Change in Year-end: Acquisition of Control and Other Tax Issues you Have Probably Never Thought About

When a corporation is starting up, the choice of year-end is often an afterthought. If the business of the corporation is seasonal, the year-end may be chosen so that it falls at a convenient time in terms of the corporation’s business operations i.e. low inventory or slack time. If the corporation is part of a larger group, it is usually preferable to align the year-ends for administrative simplicity. However, there may be strategic reasons to stagger the year-ends to achieve some tax deferral opportunities. This is particularly true if there are partnerships within the structure. If the corporation’s accountant gets involved in the decision and if there are no clear reasons to choose a particular date, the choice may be made so that the deadline for filing the annual tax returns falls at an opportune time. However, often there is no forethought and the calendar year-end will be chosen by default.

Surprisingly, once a year-end has been selected, it may be easier to change through inadvertence than by design. If a corporation wants to change its year-end, it must seek the approval of the Canada Revenue Agency (CRA). The CRA’s approval will be granted only if it can be shown that the request for change is prompted solely by “sound business reasons.” Personal convenience or the saving or deferral of income taxes will not suffice. It is not uncommon for the CRA to deny requests for a change in year-end if they are not satisfied with the reasons. It should be noted that some fluctuation in the year-end date is allowed provided that the fiscal period is no longer than 53 weeks.

Change through inadvertence can be a different story. There are a number of ways that a change in year-end may be triggered by operation of law under the Income Tax Act. Often, the owner of the corporation may not even be aware of the change and the consequences may be disastrous.

One of the more common triggers of a change in year-end is through an amalgamation of two or more corporations. The year-end of each of the corporations is said to fall immediately prior to the amalgamation.

Another year-end trigger comes as a result of the new Eligible Dividend rules which I wrote about in a previous article. Under the new legislation, where a corporation becomes or ceases to be a Canadian-controlled private corporation, the taxation year of the corporation is deemed to end immediately before that time. For example, if a private corporation owned by Canadians is bought out by non-residents or goes public, a year-end will be triggered. Interestingly, because the legislation was released in the middle of last year and made retroactive to the beginning of 2006, it was possible that a year-end had occurred and the corporation was already late in its tax filings before anyone had laid eyes on the rules. Go figure.

One of the most common of the inadvertent year-end triggers occurs when there has been an acquisition of control of the corporation. The rules for determining whether an acquisition of control has taken place are complicated and beyond the scope of this article. Suffice to say that if control of the corporation changes hands there is likely to be a taxation year-end at that time. However, there is an exception where control is changing hands between related parties. One particular issue to watch for involves family trusts. If a family trust owns the voting shares of a corporation and there is a change of Trustees, the CRA has taken the position that this may constitute an acquisition of control which would result in all of the ramifications as discussed below.

So, what are the consequences? First, the year-end creates a new tax filing deadline. If the year-end occurs one month after the previous one, one must go through all the same steps to have the financial statements prepared and tax returns filed as one did before. This, of course, results in added time and expense. Further, if the corporation is changing hands one has to address who will be responsible for the expenses incurred in the preparation of the returns.

Second, the shortened year is still treated as a full taxation year for tax purposes. Therefore, any losses or credits which are carried forward and subject to a limit of the number of eligible years will lose a year of eligibility regardless of the length of the year. However, deductions such as the capital cost allowance or the small business deduction will have to be prorated for the actual length of the taxation year. Hardly seems fair-but that is the way it is.

I would be remiss if I did not highlight some of the other consequences of an acquisition of control. The rules are designed to discourage the practice of “loss or credit trading” whereby a corporation is acquired for the primary purpose of accessing unused losses or credits. Many of the same rules apply to amalgamations as well. I will highlight a few:

Scientific research and experimental development tax credits and investment tax credits may be limited,

Elimination of the capital dividend account if control moves from non-resident to resident

Limitation or prohibition of carry forward of losses depending on the type of loss and the nature of the business activity which follows the acquisition of control.

By no means is this a comprehensive analysis of all of the ramifications relating to changes in control and year-ends. And, it is critical to be aware of the types of circumstances that may cause a corporation to get caught up in this web. Whenever there is a restructuring or reorganization of the share capital of a corporation, the corporation’s advisors need to be asked these questions. Failure to take note of an acquisition of control and change in year-end can result in substantial interest and penalties owing to the CRA as well as the loss of numerous potential tax benefits. It pays to be aware!

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