New Partnership Rules

It has become quite standard tax planning to select a year-end for a partnership that differs from the year-end of a corporate partner in order to obtain a deferral of income tax. Up to a one-year deferral of tax is possible if the partnership has a year-end that ends shortly after the year-end of the corporate partner. The 2011 federal budget introduced measures that will limit the ability of a corporation to defer tax on partnership income. Draft legislation to implement these new rules was released on August 16, 2011 by the Department of Finance.

The new rules will apply to corporate partners (other than professional corporations) with taxation years ending after March 22, 2011 that have a significant interest in a partnership. A “significant interest” generally means that the corporation (together with affiliated and related persons) is entitled to more than 10% of the partnership’s income or loss (or assets in the case of a wind-up). There are two additional conditions: the corporation must be a member of a partnership at the end of the corporation’s taxation year, and the partnership must have a fiscal-period end that is different from the corporation’s taxation year-end.

If the above conditions are met, a corporate partner will have an additional income inclusion in each year called its “adjusted stub period accrual”. The adjusted stub period accrual is essentially an estimate of partnership income earned during that part of the corporate partner's taxation year that falls after the partnership’s last fiscal period end – called the corporation’s “stub period”. To avoid double taxation, the stub period accrual added to income in one taxation year is deducted in the following year.

Stub period accrual income is calculated by a formula that looks back to the allocation of income/loss from the partnership’s previous fiscal period and then prorates that amount based on the number of days in the corporation’s stub period. Because the stub accrual is  backwardlooking, some tax deferral is still possible to the extent that there is growth in the partnership business. Stub period accrual cannot be negative, such that the corporate partner cannot accrue a loss with respect to a particular partnership, even if the corporation earns income from other partnerships for which stub period income must be accrued.

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