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Ottawa, July 19, 1995
1995-056

Draft Income Tax Amendments Introduced to Implement February 27 Budget Measures 

Related document:

• Eliminating the Deferral of Tax on Business Income Alternative Method.

Finance Minister Paul Martin today released draft legislation to implement a number of the tax measures announced in the February 27, 1995 budget.

The draft legislation deals with the following topics:

• Canadian film and video production tax credits
• Deferral of tax on business income
• Family trusts
• Limits on retirement savings
• Old age security benefits
• Refundable tax on investment income
• Scientific research and experimental development tax credit
• other measures set out in the February 27, 1995 budget

Mr. Martin said that the proposed amendments are being released in draft form to provide taxpayers and their advisors an opportunity to consider and comment on the proposed changes. Following the consultation process, the final legislation will be tabled when the House of Commons reconvenes in the fall.

To assist taxpayers in understanding these proposals, a separate section consisting of detailed explanatory notes accompanies the draft legislation.

References to "Announcement Date" in the draft legislation and explanatory notes should be read as referring to today's date.

Mr. Martin also noted that the government has consulted with taxpayers and their elected representatives concerning the budget proposal eliminating the deferral of tax on business income. As a result of these consultations, several modifications have been incorporated in the draft legislation released today. In particular, professional corporations that are not members of a partnership will be excluded from the measure, and taxpayers that cease a particular business but carry on a similar business will continue to be eligible for the transitional relief.

In addition, in response to the concerns of taxpayers who have valid non-tax reasons for having an off-calendar fiscal period, Mr. Martin also announced that the government will provide an alternative method of calculating income for the purposes of the measure eliminating the deferral of tax on business income. This alternative method permits eligible taxpayers to have off-calendar fiscal years while remaining consistent with the policy of eliminating the deferral of income for tax purposes. Attached is a summary of this alternative method, and its implications for individuals who are registrants under the goods and services tax. Legislation implementing this alternative method will be included in the Bill to be tabled in the House of Commons in the fall.

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For further information:

Tax Legislation Division
(613) 996-0597

Eliminating the Deferral of Tax on Business Income Alternative Method

The February 27, 1995 budget proposed a measure to improve the fairness of the tax system by eliminating the delay in the reporting of business income and requiring unincorporated business owners to pay taxes on their income in the year in which the income is earned. Legislation implementing the budget proposal requires that, effective for fiscal periods beginning after 1994, all sole proprietorships, professional corporations that are members of a partnership and partnerships (where at least one member of the partnership is an individual, professional corporation, or another affected partnership) have a December 31 fiscal year-end.

Subsequent to the release of the budget, the government consulted with taxpayers and their representatives concerning the impact of this requirement on unincorporated businesses. As a result of these consultations, the government has decided to provide an alternative method of calculating income which permits eligible taxpayers to retain their current fiscal year-end while maintaining the policy of eliminating the possibility of deferring the reporting of income for tax purposes. This method is briefly described below. Legislation implementing this alternative method will be included in the Bill to be tabled in the House of Commons in the fall.

Who is eligible?

This alternative method will be available, on a business-by-business basis, to individuals and partnerships, all the members of which are individuals. However, partnerships that are members of other partnerships will not be able to utilize this alternative method.

How will it work?

Eligible individuals who elect to retain their non-December year-end for a business (including individuals who are members of an eligible partnership that has so elected) will be required to adjust their income from the business to a calendar year basis for income tax purposes. Each year the income reported for each business (before transitional relief for additional 1995 income) will be calculated as follows:

Business income based on off-calendar fiscal period Add: Additional income inclusion for the current taxation year Less: Additional income inclusion for the previous taxation year Equals: Business income for tax purposes (before transitional relief).

The additional income inclusion for each taxation year will be a formula-based estimate of the business income earned between the end of the fiscal period and December 31 of the year. It will be calculated as follows:

Additional income inclusion = A x B / C where A is business income earned during the off-calendar fiscal period ending in the calendar year; B is the number of days during which the business was carried on after the end of the fiscal period and before the following January 1; and C is the number of days in the business' fiscal period ending in the calendar year.

As a result of this change, most existing businesses will be able to elect to continue with their current fiscal year-end and new businesses carried on by individuals and eligible partnerships will be allowed any fiscal year-end selected. Individuals and eligible partnerships that initially adopt the alternative method will be permitted to change to a December 31 fiscal year-end for a taxation year provided notification is made before the filing-due date of the individuals' or partners' income tax returns for the year of the change. However, once a business of an individual or eligible partnership has adopted a December 31 fiscal year-end, it will not subsequently be allowed to change to an off-calendar fiscal year-end.

When must the election be made?

For each existing business of an individual, the election to retain its current year-end date must be made by the individual's filing-due date for the 1995 taxation year (June 15, 1996 for individuals reporting business income). Elections in respect of existing businesses carried on through a partnership must be filed on behalf of the partnership, by a person designated by the partnership for that purpose, by the same date.

Transition

The transitional relief provisions will parallel the relief provided by the budget proposal (that is, generally, 5 per cent of the 1995 additional income will be included in income in 1995, 10 per cent of the 1995 additional income will be included in each of the next eight years and the remainder will be included in the last year). The amount eligible for the reserve shall, subject to restrictions comparable to those applicable to the calculation of the reserve in respect of "December 31, 1995 income", be the calculated estimate of business income earned between the end of the 1995 fiscal year and December 31, 1995.

Illustration of alternative method

Consider an individual with the following characteristics:

• the individual's unincorporated business earns $120,000 in each fiscal year; and
• the business has a January 31 year-end -- the reporting of 11 months of income is deferred one year.

Income of $110,000, earned between February 1, 1995 and December 31, 1995, is currently deferred for tax purposes.

Goods and Services Tax

Given that the alternative method described above will enable an individual to retain a non-calendar fiscal period, the election under the Goods and Services Tax (GST) to adopt that fiscal period as the individual's fiscal year for GST purposes will continue to be available. As is currently the case, this GST election must be filed at the beginning of the fiscal year in which it becomes effective. If an individual has already made this GST election and will be electing to keep the non-calendar fiscal period for income tax purposes, no further GST election will be necessary.

Individuals who so elect and are annual GST filers will have to file their GST return and remit net tax within three months after the end of their fiscal year. As announced in the budget, the GST filing due date for individuals who are annual filers with a December 31 fiscal year-end will be June 15 to enable them to file their GST and income tax returns concurrently. However, their net GST remittance will be due April 30.

Where a GST registrant that is an individual or eligible partnership chooses not to make the income tax election, the registrant's GST reporting periods will not be affected until 1996. If such a registrant's GST fiscal year would have straddled December 31, 1995 based on the former income tax rules, the registrant's reporting periods during fiscal years beginning in 1995 will be determined on the basis of that fiscal year rather than the calendar year. Subsequently, the registrant's reporting periods will be determined as if the income tax changes took effect in 1996.

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For further information:

Income tax
Bob Morrison
Business Income Tax Division
(613) 995-9920

Kerry Harnish
Tax Legislation Division
(613) 992-4385

Goods and services tax
Florence Schwartz
Sales Tax Division
(613) 995-3359