30 May 2013 External T.I. 2013-0479711E5 - 34.2(11) - Transitional reserve

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Must the corporate partner be a member of the partnership on March 22, 2011 in order to be able to claim a transitional reserve in respect of the partnership under subsection 34.2(11)?

Position: Yes.

Reasons: In order for a corporate partner to claim a transitional reserve under subsection 34.2(11), the corporate partner must have QTI in respect of the partnership. Based on the definition of QTI provided under subsection 34.2(1), the corporate partner must be a member of the partnership on March 22, 2011. Further, paragraph 34.2(13)(a) provides that the corporation must be a member of the partnership "continuously since before March 22, 2011".

XXXXXXXXXX
2013-047971
Chrys Tzortzis, CA

May 30, 2013

Dear XXXXXXXXXX:

Re: Transitional reserve under subsection 34.2(11)

We are writing in response to your email sent on February 27, 2013 in which you inquire whether or not a corporation must be a member of the partnership on March 22, 2011 in order to be able to claim a transitional reserve in respect of the partnership under subsection 34.2(11) of the Income Tax Act (the "Act").

You provide a hypothetical situation where a corporation is incorporated in August 2012 and becomes a member of an existing single-tier partnership in September 2012. You state that the newly-formed corporation chooses to establish a taxation year end of April 30th with its first taxation year ending on April 30, 2013 and that the partnership has an established fiscal period end of May 31st. In addition, you state that the corporation does not have a significant interest in the partnership but you wonder whether or not the corporation would be able to claim a transitional reserve under subsection 34.2(11) in respect of the partnership in a subsequent taxation year if the corporation increases its interest in the partnership such that it would have a significant interest in the partnership in that subsequent year which would result in an adjusted stub period accrual (ASPA) income inclusion under subsection 34.2(2) of the Act in that subsequent year. More specifically, you wonder whether or not the ASPA income inclusion for that subsequent year could be deferred and recognized over 5 years.

Our Comments

Budget 2011 introduced a measure to limit the deferral of tax on income earned by a corporation through a partnership that arises if the partnership has a fiscal period that differs from the corporation's taxation year. The main rules implementing this measure are found in new sections 34.2 and 34.3, and amended section 249.1 of the Act. The two main aspects of new section 34.2 are the rules related to ASPA and those related to qualifying transitional income (QTI). The October 2011 Explanatory Notes provide the following explanation of the measure for transitional relief:

The adjusted stub period accrual rules generally apply to taxation years of a corporation that end after March 22, 2011. In many cases, these rules could result in an income inclusion of a significant incremental amount of partnership income for a corporation's first taxation year ending after March 22, 2011. To mitigate the potential cash-flow impact on taxpayers, transitional relief will generally result in no additional taxes being payable for that first taxation year. Instead, the additional income will be brought into the corporation's income over the five taxation years that follow that first taxation year.

Whether a corporate partner is eligible for transitional relief depends initially on whether the corporation has qualifying transitional income (QTI) in respect of a partnership.

As noted above and pursuant to subsection 34.2(11), the corporation must have QTI in respect of the partnership in order to be eligible to claim a transitional reserve in respect of the partnership. A corporation's QTI in respect of a particular partnership is defined under subsection 34.2(1) of the Act as follows:

"qualifying transitional income", of a corporation that is a member of a partnership on March 22, 2011, means the amount that is the total of the following amounts, computed in accordance with subsection (15),

(a) the corporation's eligible alignment income in respect of the partnership, and

(b) the corporation's adjusted stub period accrual in respect of the partnership for

(i) if there is a multi-tier alignment in respect of the partnership, the corporation's taxation year during which ends the fiscal period of the partnership that is aligned with the fiscal period of one or more other partnerships under the multi-tier alignment, or
(ii) in any other case, the corporation's first taxation year that ends after March 22, 2011.

Therefore, a corporation must be a member of the partnership on March 22, 2011 in order to have QTI in respect of the partnership which is a requirement under subsection 34.2(11). Further, subsection 34.2(13) of the Act sets out the circumstances under which a corporation cannot claim a reserve under subsection 34.2(11). In particular, paragraph 34.2(13)(a) of the Act provides that the corporation cannot claim the transitional reserve unless the corporation has been a member of the partnership "continuously since before March 22, 2011". Additionally, subparagraph 34.2(13)(a)(ii) of the Act requires that, in the case of a corporation that is a member of a partnership in respect of which there is no multi-tier alignment, the corporation must also be a member of the partnership

(A) at the end of the partnership's fiscal period that begins before March 22, 2011 and ends in the year of the corporation that includes March 22, 2011, and
(B) at the end of the partnership's fiscal period commencing immediately after the fiscal period referred to in clause (A) and continues to be a member until after the end of the year of the corporation that includes March 22, 2011.

The October 2011 Explanatory Notes confirm as follows:

In addition to being a member of a partnership on March 22, 2011, a corporation is required to satisfy the conditions in new subsection 34.2(13) in order to deduct, as a reserve, an amount under new subsection 34.2(11) for a taxation year.

Accordingly, in the situation described above, as the corporation was not a member of the partnership on March 22, 2011, it is not eligible for transitional relief in respect of that partnership and cannot claim a transitional reserve under subsection 34.2(11). Additionally, the remaining conditions in subparagraph 34.2(13)(a)(ii) have also not been met. Further, an ASPA income inclusion in a subsequent year cannot be deferred and recognized over 5 years as transitional relief is only available for the specific ASPA referred to in the definition of QTI. Once the corporation's QTI in respect of the partnership is determined, it remains constant (subject to a one-time adjustment under subsection 34.2(17) of the Act).

However, if certain conditions are met, new partners may avail themselves of the designation under subsection 34.2(3) of the Act. Subsection 34.2(3) generally applies to a corporation that becomes a member of a partnership during a fiscal period of the partnership (the "particular period") that begins in the corporation's taxation year and ends after the taxation year but on or before the filing-due date for the taxation year and the corporation has a significant interest in the partnership at the end of the particular period. In general terms, subsection 34.2(3) provides a mechanism for a corporation that becomes a member of a partnership in a year to apportion its income from the partnership for the particular period between two taxation years – the taxation year in which the particular period began and the taxation year in which it ends.

We trust the above comments will be of assistance.

Yours truly,

G. Moore
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch