A new focus on Canadian economic growth and productivity makes it a good time to reconsider a formal system of group taxation for Canadian corporations. This issue has surfaced frequently in the decades since Canada’s tax consolidation regime was repealed in the 1950s and successive governments have opted not to implement a formal consolidation or loss transfer system.
In the Canadian income tax system, each corporation is taxed as a separate entity. As such, corporations that incur losses for tax purposes aren’t able to use them to reduce the taxable incomes of other enterprises in the corporate group. Corporations that incur a non-capital loss may apply the loss against the taxable incomes of other years. Alternatively, corporations may employ tax planning strategies to utilize losses within a corporate group. For example, loss companies can amalgamate with (or wind up in) profitable companies, or assets can be shifted to generate income in loss companies. However, these techniques involve costs, compliance requirements and potential tax risks, and may not be feasible in all cases due to commercial, legal or tax constraints.
The inability to transfer losses within a corporate group puts Canada out of step with other major jurisdictions, such as the United Kingdom and the United States, which allow for group relief or consolidated tax reporting to achieve similar outcomes. Modern corporations typically operate through multiple subsidiaries and function as a single economic unit. Taxed as an economic unit, this ensures that the corporate tax system reflects the reality of how businesses are structured and operate. There’s no logical reason why a corporation operating in multiple divisions – some of which incur losses – should pay less tax than a company that structures those divisions as separate subsidiaries.
Two primary schemes can be used to allow a corporate group to benefit from losses of one or more members: full consolidation and loss transfer. Each scheme has its own advantages and disadvantages, varying in complexity, administrative burden and economic impact. Additionally, these approaches differ in their effects on provincial treasuries, as they influence how tax revenues are allocated among jurisdictions and how losses are recognized across different tax bases.
Full consolidation
In this arrangement, members of a corporate group aggregate their taxable incomes and losses in some manner and pay tax based on collective income. Provincial taxes could be calculated at the consolidated level using the existing formulas (i.e., Regulation 400). Consolidation adds complexity to the tax system because rules are needed to specify not only what entities can be consolidated, but how to handle changes to the group.
Alternatively, consolidation could be achieved, to some extent, by allowing corporations in a group to be treated as partnerships for tax purposes in certain cases. When a corporation is treated as a partnership, members are deemed to earn their share of income and losses but only in cases where it’s possible to determine the entitlement of each partner to corporate income. Partnership losses would be passed on to the partner and used to offset their earned income.
This approach was suggested by the Carter Commission and proposed in the 1969 paper Proposals for Tax Reform, which suggested that all of the shareholders of a “closely-held corporation” should be able to elect that the corporation be taxed as a partnership. An advantage of this approach is that the tax system has already detailed rules for the allocation of partnership income, including the rules that allow members of partnerships to have their proportionate share of revenues and wages for the purpose of provincial allocation.
Loss transfer
This mechanism would allow one company in a group with a current-year loss to transfer the loss to another group entity to reduce its tax. Loss transfer was the preferred approach of Michael Wilson, the 1984 finance minister. The major obstacle is provinces. Most use the federal definition of taxable income, so any reduction to federal taxable income would also decrease the provincial tax base. Ontario would lose if, for example, corporations with a permanent establishment (PE) in the province reduce their taxable income by receiving losses from a corporation with a PE only in Manitoba. Loss transfer also opens the door to tax planning by placing expenses (i.e. interest) in one jurisdiction and using the losses to offset provincial income tax in a higher-tax province.
Past efforts stalled
The most recent consultation on group taxation was carried out in 2010, with the government publishing the consultation paper, The Taxation of Corporate Groups. In the 2013 budget, the government stated that consultations with provincial and territorial officials had not produced a consensus, and therefore a formal system of corporate group taxation wasn’t a priority at the time. However, given that many other jurisdictions have implemented group taxation frameworks and the renewed focus on economic growth and productivity, it may be a good time to revisit this issue.
John Oakey, CPA, is vice-president of taxation at CPA Canada.
Originally published by CPA Canada.
