also acquired the former property and to continue to own it until the transferee no longer owns the similar property.

In either case, for the purpose of claiming a deduction by the transferee under paragraph 20(1)(a) of the Act, the life of the former property in the hands of the transferee is deemed to be the term remaining at the time the transferor originally acquired the property. For instance, a license with a 20-year life when it was originally acquired by the transferor, but with 5 years remaining at the time of the transfer, would be considered to have a 20 year life in the hands of the transferee for the purposes of claiming a deduction under paragraph 20(1)(a).

There may be circumstances where, but for an election under subsection 13(4.2), a portion of the consideration given by a transferee upon the sale of a limited period franchise, license or concession might reasonably be considered to be an eligible capital amount to the transferor and an eligible capital expenditure to the transferee. For instance, a portion of the consideration may reasonably relate to the preferred status that the transferee may receive in obtaining a new property at the end of the term. Where an election under subsection 13(4.2) is made, subsection 13(4.3) provides that such an amount will be neither an eligible capital amount to the transferor, nor an eligible capital expenditure to the transferee, but will instead be included in the cost to the transferee and proceeds of disposition of the transferor of the former property.

In this regard, it is also proposed that section 1101 of the Regulations be amended, applicable after December 20, 2002, by adding the following after subsection (1af):

(1ag) If more than one property of a taxpayer is described in the same class in Schedule II, and one or more of the properties is a property in respect of which the taxpayer is a transferee that has elected under subsection 13(4.2) of the Act, a separate class is prescribed for each such property of the taxpayer that would otherwise be included in the same class.

If, subsequent to the acquisition of the former property by the transferee, the life of the former property expires and a similar property in respect of the same fixed place is not acquired by the transferee, the transferee may, under subsection 20(16) of the Act, be entitled to a terminal loss in respect of the former property. Refer to the commentary to new paragraph 20(16.1)(b) of the Act regarding limitations in respect of the deduction of such a terminal loss.

New subsections 13(4.2) and (4.3) apply in respect of dispositions and terminations that occur after December 20, 2002.

Example 1

Ms. Mubarak is a franchisee with 5 years remaining of a 20-year agreement. The original cost was $60,000, and the undepreciated capital cost ("UCC") is $15,000. The agreement is transferable, so she agrees to sell the franchise to Mr. Grando at its fair market value of $85,000. Ms. Mubarak will, in the same taxation year, purchase from Ms. Vincent a replacement franchise that has 15 years remaining of a 20-year term, for $100,000.

But for the making of an election under subsection 13(4.2), Ms. Mubarak would have a capital gain of $25,000 (i.e., $85,000 - $60,000) and a UCC balance of $55,000 (i.e., $15,000 + $100,000 - $60,000) before deducting any capital cost allowance for the year. The adjusted cost base ("ACB") of her replacement franchise would be $100,000. Mr. Grando would have acquired a Class 14 property with an ACB and capital cost of $85,000, depreciable over 5 years.

If Ms. Mubarak and Mr. Grando jointly elect under subsection 13(4.2), Ms. Mubarak may elect under subsections 13(4) and 44(1) to defer the capital gain, such that the ACB and capital cost of the replacement franchise will be deemed to be $75,000 (i.e., $100,000 less the $25,000 deferred capital gain). Furthermore, Ms. Mubarak’s UCC balance for Class 14 will be $30,000 (i.e., an increase equivalent to the $100,000 cost of the replacement franchise less the $85,000 proceeds from the former property), to be amortized over the remaining 15-year term. In this regard, note that the term for amortizing Ms. Mubarak’s replacement franchise is unaffected by her and Mr. Grando’s joint election in respect of the former property. Mr. Grando, on the other hand, will be required to amortize his $85,000 cost of the former property over 20 years, which was the term of the former property when it was first acquired by Ms. Mubarak.

If Mr. Grando does not enter into a new agreement with the franchisor after the 5-year period, he will be eligible for a terminal loss (even if there are other Class 14 assets, because the $85,000 property will be in a "separate class"). However, a terminal loss will not be available if a person dealing non-arm’s length with Mr. Grando, at any time before the time that is 24 months after the expiry of the old agreement, enters into a new franchise agreement in respect of the same fixed place.

