2020-0870401I7 Application of Part XII.6 tax re Draft legislation

Principal Issues: How the proposed measures apply to a hypothetical situation

Position: See Interpretation

Reasons: Application of the new legislative proposals

Author: Payette, André
Section: 66(12.66), 164(3), 211.91(1), 211.91(2), 211.91(2.1), 66(12.6001), 66(12.731)

Program Officer
Complex Transactions Section
Medium Business Audit Division
Small and Medium Enterprises Directorate                                                        André Payette
Compliance Program Branch                                                                             2020-087040

February 24, 2021

Attention: Kirby Joseph    

Re: Draft legislative proposals of December 16, 2020 “Flow-Through Shares – Time Extension”

This is in response to your request for our views on the calculation of the amount of tax payable by a corporation under Part XII.6 of the Income Tax Act (Canada) (the “Act”) where the draft legislative proposals released by the Department of Finance on December 16, 2020 (the “Draft Legislation”) apply in respect of Canadian exploration expenses (“CEE”) renounced by the corporation to flow-through shareholders of the corporation.

Unless otherwise stated, all statutory references in this letter are to the provisions of the Act.

Background – Part XII.6 Tax

Part XII.6 of the Act levies a tax on issuers of flow-through shares that use the one year look-back rule for flow-through shares under subsection 66(12.66) (the “Look-Back Rule”). Under the Look-Back Rule, certain Canadian exploration expenses (“CEE”) and Canadian development expenses (“CDE”) incurred in a calendar year can be flowed through to an investor and treated as if they had been incurred at the end of the preceding calendar year. Part XII.6 provides for a tax, which compensates the government for the acceleration of the deduction resulting from the application of subsection 66(12.66) of the Act.

More specifically, where a corporation has issued flow-through shares under the Look-Back Rule in a particular year (the “FTS Issuance Year”), the corporation must pay a tax under Part XII.6 in respect of each month (other than January) in the year (the “Renunciation Year”) (footnote 1)  following the FTS Issuance Year.  The tax per month is generally equal to the balance of funds at the end of the month in respect of the renunciation that have not been spent on qualifying CEE or CDE, multiplied by an interest rate. The interest rate is equal to 1/12 of the annual interest rate prescribed for the purposes of determining refund interest under subsection 164(3) of the Act. However, if funds remain unspent at the end of the Renunciation Year, there is an extra charge levied for December equal to 1/10 of the unspent balance at the end of that month.

Draft Legislation (footnote 2)

Under the Draft Legislation, for corporations that issued flow-through shares pursuant to flow-through share agreements entered into in 2019 or 2020 and that made renunciations under the Look-Back Rule:

*    The deadline for filing Part XII.6 tax returns has been extended by one year; and

*    Part XII.6 tax is to be applied as if the renounced CEE or CDE was incurred:

o    In January 2020, if the expenses were incurred in 2020 and the flow-through share agreement was entered into in 2019;

o    In January 2021, if the expenses were incurred in 2021 and the flow-through share agreement was entered into in 2020; and

o    In any other case, 12 months earlier than when the expenses were actually incurred.

Issue

You have asked to confirm the amount of the Part XII.6 tax that would be payable, taking into account the Draft Legislation, in the following hypothetical fact situation:

1.    A principal-business corporation (“PBC”) issues flow-through shares in December of 2019 pursuant to a flow-through share agreement entered into in December of 2019.

2.    The PBC renounces $5M of CEE to its flow-through shareholders in January of 2020 but with an effective date of December 31, 2019 in accordance with the Look-Back Rule.

3.    The PBC incurs $3M of CEE in August 2020 (the “August 2020 Expenses”) and the PBC incurs the remaining $2M of CEE in July of 2021 (the “July 2021 Expenses”).

Our Comments

This technical interpretation provides general comments about the provisions of the ITA and related legislation. It does not confirm the income tax treatment of a particular situation involving a particular taxpayer, but it is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R10, Advance Income Tax Rulings and Technical Interpretations.

