Making Lemonade out of losses: Tax planning in troubled times

The new provincial and federal tax relief measures and assistance programs implemented to help Canadian businesses combat the devastating economic impact of COVID-19 have been at the forefront of recent tax-planning discussions. While these government initiatives have provided welcome relief to many taxpayers, the financial downturn opens up a whole range of other tax-planning opportunities that businesses should consider to help improve their cash flows. We explore some of these tax-planning opportunities here.

Reducing the cash-flow drain of unnecessary income tax instalments

Under COVID-19 relief measures, arrears interest and penalties for income tax instalment payments due after March 18, 2020, and before September 1, 2020, have been suspended, and the due date for these payments has been deferred to September 1, 2020.¹ As the due date for deferred payment approaches, Canadian businesses that are forecasting reduced profitability or losses this year should consider reducing or eliminating income tax instalment payments.

Income tax instalments for a given tax year are usually calculated based on the income tax liability of the previous or second previous tax years, but taxpayers also have the option of calculating instalment payments based on their estimated income tax liability for 2020 if it is expected to be lower than in 2019 or 2018. Care should be taken in making tax payable estimates, however, as penalties and interest will apply if the estimated amounts end up being lower than the actual ones.

If instalment payments were made in early 2020 and their total amount exceeds that of the estimated taxes owing for the year, it may be possible to request that the excess payment be transferred to another tax account to cover other tax liabilities (such as payroll or GST/HST) or that it be refunded (if it has caused or will cause undue hardship).²

Carrying back current-year tax losses to previous taxable years

Businesses that have incurred or are incurring losses for tax purposes in the current fiscal period should file their 2020 income tax returns as soon as possible to expedite refunds generated from carrying back losses to previous taxable years. As losses can be carried back against taxable income earned in any of the three previous taxation years, taxpayers should weigh the benefits of each option. For example, you could carry back losses to the year with the highest tax rate to get the biggest refund, or you could carry back losses to the earliest of the three years, regardless of the tax rate, to create more room for loss carry-backs in subsequent years.

For businesses with calendar year-ends, it will be at least another six months before tax returns can be filed, which—for the cash strapped—can seem like a long time to wait. If your business or your client’s business is one of them and the year can’t end soon enough, consider if there are any opportunities to trigger an early tax year-end to accelerate a loss carry-back request. For example, if there is a dormant or redundant entity in your group, consider amalgamating it with your operating entity now to trigger a year-end immediately before the amalgamation.

Note: Refund interest begins to accrue 30 days after a loss carry-back request is made, but interest on income taxes owing begins to accrue on the balance due date. This means that arrears interest will be payable if taxes owing for 2019 are left unpaid in anticipation of a refund from a 2020 loss carry-back.

Maximizing current-year tax losses for carry-back

Certain tax-planning measures can be taken to maximize the amount of capital and non-capital losses that can be carried back to previous taxation years. One such measure is the ability under the Income Tax Act to value inventory at the lower of cost and fair market value (FMV).³ As a result of the current financial crisis, many businesses are or will be holding inventory that is no longer as valuable as it was at the time of acquisition. A writedown of this inventory (which may include “work in progress”) to FMV can increase that taxpayer’s loss for income tax purposes.

Where a taxpayer holds capital property that has decreased in value below its original cost, a sale of said property could trigger a capital loss that can be carried back to offset the taxpayer’s previously recognized capital gains. Where the capital property is disposed of to persons affiliated with the taxpayer, care must be taken to avoid the application of certain “stop-loss” provisions.⁴

Another possible source of tax deductions in troubled times is a writedown or reserve taken on taxpayers’ accounts receivable balances. Given that many businesses are experiencing liquidity or going-concern issues related to the COVID-19 crisis, taxpayers should carefully review their accounts receivable balances to ascertain if a deduction can be claimed for tax purposes related to doubtful or bad debts.⁵ Case law from 2015 supports the argument that a reserve for a doubtful debt may be claimable for a given taxation year even if the information necessary to support this reserve is received after the taxpayer’s taxation year-end.⁶

Using losses going forward – some tools

Where there is no ability to carry back business losses to previous taxation years, another common strategy is to use these losses to try to shelter taxable income in future years. Given the 20-year loss carry-forward limitations, if the future taxable income is earned by the same entity that generates the losses, this process will be straightforward.

However, if the losses are generated by one corporation and the future taxable income is earned by another corporation under common control, additional tax planning will be required.

There are various ways in which the losses of a corporation can be accessed to shelter the profits of other companies within a corporate group. Some of the more conventional ways include:

1. Having the loss company charge the profit-making corporation with fees for service;
2. Creating intercompany share/loan arrangements similar to those described in the Canada Revenue Agency’s Advance Income Tax Ruling ATR-44;
3. Transferring assets with appreciated value from the loss company to the profit-making company on a taxable basis; and
4. Amalgamating or winding up the loss-making entity into the profit-making entity.

Note: Without careful tax planning, any of the techniques described above could lead to unintended adverse income tax consequences.⁷ That’s why it’s important to involve an experienced income tax practitioner when implementing any loss-consolidation planning between taxpayers.

Every dollar counts

Careful tax planning alone will not save a business struggling to survive through our current economic crisis. However, every dollar added to a tax refund or subtracted from taxes payable through loss consolidation will increase the business’s chance of remaining economically viable. Therefore, any time tax losses are realized, businesses should consider both how to maximize these losses and how to use them to reduce income taxes payable.

Authors

Alexandra Hale is a senior manager in tax at KPMG LLP in Vancouver, where she specializes in Canadian corporate tax.

Shane Onufrechuk is a partner in tax at KPMG LLP in Vancouver and chair of both the CPABC Professional Development Taxation Program Advisory Group and the CPABC Taxation Forum. He is also involved in teaching and course development for the CPA profession.

Footnotes

1. Government of Canada, “Income tax filing and payment deadlines: CRA and COVID-19,” canada.ca/en/revenue-agency. Accessed May 27, 2020.
2. Income Tax Act (ITA), subsection 164(1.51).
3. Ibid, subsection 10(1).
4. See subsection 40(3.3) and paragraph 40(2)(g) of the ITA.
5. Pursuant to paragraphs 20(1)(l) and 20(1)(p) of the ITA.
6. Delle Donne v. The Queen (2015 TCC 150).
7. For example, the provisions of ITA subsection 69(11) are commonly overlooked.