Example 2

Consider the same example, except that the original franchise agreement of Ms. Mubarak (the former property) is not transferable, but instead must be terminated and renewed with the franchisor. Suppose that it is renewed by Mr. Grando for a period of 12 years, with an additional amount of $120,000 paid by Mr. Grando to the franchisor for the new agreement.

In this case it is arguable that, for Mr. Grando, the $85,000 payment to Ms. Mubarak is, absent an election under subsection 13(4.2), an eligible capital expenditure by Mr. Grando. That is, Mr. Grando will pay a separate amount of $120,000 to the franchisor for a Class 14 asset, but the $85,000 payment to Ms. Mubarak is, in effect, incurred to acquire the right to renew the franchise, not to acquire a Class 14 property. Ms. Mubarak has likewise received proceeds of disposition of an eligible capital property (i.e., an "eligible capital amount", 3/4 of which would reduce her CEC balance), not proceeds of disposition of a Class 14 property. Absent an election under subsection 13(4.2), Ms. Mubarak would not be entitled to acquire a replacement eligible capital property, but could be entitled to claim a terminal loss on the termination of the original franchise agreement (if she had no other Class 14 assets on hand at the end of the taxation year of disposition). Subsection 14(1) would apply to the eligible capital amount received by Ms. Mubarak.

The $120,000 cost of the new agreement to Mr. Grando, paid to the franchisor, could be written off by Mr. Grando over its 12-year term.

If Ms. Mubarak and Mr. Grando jointly elect under subsection 13(4.2), no part of the proceeds of disposition for the former property will be an eligible capital amount or an eligible capital expenditure. The results are the same as in Example 1, except that Mr. Grando will now have two Class 14 properties:

Example 3

Consider again Example 1, but suppose that the replacement franchise, purchased by Ms. Mubarak from Ms. Vincent, is itself the subject of a joint election by them under subsection 13(4.2). Ms. Mubarak is required to amortize her $30,000 UCC (see Example 1) over the original 20-year term of Ms. Vincent, not over its remaining 15 years.

Clause 53

Eligible Capital Property

ITA
14

Section 14 of the Act provides rules concerning the tax treatment of expenditures and receipts of a taxpayer in respect of eligible capital properties and operates on a pooling basis. Annual deductions, which are calculated as a percentage of this pool, may be claimed under paragraph 20(1)(b) of the Act. "Eligible capital property" includes goodwill, customer lists, farm quotas and licenses of unlimited duration.

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) applies generally to dispositions of eligible capital property that occur after February 27, 2004, and in particular to dispositions of goodwill that occur after December 20, 2002.

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

over

The amount included in Variable A of Mrs. Y's cumulative eligible capital balance is calculated as follows:

  • 3/4 of her deemed eligible capital expenditure of $700,000
  $525,000

less 1/2 of the amount by which

   
  • the taxable gain of Mr. X
$450,000  

exceeds

   
  • 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 generally apply to taxation years that end after February 27, 2000.

Restrictive Covenant Amount

ITA
14(5.1)

New subsection 14(5.1) of the Act provides that the description E of the definition "cumulative eligible capital" in subsection 14(5) does not apply to an amount if the amount is required to be included in the taxpayer’s income because of subsection 56.4(2). However, subsection 56.4(2) does not apply to an amount if paragraph 56.4(3)(b) applies to the amount, in which case the amount may be a cumulative eligible capital receipt for the purposes of applying section 14. As well, if new subparagraphs 56.4(7)(d)(i) or (ii) apply, consideration that could reasonably be regarded as being for the restrictive covenant granted by a taxpayer for nil proceeds may be – depending on the circumstances – a goodwill amount (as defined by new subsection 56.4(1)) that is to be included in computing the cumulative eligible capital of the taxpayer, or the taxpayer’s eligible corporation (as defined by new subsection 56.4(1)). New section 56.4 is more fully described below in the notes accompanying that provision.

New subsection 14(5.1) is consequential to the rules for restrictive covenant amounts as set out in new section 56.4, and applies after October 7, 2003.

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 December 20, 2001.

Clause 54

Shareholder Benefits

ITA
15

Section 15 of the Act requires the inclusion in income of certain benefits received or enjoyed by shareholder of a corporation.

