The Taxation of Corporate Groups. Consultation Paper

Transcription

1 The Taxation of Corporate Groups Consultation Paper November 2010

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3 Table of Contents 1. Introduction Policy Objectives The Unit of Corporate Taxation Loss Utilization in Canada Currently Provincial/Territorial Considerations Possible Approaches Design Parameters Eligible Groups Degree of Common Ownership Non-Corporate Entities and Non-Resident Corporations Common Parent Corporation Range of Attributes Elective Components Pools of Unused Tax Attributes Entry To and Exit From an Eligible Group Use of Carry Overs Within an Eligible Group Existing Approach Grandfathering Provisions Use of Previously Accumulated Tax Attributes in a New System Consultative Process Annex 1: Summary of Questions Annex 2: Federal and Provincial Revenue Considerations Unused Losses and Other Tax Attributes Use of Losses Over Time Provincial Revenue Considerations Annex 3: Statistics on Corporate Groups i

4 Annex 4: Group Taxation and Loss Utilization in Other Countries Overview of Group Taxation Regimes in Other Countries Treatment of Sub-National Jurisdictions Loss Carry-Overs ii

5 The Taxation of Corporate Groups The Taxation of Corporate Groups 1. Introduction Over the last several years, the Government has taken significant steps to improve the competitiveness of the tax system for Canadian businesses, and followed through on the Economic Action Plan and Advantage Canada commitments to reduce taxes on business investment. The Government is committed to continuing on this track. Unlike many other countries, Canada does not have a formal system to consolidate the tax reporting of corporate groups or to otherwise offset the profits and losses of the members of a corporate group. Currently, Canada s tax system taxes corporations on a stand-alone basis, although it is often possible for corporate groups to offset the profits and losses of group members through intra-group transactions and restructurings. The Government has heard various concerns from the business community and from the provinces 1 regarding the current transaction-based approach for using tax losses within corporate groups. As a result, Budget 2010 indicated that the Government is exploring whether new rules for the taxation of corporate groups such as a more formalized system of loss transfers or some form of consolidated reporting could improve the functioning of the tax system. This could be achieved if a new system leads to increased economic efficiency by better aligning the unit of taxation with the economic reality of economically integrated corporate groups. This examination of corporate group taxation builds on a number of policy developments over the last 25 years: In 1985, a Ministerial discussion paper entitled A Corporate Loss Transfer System for Canada recommended the adoption of a system allowing losses to be transferred between members of a corporate group. While the proposal was never adopted, the paper outlined a number of considerations which remain relevant today, including many that will be discussed in greater detail below. In 1996, the Auditor General of Canada suggested that complex loss utilization strategies should not be necessary to allow loss transfers between affiliated corporations. In 1997, the Technical Committee on Business Taxation recommended that the federal government consider, in consultation with the provinces, a formal system for transferring losses between members of the same corporate group, starting with the 1985 proposal. In December 2008, the Advisory Panel on Canada s System of International Taxation suggested that the federal and provincial governments should work together to consider how a tax consolidation system could operate in Canada. These important policy references will be considered by the Government as the review of group taxation progresses. 1 This paper generally uses the term provinces to include the territories. 1

6 The introduction of a new system for the taxation of corporate groups would constitute a fundamental change to the Canadian corporate tax system. The intention of the current consultation process is to explore a wide range of possible approaches. Accordingly, this paper outlines a variety of topics about which the Government is seeking to gather information and views from stakeholders; questions about these topics are posed throughout the paper, and are also summarized in Annex 1 for convenience. Stakeholder responses will help the Government to gauge the importance of various issues and the breadth of support for a new system of group taxation, to better define the issues such as the type of group taxation system favoured by stakeholders, and to increase understanding of some of the possible implications of a new system of group taxation. The Government will use the responses from this consultation to evaluate whether new rules for the taxation of corporate groups have the potential to broadly address the concerns of stakeholders, including the provinces and the business community. Because of the challenges involved in fully satisfying both levels of government and the business community, participants are encouraged to recognize competing interests and provide input about their most important priorities. Stakeholders will be consulted again if a new system of group taxation is proposed as a result of this exercise. 2. Policy Objectives The Canadian corporate tax system is designed to raise revenues in an economically efficient manner. An efficient tax system allows resources to be allocated to their most productive uses, without distorting corporate decision making. In the context of corporate groups, efficiency is enhanced when the unit of taxation more closely matches the economic reality of a corporate group that is an economically integrated unit. Distortions could occur if the system for taxing corporate groups creates a conflict between efficient tax and business structures or if it provides different treatment for corporate structures that are functionally equivalent. Distortions can also arise if the system for taxing corporate groups leads to structures and transactions that distort market signals. For example, differences between the economic, legal and tax treatment of profits and losses could result in an inefficient allocation of resources. An efficient tax system also contributes to providing a more competitive environment for businesses, making Canada a preferred investment location compared to other countries. While Canada has the lowest effective tax rates on new business investment in the G7, it may be possible to further enhance competitiveness by improving the efficiency of the tax system with respect to its treatment of corporate groups. At the same time, it is important to take into consideration the entire corporate taxation system and not examine specific components of the system in isolation for example, the ability of corporations to use losses also needs to consider their ability to carry losses over to offset against profits in other years, or to take certain deductions (such as capital cost allowance) on a discretionary basis. The principle that corporate groups with similar or equivalent structures should be taxed in a similar way is important for making the tax system fairer as well as more efficient. Fairness also requires looking at different types of corporate groups. For instance, smaller corporate groups 2

