The following comments are based on the Department of Finance press release dated July 19, 1995. We expect these proposals outlined to become law this fall.
Contained in the February 27, 1995 budget was an amendment to eliminate the deferral of tax on business income, whereby all unincorporated businesses would be required to change their fiscal year-end to December 31st, effective in the taxation year 1995. These original proposals were outlined before Finance Minister Paul Martin and his government had consulted with the taxpayers affected. For our commentary on the original proposals, see Part 1 of this topic.
The Department of Finance has announced amendments to the original legislation. As a result of consultation with taxpayers and elected representatives, the government has decided to provide an alternative method of calculating taxable income which permits eligible taxpayers to retain their current fiscal year-end while still maintaining the policy of eliminating the deferral of business income for income tax purposes. In addition, there are changes to GST and its reporting.
The alternative method will be available, on a business-by-business basis, to individuals and partnerships, all the members of which are individuals. Hence, partnerships that are members of other partnerships, or partnerships where one or more of the partners is a corporation, will not be able to utilize this alternative method.
Eligible individuals who elect to retain their non-December 31st year-end, will be required to adjust their business income to a calendar basis for income tax purposes. Each year, their income reported for each business will be as follows:
Business income based on non-calendar fiscal year
Add: Additional income inclusion for the current taxation year.
Subtract: Additional income inclusion for the previous taxation year.
Equals: Business income for tax purposes (before any transitional relief).
The additional income inclusion for each taxation year will be an estimate of the income earned between the end of the taxpayers fiscal period and December 31st, based on the following formula:
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.
The result of these changes is that most businesses will be able to elect to retain their current fiscal year-end. New businesses for individuals and eligible partnerships will be allowed to choose any year-end they wish. Those initially adopting the alternative method will be allowed to change to a December 31st year-end provided that notification is made before the filing due date of the tax return for the year of the change. However, once the switch to December 31st has been made, the individual or eligible partnership will not be allowed to change back to an off-calendar fiscal year-end.
For each existing business of an individual, the election to retain its current year-end date must be made by the individuals filing due date for the 1995 taxation year. That is, by June 15, 1996. Elections in respect of businesses carried on through a partnership must be filed on behalf of that partnership by a person designated by the partnership, by the same date.
Transitional relief will parallel the relief provided by the original budget proposal. The amount eligible for the ten year reserve will be the estimated amount of business income earned between the end of the 1995 fiscal year and December 31, 1995. See Part 1 of this topic for information on how to apply the transitional relief provisions.
Even when electing to use the alternative method, individuals and eligible partnerships will still be required to include more than twelve months of income in 1995. However, the additional taxable income is eligible for the ten year reserve.There are provisions in the legislation designed to eliminate the artificial increase of income in estimating the additional income for the period ended December 31st. That is, all discretionary deductions must be made based on their maximum amounts. Therefore, discretionary deductions such as capital cost allowance cannot be reduced in order to increase taxable income.
There appears to be less restriction on the recognition of revenue. Therefore, it may be possible to accelerate the recognition of revenue into 1995, that otherwise would be in 1996, in order to take advantage of the maximum tax deferral. This may mean billing work-in-progress outstanding at December 31st.
Individuals that are members of partnerships calculate their estimate of income based on their share of the partnerhsips income less any expenses incurred by the individual.
In order to be eligible for the ten year reserve, the business must have been carried on in 1994. That is, no new businesses beginning in 1995 are eligible for the reserve treatment. In addition, the business must have been required to report income on a calendar basis because of these new rules. Thus, the ten year reserve is not available to any business that has requested a legal year-end change.
In order to remain eligible for the reserve, the individual must continue to carry on the business which claimed the reserve. If however, you cease one business to start a same or similar business, you will continue to be entitled to the reserve. This was not the case under the original proposals made.
If you die or become bankrupt, you are no longer entitled to the reserve.
If you retire from a partnership, you must retain an income interest in that partnership in order to remain eligible for the reserve. It seems that retaining even a $1 income interest would satisfy this requirement.
Even if the election to use the alternative method has been made, you may change at any time to a December 31st year-end for income tax reporting. However, once the change has been made, it cannot be undone.
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 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 of their fiscal year-end. 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 returns and income tax retuns concurrently. However, their net GST remittance will still be due by April 30.
Where a GST registrant chooses not to make the income tax election, that is, chooses to change to a December 31 year-end, 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 will be determined based on that fiscal year rather than the 1995 calendar year. Subsequently, the registrant's reporting periods will be determined as if the income tax changes took effect in 1996.
In order to avoid any adverse tax consequences, and to maximize all tax opportunities, affected individuals and partnerships should consult with their financial advisors or a representative of Ormsby & Mackan for further details.
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