Forgiven Amount

ITA
15(1.21)

Subsection 15(1.2) of the Act provides that, for the purpose of subsection 15(1), the value of the benefit where an obligation issued by a debtor is settled or extinguished is deemed to be the forgiven amount in respect of the obligation. Subsection 15(1.21) of the Act provides that, for the purpose of subsection 15(1.2), the expression "forgiven amount" in respect of an obligation has the meaning that would be assigned by subsection 80(1) of the Act if certain assumptions were made.

Subsection 15(1.21) of the French version of the Act refers to conditions that must be met in order for the provision to apply. This statement could be interpreted as requiring that the obligation referred to in the preamble of subsection 15(1.21) be a commercial obligation. In order to avoid this interpretation, the French version of subsection 15(1.21) is amended to clarify that the statements made in paragraphs 15(1.21)(a) to (d) are assumptions and not conditions.

This amendment applies to taxation years that end after February 21, 1994.

Shareholder Debt

ITA
15(2)

Subsection 15(2) of the Act requires that certain shareholder indebtedness be included in computing the income of the debtor. Included in such indebtedness are loans from a corporation to its shareholders, loans to persons connected with the shareholders, as well as loans from a partnership to a shareholder of one of its corporate members.

Subsection 15(2) was amended in 1998 by S.C. 1998, c.19, s.75(1) [formerly Bill C-28], generally applicable to loans and indebtedness arising in the 1990 and subsequent taxation years. Prior to that amendment, the English and French versions of subsection 15(2) referred to the expression "has become indebted" (devient la débitrice). However, the 1998 amendments incorrectly introduced into the French version of the subsection the expression « contracter une dette » (to incur a debt). This unintended inconsistency in terminology is corrected in the French version by replacing the expression « contracter une dette » (to incur a debt) with the expression « devient la débitrice » (has become indebted).

This amendment applies to loans made and indebtedness arising in the 1990 and subsequent taxation years.

Clause 55

Prohibited Deductions

ITA
18

Section 18 of the Act prohibits the deduction of certain outlays and expenses in computing a taxpayer’s income from a business or property.

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.

Losses – Adventurers in Trade

ITA
18(14)

Subsection 18(14) of the Act describes the circumstances in which the loss-deferral rule in subsection 18(15) applies to dispositions of property that is described in an inventory of a business that is an adventure or concern in the nature of trade. Paragraph 18(14)(c) excludes from the application of the rule dispositions under specified provisions of the Act. As a consequence of the restructuring of section 132.2 of the Act, the reference in paragraph 18(14)(c) to paragraph 132.2(1)(f) is replaced by references to paragraphs 132.2(3)(a) and (c).

This amendment applies to dispositions that occur after 1998.

Clause 56

Non-application of Section 18.1

ITA
18.1(15), (16) and (17)

Section 18.1 of the Act provides rules that restrict the deductibility of a taxpayer’s cost of a "right to receive production", by prorating the deductibility of the amount of the investment over the economic life of the right. In the transactions that are subject to these rules, investors undertake to pay expenditures that would otherwise be expenses payable by the "vendor" (e.g., payroll, selling commissions) in exchange for a right to receive future income (a "right to receive production"), usually from the vendor's business operations. Such an expenditure by the taxpayer, referred to as a "matchable expenditure", is defined in subsection 18.1(1) of the Act.

Subsection 18.1(15) of the Act provides two general exceptions to the application of the matchable expenditure rules. One such exception, in paragraph 18.1(15)(b), generally applies where the matchable expenditure relates to the issuance of an insurance policy for which all or a portion of a risk has been ceded to the taxpayer. This exception remains unchanged other than changes in numbering.

Paragraph 18.1(15)(a) provides the other exception to the matchable expenditure rules, applicable only if no part of the expenditure of the taxpayer can reasonably considered to have been paid to another person to acquire the right to receive production from that person. If this condition is met, the expenditures must meet one of two further criteria. Subparagraph 18.1(15)(a)(i) allows the exception if the taxpayer’s expenditure cannot reasonably be considered to relate to a tax shelter investment and none of the main purposes of making the expenditure is to obtain a tax benefit. Alternatively, subparagraph 18.1(15)(a)(ii) allows the exception if, in the same year as the matchable expenditure is made, the total revenues of the taxpayer from the right to receive production exceed 80% of the expenditure. If this 80% revenue threshold is met, the portion of the expenditure that is deductible is limited only by general rules that apply to all business expenditures.