7 The Taxation of Corporate Groups may have different needs and fewer resources for managing their tax burdens than larger corporate groups. A new system of group taxation may also address concerns expressed by stakeholders that the current approach is unduly complex. A new system could potentially reduce compliance costs for taxpayers and the cost the Government incurs in administering the system by making the rules clearer and more transparent, and by reducing the number and cost of loss utilization transactions undertaken by corporate groups. However, at the same time, a new system for the taxation of corporate groups could introduce new rules for complying with the system, or consequential changes to ensure the integrity of the tax system, which could increase complexity. In addition to these policy objectives, the Government must carefully consider any potential revenue impacts of a system of group taxation for both the federal and provincial governments before moving ahead with an explicit proposal. This will include an evaluation of the effect that a lower tax base could have on the Government s commitments for returning to fiscal balance and on the income of provinces. (The potential revenue effects are discussed in greater detail in Annex 2.) An additional consideration will be the impact that a new system of group taxation could have on federal-provincial tax arrangements, which will be further discussed in Section 5. In assessing what approach could be taken in developing a formal system of group taxation, it will be important to consider the competing priorities of the various objectives. The Government is interested in stakeholders views regarding the most important benefits that they expect would be obtained from a new system for the taxation of corporate groups. 3. The Unit of Corporate Taxation Under Canada s corporate income tax system, the basic unit of taxation is the corporation as a stand-alone entity. There are several rationales for this approach: it is a simple definition; the entity can be clearly identified; the definition corresponds to the legal definition of the entity; and it respects legal concepts such as the limited liability of a corporation. The separate-entity approach implies that income from one part of a corporation can be offset by losses from other activities within the same corporation, while losses by one corporation may not be used directly against the income of another corporation, even where the other corporation is in the same corporate group. Other possible choices for the tax unit are the establishment or activity unit within a corporation, or the group of corporations which are economically integrated. The activity unit approach would treat each line of business as a separate source of income and tax each such source independently. Such an approach would be rigid and complex in practice, as the dividing lines between a corporation s different activity units would in many cases be unclear, and would not reflect that a corporation s ability to pay tax depends on the overall results of all the corporation s income-earning activities. The corporate group approach recognizes these cross-over effects from different lines of business and extends the principle beyond the confines of the legal entity. Where the corporate group consists of an economically integrated unit, moving to a larger unit of taxation has the potential to better reflect the economic unit and thus improve the efficiency of the tax system. This suggests that the tax system ought to provide at least some recognition of 3

