In the 2018 federal budget, the Department of Finance proposed amendments to section 96 of the Income Tax Act (Canada) (the “Act”) in respect of the at-risk rules for limited partnerships. The budget states that the amendments are clarifying the application of the at-risk rules to apply to a partnership that is itself a limited partner of another partnership (such partner will be referred to hereafter as a “partnership partner”). In the words of the government, this measure and related changes will ensure that “the at-risk rules apply appropriately at each level of a tiered partnership structure.”
Consider the following facts. Suppose partnership X and corporation Y are limited partners of partnership Z. Partnership Z incurs losses from a business or from property in 2018 that can be allocated to each of X and Y under subsection 96(1) of the Act. The deductibility of each partner’s share of losses of partnership Z (including partnership X) will be restricted to the extent of the partner’s at-risk amount in partnership Z under subsection 96(2.1) of the Act (The “at-risk amount” of a partner is defined in the Act. It generally refers to the capital that the partner has put at risk in the partnership).
The proposed amendments also provide that a partnership partner will not be entitled to “limited partnership losses”. Under the current rules, a limited partnership loss is available for a taxpayer to carry forward indefinitely under paragraph 111(1)(e). (A limited partnership loss is the amount equal to the partner’s share of loss of the partnership in excess of the partner’s at-risk amount in respect of the partnership).
Rather than providing a partnership partner with an attribute of a limited partnership loss, the proposals state that the amount that would otherwise be considered a limited partnership loss will reduce the partnership partner’s allocated share of loss of the partnership. Thus, such excess loss (which cannot be deducted in computing the partner’s income) will be reflected in the adjusted cost base (“ACB”) of the partnership partner’s limited partnership interest.
Consider the above-noted example again. Let us assume that partnership X is allocated a $100 non-capital loss of partnership Z and partnership X’s at-risk amount in respect of partnership Z is $40. The new rules will reduce partnership X’s share of non-capital loss of partnership Z to $40 (i.e., $100 less $60—the amount in excess of partnership X’s at-risk amount). Therefore, in computing partnership X’s ACB of its partnership Z interest, $40, instead of $100, of non-capital loss will grind partnership X’s ACB under subparagraph 53(2)(c)(i). Accordingly, the amount of partnership X’s loss that exceeds its at-risk amount in respect of partnership Z (i.e., $60) is reflected in the ACB of partnership X’s limited partnership interest. Partnership X’s excess non-capital loss is trapped. If partnership X were to subsequently dispose of its partnership Z interest in a future fiscal period, it would result in partnership X realizing either a lower capital gain or higher capital loss depending on the value of the interest at the time of disposition.
If corporation Y were similarly allocated a $100 non-capital loss of partnership Z and had a $40 at-risk amount in respect of partnership Z, corporation Y would be deemed to have a limited partnership loss of $60 in respect of partnership Z. Corporation Y may deduct that limited partnership loss in a future taxation year to the extent that corporation Y’s at-risk amount in respect of partnership Z has increased under paragraph 111(1)(e). After the end of partnership Z’s fiscal period, the amount that corporation Y deducted as a limited partnership loss will grind corporation Y’s ACB of its partnership Z interest under subparagraph 53(2)(c)(i.1). Due to the sole fact that corporation Y is not a partnership partner, corporation Y’s excess loss may be carried forward indefinitely and used in a future year to reduce its taxable income.
Not only will the above-noted amendments apply to taxation years the end on or after budget day (i.e., on or after February 27, 2018), but also to losses incurred in a lower-tier partnership in taxation years prior to budget day.
These changes to the at-risk rules were made in response to the Federal Court of Appeal’s decision in Green v. The Queen (2017 FCA 107). In Green, the Court unanimously concluded that, based on a textual, contextual and purposive analysis of the at-risk scheme for limited partnerships, the at-risk rules do not apply to partnerships who are themselves limited partners of a partnership. The court also concluded that business losses incurred by a lower-tier partnership, including the portion deemed to be limited partnership losses, retain their character as business losses in the top-tier partnership and could be allocated by the top-tier partnership to its individual partners. The individual partners would then be subject to the at-risk rules. Therefore, the decision stands for the proposition that limited partnership losses incurred by a lower-tier partnership in a tiered partnership structure could be deductible by a taxpayer that is a limited partner of the top-tier partnership.
The outcome of Green was at odds with the Canada Revenue Agency’s (the “CRA”) well-established position. The CRA has stated as far back as 1995 that the at-risk rules apply to partnerships who are themselves members of a limited partnership and that the partnership partner has no ability to carry forward and deduct its limited partnership loss in a future year. The CRA’s position effectively traps limited partnership losses of a partnership partner.
The government’s concern, as stated in the 2018 federal budget, is that Green is inconsistent with the policy underlying the at-risk rules—that a limited partner should not be able to shelter income from other sources with partnership losses in excess of the capital at-risk in the partnership. Cognizant of the indefinite carry forward of limited partnership losses, the government found that the implications of Green would provide unintended tax advantages through the use of complex partnership structures and posed a significant risk to the tax base.
These amendments notably did not incorporate the recommendations made by the Joint Committee on Taxation of the Canadian Bar Association and the Chartered Professional Accountants of Canada. The Committee made a submission regarding Green in January 2018, stating that while the Green decision had an appropriate result in the circumstances, it could lead to inappropriate results in other contexts. On this basis, the Committee recommended that any legislative response to Green should avoid provisions resulting in the inappropriate denial of limited partnership losses that the court clearly found to be unacceptable in interpreting the existing at-risk rules.
In all, this is another example among many of the ongoing dialogue between Parliament, the CRA, the courts, and taxpayers. It serves as a good reminder that the development of tax law in Canada is fluid and is subject to a continuous process of stakeholder consultation and debate.
ABOUT THE AUTHOR
Rachel Gold is a tax associate at KPMG Law LLP.
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