Subparagraph 18.1(15)(a)(i) is renumbered as new subsection 18.1(16) and remains unchanged. The alternative exception in subparagraph 18.1(15)(a)(ii) (the 80% revenue threshold) is renumbered as new subsection 18.1(17) and no longer provides a general exception to the application of the matchable expenditure rules. This amended rule provides that if any portion of the matchable expenditure can reasonably be considered to relate to a tax shelter or a tax shelter investment, subsection 18.1(4), which requires the amortization of the expenditure (subject to an income limit), will apply without reference to paragraph 18.1(4)(a). The result is that the cumulative amount deducted in respect of a matchable expenditure may not exceed the taxpayer’s cumulative revenue from the associated right to receive production.

The amendments to section 18.1 generally apply in respect of expenditures made by a taxpayer on or after September 18, 2001.

Clause 57

Deductions

ITA
20

Section 20 of the Act provides rules relating to the deductibility of certain outlays, expenses and other amounts in computing a taxpayer’s income for a taxation year from business or property.

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.

Deduction for Foreign Tax

ITA
20(12)

Subsection 20(12) of the Act allows a taxpayer to deduct, in computing income for a taxation year from a business or property, non-business income taxes paid to a foreign government in respect of the income. The subsection is amended to make explicit the requirement that the taxpayer claiming the deduction be resident in Canada during all or part of the year for which the claim is made. This amendment is clarifying only, and applicable after December 20, 2002. (Accordingly, the amendment is effective for any application of the Act after that date.)

Terminal Loss

ITA
20(16)

Subsection 20(16) of the Act permits a taxpayer to deduct, in computing the taxpayer’s income for a year, the terminal loss of the taxpayer in respect of a class of depreciable property at the end of the year. That subsection is amended to add a reference to new descriptions D.1 and K of the definition "undepreciated capital cost" in subsection 13(21) of the Act. For information about those new descriptions, see the commentary to subsection 13(1).

This amendment applies to taxation years that end after February 23, 1998, and corrects a technical deficiency.

Non-Application of Subsection (16)

ITA
20(16.1)

Subsection 20(16.1) of the Act provides that a terminal loss under subsection 20(16) in respect of a depreciable property that is a "passenger vehicle" costing more than a prescribed amount (currently set at $30,000) is not deductible in computing income. That rule is renumbered as paragraph 20(16.1)(a) and new paragraph 20(16.1)(b) is added, applicable to taxation years that end after December 20, 2002. These amendments are made concurrently with the addition of subsections 13(4.2) and (4.3) of the Act and with the amendment of the definition "former business property" in subsection 248(1) of the Act.

New paragraph 20(16.1)(b) provides that a terminal loss is not available in respect of another person’s former business property that was deemed under paragraphs 13(4.3)(a) or (b) (as the result of a joint election under subsection 13(4.2) by the taxpayer and the other person) to be owned by the taxpayer. For further information, refer to the commentary to subsections 13(4.2) and (4.3).

Clause 58

Scientific Research and Experimental Development

ITA
37

Section 37 of the Act sets out the rules governing the deductibility of expenditures incurred by a taxpayer for scientific research and experimental development (SR&ED).

ITA
37(8)(a)(ii)(B)(V)

Paragraph 37(8)(a) of the Act provides rules for interpreting the expression "expenditures on or in respect of scientific research and experimental development" which is used in subsections 37(1), (2) and (5).

Clause 37(8)(a)(ii)(B) provides for the alternative "proxy" method for determining SR&ED expenditures. Subclause 37(8)(a)(ii)(B)(V) provides that, in the context of the proxy method for determining SR&ED expenditures, the references to expenditures on or in respect of SR&ED (other than in subsection 37(2)) include only, among things listed in clause (8)(a)(ii)(B), the cost of "materials consumed" in the prosecution of SR&ED in Canada.

Subclause 37(8)(a)(ii)(B)(V) is amended for costs incurred after February 23, 1998 in two respects. First, the phrase "materials consumed" is changed to "materials consumed or transformed". Second, the reference in the French version of the subclause to "matières" is changed to "matériaux".