8 the relationships between the members of a corporate group. An important first question is how to identify an economically integrated corporate group in this context. One could start by considering wholly-owned corporate groups. Within these groups, the economic and legal interests of the owners in each member are essentially the same. It can be expected that the members of such corporate groups will not interact with each other out of self-interest but with regards to the best interests of the overall group. There may also be synergies from the coordinated actions of group members, the returns to which may be difficult to allocate between the members of a corporate group. Corporate groups whose members have significant common ownership but which also have minority shareholders are somewhat different. In particular, the economic and legal interests of the owners are no longer necessarily fully aligned. The divergence of these interests may become more significant as the proportion of the corporation owned by minority shareholders increases. At the same time, majority-owned groups may exhibit high economic integration, despite the presence of minority shareholders, when the degree of common- or cross-ownership leads to common control of all the group members. In such cases, the economic interests between member corporations can lead to coordinated activity with many of the same behaviours as are seen in wholly-owned groups. Thus a focus on corporations under common control would provide a broader recognition of economically integrated units than considering only wholly-owned groups. There can be situations where a focus on common ownership or control would overstate the integration of the interests of the members of a corporate group. For example, a corporate group may choose to undertake its activities through separate corporations in order to make use of legal entity protections such as limited liability. Additionally, despite having common ownership, a corporate group may decide for business reasons to decentralize decision-making or encourage business units to actively compete against each other in the marketplace. Nevertheless, a focus on common ownership or control would appear to be a reasonable way to identify economically integrated units. The alternative subjective tests of integration of management, decision-making, and other similar criteria would likely be more difficult to apply in practice. The relevance of corporate groups is already reflected to a certain extent in the Income Tax Act. In particular, there are express provisions in the Act which recognize the integration of the interests of members of a corporate group. At the same time, the mechanisms used to determine whether a corporate group exists can vary depending on the provision and their specific purposes. This helps to illustrate that the determination of the most appropriate way to apply income tax rules to corporate groups is not straightforward, even if the corporate group, however defined, more closely corresponds to the economic unit than either the separate entity or activity unit bases of taxation. 4. Loss Utilization in Canada Currently As mentioned in Section 3, the Income Tax Act has express provisions which recognize the integration of the interests of members of a corporate group. In 1988, the Government noted that explicit exceptions in certain rules, including the corporate loss limitation rules, are intended to apply with respect to transactions that would allow losses, deductions, and credits earned by one corporation to be claimed by related corporations, and stated that the scheme of the Income Tax Act as a whole, and the expressed object and spirit of the corporate loss limitation rules, 4

9 The Taxation of Corporate Groups clearly permit such transactions between related corporations where these transactions are otherwise legally effective and comply with the letter and spirit of these exceptions. 2 Corporate groups are currently often able to make use of the flexibility, described above, that at present effectively exists within Canada s income tax system to transfer income or losses between group members. Some of the techniques which corporate groups are able to use include: Financing arrangements, under which money is borrowed by one member of a corporate group to invest in preferred shares of another member (with the interest deduction reducing income in the first corporation s hands, and generating additional interest or other income in the second); Amalgamations or wind-ups of a group member with loss carry-forward pools into another group member that is profitable; and Transfers of property between group members on a tax-deferred basis, in order to shift income-producing activities to, or to realize a gain on the final disposition of the property in, a particular group member. However, business and legal restrictions or considerations can preclude the straightforward use of such techniques. Accordingly, in some cases loss utilization transactions are relatively straightforward; in other cases corporate groups must undertake highly complex transactions in order to achieve a form of loss utilization. There may also be situations where the flexibility in the system is not sufficient to permit corporate groups to utilize losses. The Government invites stakeholders to comment on the current approach, and the most significant types of costs and benefits related to this approach. 5. Provincial/Territorial Considerations The federal and provincial governments have a shared interest in ensuring that the Canadian tax system, at both the federal and provincial levels, is economically efficient in order to encourage investment and increase living standards for Canadians. An efficient, harmonized tax system is a key component of Canada s economic union. The rules for allocating corporate taxable income among provinces are a long-standing feature of Canada s tax system. These common rules, combined with the development of similar tax bases across the country, have contributed to creating a system that is highly harmonized and generally avoids double or under taxation of income. 3 However, some provinces have raised concerns about the utilization of tax losses within corporate groups, which may affect provincial tax bases and the interprovincial allocation of income. The extent to which these concerns can be 2 Explanatory Notes to Legislation Relating to Income Tax, Minister of Finance, June 1988, p Most provinces have entered into a corporate tax collection agreement with the federal government under which they use the same tax base as the federal government. Alberta and Quebec have not entered into such an agreement, but there is a high degree of similarity between their tax bases and the tax base in the rest of the country, as well as with respect to the allocation formula. 5

