2014-0521941I7 Ontario Transitional Tax Debit/Credit

Principal Issues: Whether the increase to the Ontario transitional tax credit balance as a result of changes to reserves in pre-harmonized years is a tainting transaction.

Position: The increase to the transitional tax credit balance is tainting.

Reasons: The taxpayer can accomplish their stated objectives by not adjusting discretionary deductions in pre-harmonized years and without increasing the transitional tax credit.

Author: White, Julie
Section: TA 46(1); TA 46(2); TA 50(2); CTA 34(1.0.1)

                                                                                    February 27, 2015

Verification & Enforcement                                         Julie White
XXXXXXXXXX TSO                                                  (905) 721-5202
XXXXXXXXXX

Attn:  XXXXXXXXXX                                                 2014-052194
Large File Case Manager

Transitional Tax Debit/Credit Calculation – XXXXXXXXXX

This is in response to your email in which you asked whether the taxpayer’s request to carry back a loss from the XXXXXXXXXX taxation year to taxation years ending prior to the corporation’s transition time and to amend the deduction for insurance reserves for Ontario purposes, but not federal purposes, is a tainting transaction for purposes of the transitional tax debit/credit calculation under the Ontario Taxation Act, 2007 (TA).

You have provided the following facts:

*   The taxpayer’s total Ontario balance currently exceeds its total federal balance (herein referred to as a transitional tax credit balance) by approximately $XXXXXXXXXX created by the insurance reserves.  The taxpayer has, in the past, taken different reserve amounts for federal and Ontario purposes in order to have sufficient Ontario income to offset the Ontario corporate minimum tax (CMT) and/or special additional tax (SAT).
*   The taxpayer is creating a non-capital loss in its XXXXXXXXXX taxation year and is requesting the loss be carried back to years ending prior to the harmonization of the federal and Ontario income tax.  The loss carry back request of $XXXXXXXXXX is the same amount for both Ontario and federal purposes.
*     For federal purposes the non-capital loss carry back will completely eliminate the taxable income in the pre-harmonization years.
*   For Ontario purposes the taxable income in the pre-harmonization years will be reduced but not eliminated.  Although Ontario taxable income is being reduced, it will not result in a refund of Ontario tax because any reduction in Ontario income tax will be offset by additional CMT and/or SAT.  CMT becomes payable where it exceeds the income tax payable and the SAT becomes payable where it exceeds the combination of the income tax and the CMT. The taxpayer is also requesting a reduction to its insurance reserves claimed in the pre-harmonized years to increase its income tax to such a level that no additional CMT or SAT become payable.  This will result in the Ontario income tax payable being the same amount as before the application of the non-capital losses.  CMT and SAT will be nil or a nominal amount. 
*   The reduction of the insurance reserves for Ontario purposes only will increase the transitional tax credit balance by $XXXXXXXXXX, an amount equal to the loss carry back, with a resulting transitional tax credit balance of approximately $XXXXXXXXXX.
*   The taxpayer has filed its XXXXXXXXXX tax return claiming the transitional tax credit of $XXXXXXXXXX on the assumption that the changes to the insurance reserves claimed in the pre-harmonization years will be made.

Our comments

It is our understanding that the taxpayer wants to eliminate the federal taxable income in the pre-harmonized tax years and accomplishes this by increasing the insurance reserves claimed in the XXXXXXXXXX tax year which creates a non-capital loss of $XXXXXXXXXX for that year.  The taxpayer is requesting that the non-capital loss created in XXXXXXXXXX be applied in pre-harmonized years which will eliminate the federal income tax in those years.  The taxpayer is also requesting that the XXXXXXXXXX non-capital loss be applied to Ontario taxable income in those same pre-harmonized tax years.  Subsection 34(1.0.1) of the Corporations Tax Act (Ontario) permits the taxpayer to apply a lesser amount from a post-harmonized tax year to a pre-harmonized tax year for Ontario purposes than for federal purposes.  The taxpayer chose to carry the same amount back for both federal and Ontario purposes even though the elimination of the federal taxable income is accomplished with the federal loss carry back and without a loss carry back for Ontario purposes. 

You have asked whether the increase in the insurance reserves resulting from the application of the non-capital loss for Ontario purposes to the pre-harmonized years is a tainting transaction for purposes of the Ontario transitional tax debit and credit calculation such that subclause 46(2)(b)(v) of the TA will apply to cause the amortization period to end immediately after the start of the reference period.

In order for subclause 46(2)(b)(v) to apply the corporation must be a party to a transaction or event before the beginning of the corporation’s reference period and it may reasonably be considered that one of the main purposes of the transaction or event was to reduce or avoid the inclusion of a transitional tax debit or to increase the transitional tax credit. The transaction or event is known as a “tainting transaction”.  In our view, the decrease to the insurance reserves deducted in taxation years ending before the transition time is a tainting transaction as it increases the transitional tax credit balance by $XXXXXXXXXX. The need to adjust the insurance reserves is created by the loss carry back application for Ontario purposes, if there is no loss application, the insurance reserves do not need to be adjusted and the transitional tax credit would not be increased.

It appears that the taxpayer is attempting to avoid the creation of CMT and SAT in the pre-harmonized years by decreasing the insurance reserves and causing the income tax to be what it was before the losses were carried back.  CMT payable may be creditable against income tax in subsequent years where certain conditions are met.  SAT paid in pre-harmonized years is not creditable against income tax. The taxpayer is creating a refund of the CMT and SAT from the pre-harmonized years through the transitional tax credit when it is claimed in XXXXXXXXXX; something they are not otherwise entitled to. 

In our opinion, the request to amend the reserve balances is a tainting transaction to which clause 46(2)(v) of the TA is applicable.  Clause 46(2)(v) is applicable as the balance of the insurance reserve is changing prior to the start of the reference period.  As a result, if the taxpayer insists that the requested adjustments be made they will forfeit the transitional tax credit immediately after the beginning of the reference period.  Pursuant to clause 50(2)(b) of the TA, the $XXXXXXXXXX transitional tax credit balance will be forfeited along with the requested $XXXXXXXXXX addition.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library.  A severed copy will also be distributed to the commercial tax publishers, following a 90 day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases.  The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.  Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity.  Request for this latter version should be e-mailed to: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès.  In such cases, a copy will be sent to you for delivery to the taxpayer.

Steve Fron CPA, CA
Manager
Trust Section II
Financial Industries and Trusts Division
Legislative Policy and Regulatory Affairs Branch
Income Tax Rulings Directorate
Canada Revenue Agency

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