Clause 59

Allocation of Gain on Gifts to Qualified Donees

ITA
38.1

Paragraphs 38(a.1) and (a.2) of the Act provide a special inclusion rate for capital gains arising as a result of a gift to qualified donees of certain securities or of environmentally sensitive land. This inclusion rate is one-half of the normal inclusion rate.

Section 38.1 of the Act is added consequential to the addition of new subsections 248(31) to (33) of the Act, for gifts made after December 20, 2002. New section 38.1 provides that, where a taxpayer is entitled to an advantage or benefit in respect of a gift, only part of the taxpayer’s capital gain will be entitled to the special inclusion rate. The part entitled to the special inclusion rate is that proportion of the gain that the eligible amount of the gift is of the taxpayer’s total proceeds of disposition in respect of the property.

For additional details, see the commentary to new subsections 248(31) and (32) regarding the eligible amount of a gift and the amount of the advantage in respect of a gift.

Clause 60

Gains and Losses – General Rules

ITA
40

Section 40 of the Act provides rules for determining a taxpayer’s gain or loss from the disposition of a property.

Gift of Non-qualifying Security

ITA
40(1.01)(c)

Subsection 40(1.01) of the Act allows a taxpayer to claim a reserve in respect of any gain realized from the making of a gift of a "non-qualifying security", as defined for the purposes of sections 110.1 and 118.1 of the Act. The gift is not recognized as a gift for the purposes of those sections until a subsequent time when the security ceases to be a non-qualifying security or it is disposed of by the donee. The reserve available in subsection 40(1.01) allows the resulting inclusion in income to be deferred until the year that includes the subsequent time, unless the taxpayer first becomes non-resident or tax-exempt.

Paragraph 40(1.01)(c) is amended consequential to the addition of new subsections 248(30) to (33) of the Act, for gifts made after December 20, 2002, to provide that the reserve claimed by the taxpayer may not exceed the eligible amount of the gift. For additional details, see the commentary to subsection 248(31) of the Act regarding the eligible amount of a gift.

Reserve on Property Sold to a Controlled Partnership

ITA
40(2)(a)

Paragraph 40(2)(a) of the Act generally restricts a taxpayer's ability to claim a capital gains reserve in respect of properties disposed of to a non-resident or to a corporation that controlled the taxpayer or was controlled by the taxpayer. Paragraph 40(2)(a) is amended in respect of dispositions of property that occur after December 20, 2002, to provide that a capital gains reserve will also not be allowed to a taxpayer where the purchaser of the property is a partnership of which the taxpayer is a majority interest partner.

Limited Partner

ITA
40(3.14)(a)

Subsection 40(3.1) of the Act provides that a member of a partnership is considered to realize a capital gain from the disposition, at the end of a fiscal period of the partnership, of the member’s interest in the partnership where, at the end of the fiscal period, the member is a limited partner or was, since becoming a partner, a "specified member" of the partnership and the member’s adjusted cost base of the interest is negative at that time.

Subsection 40(3.14) of the Act provides an extended definition of "limited partner" for the purpose of determining whether a member's interest in a partnership is subject to the negative adjusted cost base rule in subsection 40(3.1).

Paragraph 40(3.14)(a) provides that a member of a partnership is a "limited partner" if, by operation of law governing the partnership agreement, the liability of the member as a member is limited. However, paragraph 40(3.14)(a) does not apply in cases where a member's liability is limited by operation of a statutory provision of Canada (or of a province) that limits the member's liability only for the debts, obligations and liabilities of a limited liability partnership (or of any member of the partnership) arising from negligent acts or omissions of another member of the partnership (or of an employee, agent or representative of the partnership) in the course of the partnership business and while the partnership is a limited liability partnership.

The Province of Quebec has amended its legislation concerning partnerships to allow partners to carry on their activities within a limited liability partnership. That legislation refers to the civil law concept of "fault/fautes". Paragraph 40(3.14)(a) of the English version does not currently refer to the civil law concept of "fault" and is amended to do so, effective after June 20, 2001.

Deemed Identical Property

ITA
40(3.5)

Subsections 40(3.3) and (3.4) of the Act set out rules under which losses on certain dispositions of non-depreciable capital property are deferred. In some cases, the application of these rules is contingent upon whether one property is identical to the disposed of non-depreciable capital property.