10 addressed will be an important consideration in the Government s examination of new rules for the taxation of corporate groups. Under the interprovincial taxable income allocation rules, which are applied at the corporate entity level, if a corporation has a permanent establishment in a particular province and has no permanent establishment outside that province, the whole of its taxable income is allocated to that province. If a corporation has a permanent establishment in more than one province, its taxable income is apportioned among those provinces according to an allocation formula. 4 Often, in the case of a corporate group, the allocations calculated for provincial taxation purposes are different for each group member. As a result, changes in the income of various group members due to intra-group transactions may result in a shifting of taxable income (or losses) between provinces. Under the current approach to loss utilization, transactions between members of a corporate group which operate in multiple provinces can also result in changes to the allocation of income. The net result of such shifts is unclear, as the direction of loss shifting will vary from group to group. A formal system of group taxation should further the economic union by helping to increase the efficiency of the tax system. However, it is difficult to ascertain the net impact that such a system would have on the revenues of particular provinces. Depending on the design of a new system of group taxation, the provincial tax base could become larger or smaller than it is under the current approach. If a new system were to permit a greater utilization of losses overall, there could be a somewhat lower provincial tax base overall, mirroring the potential impact on the federal tax base. There could also be impacts on particular provinces if the introduction of a formal system were to change the allocation of income and losses between provinces. (Annex 2 provides more information on provincial revenue implications.) The method of allocation of taxable income between provinces under a formal group taxation system would depend on the design of the system, and on how the income allocation formula would be applied to corporate groups. As noted previously, corporate groups can currently engage in certain loss utilization transactions. As a result, the potential revenue impact of a formal system may be less than it otherwise would be. In considering whether to develop a formal system of group taxation in Canada, it will be important to consider whether changes to the provincial income allocation formula would be appropriate, and what shape any such changes should take. Given the potential impact on provincial tax bases and the interprovincial allocation of taxable income, the federal government will consult the provinces prior to the introduction of any new system for the taxation of corporate groups, including whether any consequential changes to the income allocation formula would be required. The Government invites stakeholders to comment on whether a new system of group taxation should incorporate changes to the method of determining provincial income allocation, and if so, how this could be accomplished. 4 There is a general formula for allocating income among provinces, and also special formulae which apply to corporations operating in particular industries. 6

11 6. Possible Approaches The Taxation of Corporate Groups There is a range of options that the Government could consider for a new system of group taxation. These options represent different approaches to recognizing the economic integration of corporate groups in the tax system. In exploring what approach to take, the Government will consider the tradeoff between the economic efficiency of better recognizing corporate groups as integrated economic units versus the complexity that could come with departing from the current approach of taxing corporations on a separate-entity basis, in addition to other considerations discussed in this paper. The range of approaches is often described as a spectrum of options, with a consolidation system at one end and a loss transfer system at the other: A consolidation system (sometimes called a fiscal unity system) taxes the members of a corporate group as if they were a single entity. Such systems effectively combine the profits and losses of the corporate group, provide consolidated treatment for other tax attributes (e.g. investment tax credits), and generally ensure there are no immediate tax implications from intra-group transactions (e.g. dividend payments and asset transfers). A loss transfer system (sometimes called a group relief system) generally preserves the separate identities of the members of a corporate group while allowing a member of the corporate group with a loss to transfer part or all of that loss to one or more profitable members of the same group. By applying one corporation s loss against another s profits, the total tax liability of the corporate group is reduced. By treating a group of corporations as a single entity, a consolidation system would most closely correspond to the theoretically efficient objective of reflecting the integrated economic unit. A loss transfer system does not go as far as a consolidation system in treating the corporate group as a single entity; it is therefore further from the corporate group approach and closer to the separate-entity approach. As one moves along the spectrum from consolidation to loss transfer, the system can be expected to involve less complexity but it could also reduce the connection between the unit of taxation and the integrated economic unit. The placement of an approach to group taxation along the spectrum between consolidation and loss transfer depends on the policy choices made with respect to a number of design parameters. For example, a consolidation system that provides flexibility to a corporate group to decide which eligible group members participate in the consolidation system, and for what period of time, would not treat the integrated corporate group as a single entity in all circumstances, and would therefore represent an intermediate point along the spectrum. Similarly, a transfer system that applies to other tax attributes in addition to losses (e.g. investment tax credits) would come closer to treating the group as a single economic unit, and would move a system along the spectrum closer to a consolidation system. As outlined in greater detail in Annex 4, there are substantial variations in the actual implementation of group taxation policies across countries. These differences can reflect policy choices regarding the degree to which group members should maintain their separate identities, as well as the specifics of each country s corporate tax system, and other factors such as corporate or constitutional law. 7