The Calculation of Part XII.6 Tax

The tax payable under Part XII.6 is determined in accordance with a formula set out in subsection 211.91(1). The formula computes the applicable Part XII.6 tax that is payable for each month (other than January) in the Renunciation Year. For purposes of considering the issue outlined above, we have simplified the formula to the following: (footnote 3) 

(A – C) x (E/12 + F/10)

where

A    is the total of all amounts each of which is an amount that the corporation purported to renounce in the Renunciation Year under the Look-Back Rule;

C    is the total of all applicable CEE or CDE that is 

(a)   made or incurred by the end of the month by the corporation, and

(b)   in respect of the purported renunciations in respect of which an amount is included in the value of A;

E    is the rate of interest prescribed for the purpose of subsection 164(3) for the month (the “Prescribed Interest Rate”) (footnote 4) ; and

F    is

(a)   one, where the month is December, and

(b)   nil, in any other case.

Application to the Hypothetical Example

In the hypothetical example set out above, the flow-through share agreement was entered into in 2019 and the total amount of CEE renounced by the PBC in the Renunciation Year (2020) was $5M.

Under the Draft Legislation, for purposes of computing the PBC’s Part XII.6 tax for the Renunciation Year, the PBC is deemed to have incurred the August 2020 Expenses in January of 2020 and the July 2021 Expenses in July of 2020. As a result, for purposes of the calculation of Part XII.6 tax, the PBC will be considered to have incurred $3M of CEE in January of 2020 and $2M of CEE in July of 2020.

Therefore, when computing the Part XII.6 tax of the PBC for the months of February 2020 to June, 2020, the PBC will be deemed to have incurred $3M of CEE before the end of those months. The Prescribed Interest Rate for each of those months was 2%. The relevant elements of the above formula would therefore be:

A= $5M
C= $3M
E= 2%
F= nil

Applying these elements to the above simplified formula would result in the following computation:

($5M - $3M) X (0.02/12 + 0/10) = $3, 333.33

As a result, the PBC’s Part XII.6 tax payable for each month during the period of February 2020 to June 2020 would be $3,333.

Under the Draft Legislation, the PBC is deemed to have incurred the remaining $2M of CEE by the end of July 2020. Therefore, the formula in subsection 291.11(1) would result in a nil amount for each month after June 2020. For example, for July 2020, the elements to the above simplified formula would be as follows:  

A= $5M
C= $5M
E= 1%
F=nil

Applying these elements to the above simplified formula would result in the following computation:

($5M - $5M) X (0.01/12 + 0/10) = $0

As a result, the PBC would not have any Part XII.6 tax payable in respect of its $5M renunciation for any month after June, 2020.

Filing of Part XII.6 Tax Return (Form T101C)

As noted above, the Draft Legislation defers the deadline for the filing of a tax return under Part XII.6 (Form T101C) by one year. Therefore, in the above hypothetical example, the PBC would be required to file a T101C in respect of the Renunciation Year (2020) before March of 2022 (rather than before March 2021, as would have been the case in the absence of the Draft Legislation).

We trust that these comments will be of assistance.

Yours truly,

Kimberley Wharram
Manager
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  This year is referred to as the Renunciation Year in this letter because, pursuant to paragraph 66(12.66)(e), corporations that issue flow-through shares in an FTS Issuance Year and wish to rely on the Look-Back Rule must renounce the applicable CEE or CDE in January, February or March of the year following the FTS Issuance Year.
2  As discussed in technical interpretation 2020-0874621E5, taxpayers may file their Part XII.6 tax returns (Form T101C) based on the Draft Legislation.
3  For simplicity, we have assumed that the amounts for B and D in the formula in subsection 211.91(1) would be nil for purposes of the hypothetical example set out above and we have therefore removed those elements of the formula. We have also simplified the descriptions of the various elements of the formula for ease of explanation. Reference should be made to the full formula set out in subsection 211.91(1) for any calculation of Part XII.6 tax payable by a particular taxpayer.
4  The Prescribed Interest Rates for Part XII.6 tax for each month in 2010 to 2020 is available at the following webpage: https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/flow-through-shares-ftss/prescribed-interest-rates-calculation-part-6-tax.html#shr-pg0

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