Current paragraph 40(3.5)(b) treats a share that is acquired in exchange for another share under any of a number of sections as being identical to that other share. Among the effects of this deeming rule is to ensure that a deferred loss is not inappropriately realized through a transaction under one of those sections.

For example, assume that a taxpayer who on Day 1 disposed of a share for proceeds that were less than the taxpayer’s adjusted cost base of the share reacquired an identical share on Day 15. Under the loss-deferral rules, the taxpayer’s loss on the disposition will be deferred until, generally, neither the taxpayer nor an affiliated person owns such a share. If the taxpayer then exchanged that share for another, under for example an exchange under section 86 of the Act, it would be appropriate to continue to defer recognition of the deferred loss until that substituted share is disposed of. This is accomplished by treating the share acquired on the exchange as identical to the share given up.

However, paragraph 40(3.5)(b) can have an inappropriate effect where a taxpayer uses the share-for-share exchange rule in section 85.1 of the Act. Provided certain criteria are satisfied, that section permits a share-for-share exchange to take place on a tax-deferred basis, but it also allows the exchanging shareholder to realize a loss. A shareholder who chooses to do so may find that paragraph 40(3.5)(b) forces a deferral of that loss – even though the loss arises from the section 85.1 exchange itself, not from a previous disposition as in the above example.

Paragraph 40(3.5)(b) is amended to deem a share that is acquired in exchange for another share under section 85.1 to be identical to that other share only if the loss in respect of the exchanged share is suspended at the time of the exchange by virtue of subsections 40(3.3) and (3.4).

This amendment to paragraph 40(3.5)(b) applies to dispositions of property that occur after April 26, 1995, subject to the coming-into-force provisions that originally enacted subsection 40(3.5).

Clause 61

Part Dispositions

ITA
43

Section 43 of the Act provides rules governing the disposition of part of a property. For the purpose of computing a taxpayer’s gain or loss from the disposition of a part of a property, a portion of the adjusted cost base must be allocated to the part on a reasonable basis.

Ecological Gifts

ITA
43(2)

Section 43(2) of the Act applies where the part of a property donated as an ecological gift is a covenant, easement or servitude established under common law, the civil law of the province of Quebec, or the law of other provinces allowing for their establishment. Subsection 43(2) ensures that a portion of the adjusted cost base ("ACB") of the land to which the covenant, easement or servitude relates is allocated to the donated covenant, easement or servitude. For this purpose, the allocation of the ACB of the land to the gift is calculated in proportion to the percentage decrease in the value of the land as a result of the donation.

Subsection 43(2) is amended to clarify its application to "real servitudes" under the Civil Code of Quebec. This amendment applies to gifts made after December 20, 2002.

Clause 62

Life Estates in Real Property

ITA
43.1(1)

Section 43.1 of the Act deals with the disposition of a remainder interest in real property by a taxpayer who retains the life estate or estate pur autre vie in the property. Subsection 43.1(1) provides that in such a case the taxpayer will be considered to have disposed of the life estate, that has been retained, for proceeds equal to its fair market value at the time the remainder interest is disposed of, and to have reacquired the life estate immediately after that time at the same fair market value.

However, subsection 43.1(1) does not apply in cases where the remainder interest is a gift to a donee described in the definition "total charitable gifts" or "total Crown gifts" in subsection 118.1(1) of the Act. Subsection 43.1(1) is amended to also preclude its application to gifts made to donees described in the definition "total ecological gifts" in subsection 118.1(1). This amendment applies to dispositions of life interests that occur after February 27, 1995, when ecological gifts were first defined for the purposes of section 118.1.

Clause 63

Exchanges of Property

ITA
44(1)(c) and (d)

Subsection 44(1) of the Act allows a taxpayer who incurs a capital gain on the disposition of certain capital property to elect to defer tax on the gain to the extent that the taxpayer reinvests the proceeds in a replacement property within a certain period of time, namely

Paragraphs 44(1)(c) and (d) are amended to accommodate taxation years that are shorter than 12 months, by providing that the periods for acquiring replacement property end at the later of the times mentioned above and

These amendments apply, in the case of involuntary dispositions, in respect of dispositions that occur in taxation years that end on or after December 20, 2000 and, in any other case, in respect of dispositions that occur in taxation years that end on or after December 20, 2001.

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.

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