12 The range of variations shows that it is possible to achieve a particular degree of integration in the tax system through various means. For example, consolidation can be achieved by disregarding the separate identities of subsidiary corporations, with each item of revenue or expenditure of the subsidiaries being attributed to a parent corporation. Such an approach would be complex, and would require substantial modifications to basic structures and concepts in the corporate tax system, including those related to inter-company transactions. Another method of consolidation would see each subsidiary retaining its identity for tax purposes, with accounts reported on either financial statements or tax statements being aggregated on a consolidated tax return. A third consolidation technique would be to retain the identities of each member of the group and have each member calculate its income separately, following which the profits and losses of all group members would be transferred to the parent corporation. Similarly, there are various approaches to implementing a loss transfer system: some systems require a taxable payment from one member of a corporate group to another, while other systems require a loss corporation to surrender its tax loss to be used by another member of its corporate group. The following examples of other countries group taxation systems demonstrate the range of potential approaches on the spectrum between a pure consolidation system and a loss transfer system: Australia has a consolidation system which eliminates the separate identities of subsidiary members of a corporate group for tax purposes. There is no recognition or reporting of income or losses at the level of the subsidiary. Instead, any external transactions undertaken by group members are taxed as if the transaction was undertaken by the corporate parent. The system is optional for the parent corporation; however, once elected, it is irrevocable and mandatory for all wholly-owned subsidiaries. The United States employs a consolidation system whereby each member completes its own federal tax return, and then a consolidated return is prepared for the group, reporting the income, expenses, and balance sheet items of each group member. This approach preserves recognition of the separate legal entity on which tax rules are based, while still taxing the corporate group as an integrated economic unit by combining the tax results of group members. The system is optional for the parent corporation; however, once elected, it is mandatory for all subsidiaries meeting an 80 percent ownership threshold and is generally irrevocable. Group taxation provisions in the U.S. at the state level vary considerably, and are described in more detail in Annex 4. Denmark requires domestic corporate groups, generally with greater than 50 percent common ownership, to participate in a mandatory consolidated reporting system, which maintains the separate identity of group members prior to a consolidation of tax attributes. France offers a domestic consolidation system, also known as a tax integration regime. It is further from reflecting an integrated economic unit than the above examples, as it provides more flexibility to the corporate group. The tax integration regime is an optional system and the parent company decides each year which subsidiaries to include within the group, provided that the parent holds 95% or more of these subsidiaries. Elections to participate are valid for a renewable five-year period. 8

13 The Taxation of Corporate Groups Germany s Organschaft system requires that both the income and losses (but not other tax attributes) of participating subsidiaries be rolled up to the parent corporation after the income or loss of the subsidiary is determined. The parent must sign a multi-year profit/loss transfer agreement with each subsidiary with which it wishes to use this system; eligibility is determined using a 50 percent ownership threshold. This system would represent an intermediate point along the spectrum. Finland s group contribution or subvention payment system permits the shifting of taxable income using intra-group payments (e.g. cash transfers) which are tax deductible for the profitable payer and included in taxable income by the recipient. Membership in the group is determined using a 90 percent ownership threshold. This approach would be close to a loss transfer system on the spectrum. The group relief system in the United Kingdom allows certain losses and other tax attributes of one group member to be surrendered to a profitable member of the same group. Membership in the group is determined using a 75 percent ownership threshold. In addition, there are other less common approaches to group taxation. In the past, when the Canadian government has considered the issue of corporate group taxation, other systems have been discussed which could substitute for consolidation or loss transfers. For example, the 1985 Ministerial discussion paper suggested that refunding tax losses up to the value of profits in other members of a corporate group could be seen as a variation of a loss transfer system. The Government is interested in stakeholders views on: How the efficiency and competitiveness of Canada s current loss utilization rules compares to more explicit, but often less flexible, rules in other countries; How a new system of taxation for corporate groups would improve the efficiency and competitiveness of Canada s tax system; and The approach Canada should take for a new system for the taxation of corporate groups. 7. Design Parameters There are a number of issues relating to the design of a group taxation system which will need to be considered as the Government explores whether new rules could improve the functioning of the corporate tax system. How these issues are addressed in the design of a group taxation system could have implications for the relative effectiveness of a new system and for the policy and other considerations discussed in this paper. While consideration of many design issues would best be done in the context of developing a detailed proposal, stakeholder views on the key design issues discussed below will be essential in determining whether a new system has the potential to respond to the concerns of the business community and the provinces with respect to the utilization of tax losses within corporate groups. The Government will also consider the potential impact of these design issues on corporate tax revenues and on the integrity of the tax base. Stakeholders are invited to comment on additional design aspects which they think would be important to highlight at this stage. 9

14 7.1 Eligible Groups Under the current approach (described above in Section 4), loss utilization strategies are generally permitted among related corporations. As such, losses can be utilized between two corporations if there is common control. Common control can mean, for example, that two corporations can be considered related if there is more than 50 percent common- or cross-ownership of each corporation. This threshold for loss utilization is substantially lower than the thresholds of common ownership found in the formal group taxation systems in many other countries. In addition, the use of a test based on common control means that loss utilizations can currently take place when the parties to the utilization do not have a common corporate parent. Implementing a group taxation system that is simple to comply with and administer would require having clear rules defining membership in a corporate group for the purposes of the system. For example, it may be desirable that the composition of a unique corporate group can be easily determined, which would suggest that it may be preferable to use objective tests of common ownership and control (if these were to be factors in determining the composition of a group), or both, as opposed to subjective tests Degree of Common Ownership A key question for any group taxation regime is the degree of common ownership which would be used as the threshold for determining membership in an eligible corporate group. To simplify compliance and administration, a new system of group taxation could be based upon a straightforward test of the percentage of common ownership required for a subsidiary to participate in the system, which could be further augmented by an additional requirement for common control. As discussed earlier, it can be argued that economic efficiency could be enhanced by ensuring that the definition of an eligible corporate group reflects corporate groups which operate as an integrated economic entity, and that this would be best implemented by identifying corporations with common- or cross- ownership. A higher level of common ownership may be reasonable if such groups are more likely to be economically integrated entities. However, specifying a lower level of common ownership would allow more corporate groups to participate. Many, but not all Canadian corporate groups with common control also have high degrees of common- and cross-ownership (see Annex 3). A lower required threshold of common ownership for participation in a group taxation system would increase the number of minority shareholders affected by the system. Issues related to the rights of minority shareholders in corporate groups are more properly the subject of corporate law than tax law, but consideration should be given to, for example, whether rules would be appropriate to accommodate corporate groups that want to compensate minority shareholders for any loss of value they might suffer as a result of the group s participation in a formal system of group taxation. An additional consideration would be the effect that the threshold of common ownership would have on the fiscal impact of moving to a formal system of corporate group taxation. A clear understanding of the meaning of ownership will be required to apply any threshold of common ownership. For example, in Canadian corporate groups there can be a significant 10

15 The Taxation of Corporate Groups difference between the percentage of votes a corporate parent holds in a subsidiary and the percentage of the value of the corporations equity to which it is entitled. Where there is a significant difference between the percentage of votes and value held (for example, because of dual-class common shares), issues relating to the efficiency and integrity of the tax system may arise. Many other countries define their ownership thresholds in terms of both votes and value. The Government is interested in stakeholders views regarding: The appropriate threshold of common ownership for a corporation to be included in a corporate group; and The appropriate meaning of ownership to be applied for determining if a corporation meets the ownership threshold (e.g. votes, value, or both) Non-Corporate Entities and Non-Resident Corporations In some countries, trusts and similar non-corporate entities are eligible for inclusion in a group taxation system, sometimes with the caveat that the non-corporate entities must be taxed under the same rules as corporations. In considering which group members would be eligible to participate in a formal system of group taxation, the role of trusts and other non-corporate entities as intermediate tier entities in a corporate group would need to be considered. For example, the structure of trusts could be substantially different than those of corporations. It could therefore be complex to determine whether or not such entities satisfy criteria for membership in a corporate group, or if the existence of such an entity should prevent the corporate parent and the corporate subsidiary of the entity from being treated as members of the same group. A new system of group taxation in the Canadian context would generally be expected to apply to taxable Canadian corporations, including foreign branches of these corporations, but would not be expected to include foreign affiliates or foreign parents. Corporate groups can include other types of entities, however, such as Canadian branches of non-resident corporations, which can also earn income taxable in Canada. Consideration will be given to whether Canadian branches of non-resident corporations could form part of a corporate group in Canada. The Government is interested in stakeholders views regarding how trusts or other non-corporate entities and the Canadian branches of non-resident corporations that are part of a Canadian corporate group should be treated in a group taxation system. 11

16 7.1.3 Common Parent Corporation Some corporate groups are structured with one corporate parent, which directly or indirectly controls one or more subsidiary corporations (see Example 1 below). Example 1 Group with a common corporate parent Ultimate Owners HoldCo 100% 100% SubCo SubCo In other Canadian corporate groups, subsidiaries are not controlled by a common parent corporation at the top tier. For example, some corporate groups consist of multiple top-tier corporations, which could be controlled by the same individual or by various related individuals (see Example 2 below). Currently, the corporate members of such related groups may be able to engage in loss utilization transactions. 5 Example 2 Group without a common corporate parent Individual or Related family members HoldCo HoldCo 100% (combined) SubCos 5 Currently, many loss utilization transactions are permitted between related corporations. However, the Act requires that for certain loss utilizations the transactions be between corporations that are affiliated. 12

17 The Taxation of Corporate Groups There are also situations where a group of individuals, corporations, etc. that are not necessarily related may form a group of persons that control several corporations (see Example 3 below). These structures occur, for example, where unrelated persons act together to form a group of persons in control. The corporations in such structures may be considered related corporations under the current definitions in the Act, and could thus currently be allowed to undertake loss utilization transactions. Example 3 Group of unrelated owners Group of persons acting together HoldCo HoldCo 50% 50% 50% 50% SubCo SubCo Ownership structures without a common corporate parent, such as those illustrated in Examples 2 and 3, are not typically permitted under the group taxation systems of other countries, and accommodating them in a formal system of group taxation would raise issues. For instance, consideration would have to be given to whether such groups demonstrate a sufficient degree of economic integration or common- or cross- ownership in their ownership structure which would justify tax treatment as a single economic entity. More practically, under a formal system, the rules for determining the eligibility of the group or of particular group members would need to be clear, simple, and of general application. Without a common parent corporation, it may be difficult to develop a clear test to determine membership in a corporate group, or to identify a unique corporate group. Also, a designated corporate parent would be required for some of the possible approaches to a group taxation system (for example, if profits and losses of participating subsidiaries are to be rolled up to the parent). There would likely be other complexities as well. 6 The Government is interested in stakeholders views regarding whether eligible groups of corporations should have a common parent corporation, and if not, how groups without a common corporate parent should be treated in a group taxation system. 6 Consideration would also need to be given to the treatment of Canadian corporate groups that are controlled by non-residents. 13

18 7.2 Range of Attributes The use of current-year non-capital losses should clearly be incorporated into a group taxation regime. However, there are a variety of other tax attributes which could possibly be integrated into such a regime. These include other types of losses, investment tax credits, and deduction pools (e.g. capital cost allowance, expenditures on scientific research and experimental development). The inclusion of a wider range of tax attributes into a group taxation system would more closely equate the unit of taxation to the economically integrated corporate group. A pure consolidation system would likely feature consolidation of all tax attributes. However, other approaches to group taxation would allow options for the scope of attributes subject to the regime. For example, a transfer system could be narrowly focused on loss transfers, or could encompass a broader range of attributes. While many existing transfer systems do not extend beyond transfers of income and losses, extension to other attributes would clearly be possible. A transfer system which allowed the transfer of a wide range of attributes could potentially approximate the effects of a consolidation system. Approaches to group taxation based on a formal system of attribute transfers may be simpler where fewer tax attributes are eligible for transfer, as fewer rules would be required. With respect to some tax attributes, it could be complex to design transfer rules that would respect existing limitations regarding their use. Given that the overall value of non-capital losses in the tax system is higher than that of other tax attributes (see Annex 2), the efficiency gains from extending a transfer system to more attributes would have to be balanced against the potential for increased complexity if more tax attributes were to be included in a group taxation system. Limiting the range of attributes could also help to constrain the fiscal impact for federal and provincial governments. Another consideration is the extent to which certain attributes are a means to an end. For example, it is unclear whether corporate groups would want to transfer deduction pools for their own sake, or whether transferring losses or investment tax credits would allow adequate utilization of such attributes. The Government is interested in stakeholders views regarding the most important attributes which should be considered with respect to a new system for the taxation of corporate groups. 7.3 Elective Components An important element in designing a group taxation system is the extent to which participation is voluntary or mandatory, and the discretion that a group has in deciding which members to include and which attributes to transfer or consolidate. Under the current approach, a corporate group has a high degree of flexibility in deciding whether to engage in a loss utilization transaction, which members of the group should be involved, and how to do so. While this approach allows for considerable flexibility in tax planning, such planning can be complex, opaque, and may contribute to the concerns raised by the provinces about the use of loss utilization transactions to shift income between provinces. In general, a group taxation system with more elective components would likely afford greater opportunities to taxpayers to manage their tax burdens. On the other hand, requiring participation 14

19 The Taxation of Corporate Groups of all eligible members and the transfer of all eligible attributes would be more efficient as it would better align the unit of taxation with the economically integrated corporate group. In addition, implementing a group taxation system with less flexibility could be a straightforward approach to reducing the ability of corporate groups to engage in interprovincial tax planning by transferring income between different group members. These advantages could be further enhanced with a requirement that elections to participate continue for a minimum number of years, or indefinitely. Such a requirement would also increase the stability and predictability of the group taxation system for both taxpayers and governments, and could alleviate issues related to the use of carryover tax attributes by corporate groups (discussed below). The type of elections which could be incorporated into a group taxation system would depend in part on the type of system under consideration. In a consolidation system, a corporate group would likely have no discretion on which tax attributes to consolidate, but there can be discretion in terms of membership in the system. In most (but not all) countries with a consolidation system, participation is voluntary, but varying degrees of discretion are allowed once a corporate group elects to participate: some countries do not allow for deconsolidation, while others require participation for a minimum number of years, or for only a single year. Also, some countries require all members of a corporate group to join (i.e. an all-in rule), while others allow discretion as to which members of a corporate group participate. An attribute transfer system typically provides a wider range of design options, in terms of both the attributes that are included in the system (as discussed above) and the participation of members of the corporate group. Most such regimes allow corporate groups to decide on a year-to-year basis whether to participate and, if so, which group members should be involved. However, some systems (such as the one used by Germany) require participating group members to transfer income and losses to the parent corporation, and to commit to the system for a certain time period. The development of an attribute transfer system would therefore require consideration of the same elective components as a consolidation system, in addition to consideration of which attributes could be transferred. The Government is interested in stakeholders views on the extent to which participation in a group taxation regime should be voluntary or mandatory for the group and/or individual group members, and to what extent corporate groups should have flexibility in determining which attributes to transfer or consolidate. 7.4 Pools of Unused Tax Attributes Canada s corporate tax system generally allows corporations to carry over 7 unused tax attributes (particularly losses and investment tax credits) to offset taxable income or tax payable of other taxation years. At the same time, the Act generally limits the ability of corporations to carry over such attributes following an acquisition of control. In considering a system of group taxation, consideration will need to be given to whether or not an eligible corporate group should 7 Currently, the Act permits losses and investment tax credits to be carried back up to three years and carried forward up to 20 years. 15

20 have access to the unused attributes of its group members from other years. This issue arises in two contexts first, when a corporation enters into, or exits from, an eligible group for purposes of a group taxation system, and second, on a year-to-year basis within the eligible group. Issues associated with the current approach and the use of previously accumulated tax attributes in a new system are discussed in Sections 7.5 and Entry To and Exit From an Eligible Group A decision would be needed regarding whether a formal system of group taxation should allow a corporate group to utilize the tax attributes of a corporation that were accumulated prior to the corporation s joining the eligible group and participating in the group tax system, and if so, to what extent. Depending on the specifics of the system design, such entries could occur, for example, when a corporation meets the qualifying criteria to participate in the system as part of a particular group, or because a formal election to participate is made. Countries with consolidation systems generally quarantine the attributes earned prior to a corporation s entry into a group for purposes of the consolidation system. Usually, such attributes can only be used to offset income earned in the corporation in which the attribute originated. Another approach, followed in at least one country, is to limit the proportion of these attributes that can be used in a given year. Countries with transfer systems generally similarly restrict the transfer of attributes accumulated while parties to the transfer did not meet the eligibility requirements for the group tax system. If placing restrictions on the use of pre-entry attributes, and particularly losses, is appropriate, consideration would be given to the type of new rules that would be needed in order to quarantine or otherwise restrict these attributes. Such rules would likely be in addition to any necessary modifications of current tax rules such as the continuity of ownership test or the same business test, or new rules which would test to ensure that the transferor and the transferee are part of the same corporate group both in the year in which the attributes are incurred or earned, and the year in which they are used. The Act already contains rules regarding the utilization of many tax attributes following an acquisition of control. Consideration will be given to making use of these or similar rules. Similarly, rules may also be needed regarding the utilization of tax attributes accumulated within a group when a corporation leaves a group for purposes of the group taxation system, or otherwise is no longer participating in the group taxation system. For example, it would need to be decided whether the corporation s unused losses and other attributes incurred while the corporation was part of the group should stay with the corporate group or with the exiting corporation. This may be of more relevance for a consolidation system which facilitates pooling of tax attributes than for an attribute transfer system where tax attributes remain with the originating corporation even while the group exists Use of Carry Overs Within an Eligible Group With respect to corporations that are part of the same eligible corporate group for purposes of the group taxation system on a year-to-year basis, it would need to be decided whether a corporate group would be able to offset losses or other tax attributes accumulated in one member corporation during one taxation year with income earned by other members during a different taxation year, during which years each is a member of the same corporate group. 16