February 2008
Release No. 08-01

If you own a corporation which is liable to pay Ontario corporate income and capital taxes, you may have heard of plans to combine the Ontario corporate tax return (Form CT23) with the federal corporate tax return (Form T2). The purpose of this Fast Facts is to update you on the government’s plans as it moves towards the harmonization of the CT23 with the T2 and to review how this will impact your corporation.

This change has been widely lauded by the business community as it will reduce the tax compliance burden on Ontario corporations and will also result in the government being more efficient in administering corporate taxes.

When Does Harmonization Occur?

Your corporation will no longer have to file a separate Form CT23 for taxation years that end after 2008. Therefore, if your corporation has a December 31st year-end, the first year you will be impacted is the year ending December 31, 2009. However, corporations with non-calendar year-ends will be impacted sooner – for example, if your corporation has a January 31st year-end, you will file your first combined corporate tax return for the taxation year which ends on January 31, 2009.

What is the Main Impact of Harmonization?

The key concept behind harmonization is the fact that both federal and Ontario tax will now apply on the same taxable income amount. Therefore, the most significant impact of harmonization is that Ontario corporations will be required to adopt federal tax attributes at the time they transition to the new system. Tax attributes represent amounts your company can deduct for tax purposes such as losses carried forward from previous years and tax depreciation pools (known as undepreciated capital cost). Basically what will happen is to the extent that these attributes are different for federal and Ontario corporate tax purposes at the transition time (the first day of the taxation year in which your corporation will file a harmonized corporate tax return), the Ontario attributes will be adjusted to the federal attributes at that time.

However, it’s not as simple as that. To the extent that this adjustment results in a net increase to your Ontario attributes (because the aggregate federal attributes exceed the aggregate Ontario attributes), your company will have to pay for the increase in these attributes. This is known as a “transitional debit”. To the extent that this adjustment results in a net decrease to your Ontario attributes (because the aggregate Ontario attributes exceed the aggregate federal attributes), your company will be eligible to claim a tax credit as compensation. This is known as a “transitional credit”.

What are the Tax Attributes that are Adjusted for at the Transition Time?

The types of attributes that may result in a transitional debit or credit (because Ontario attributes are being adjusted to equal what the federal attributes are) include the following:

• Undepreciated Capital Cost (UCC)
• Donations carried forward
• Cumulative Eligible Capital (CEC)
• Scientific Research and Experimental Development (R&D) pools
• Non-capital losses carried forward
• Net-capital losses carried forward
• Adjusted cost base (ACB) of partnership interests
• Negative ACB of partnership interests
• Reserves deducted (either provincially or federally)
• Inventory adjustments for farming businesses
• Discretionary deductions (either provincially or federally)

More Details on the Transitional Debit

If your aggregate federal attributes exceed your Ontario attributes at the transition time, this difference is multiplied by the general Ontario corporate tax rate, which is currently 14% (if your company has permanent establishments in jurisdictions other than Ontario, the calculation is prorated to take this into account). Your corporation will then have to pay this amount in equal instalments over five taxation years, beginning in the taxation year ending in 2009. Effectively, the government is making your corporation pay for the additional Ontario attributes that have been given to the company. You should note that the transitional debit is always calculated at 14% even though your actual Ontario corporate tax rate may be different (for example, if your company is a manufacturer, which has an effective Ontario corporate tax rate of 12%, or is eligible to pay Ontario corporate tax at the small business tax rate of 5.5%).

For example, assume at the transition time your corporation has federal UCC balances totaling $10 million and Ontario UCC balances of $8 million, and that all other attributes are equal. As the federal attributes exceed the Ontario attributes by $2 million, your company will have a transitional debit of $280,000 ($2 million x 14%) which must be paid over five years at $56,000 per year.

Whether this is positive or negative for your corporation will depend on your specific facts. To the extent that you can deduct the additional attributes more quickly than you have to pay for them, this will generally be positive, as long as these attributes reduce your tax at a 14% corporate tax rate. However, if you will not be able to utilize the additional attributes at that rate before they have to be paid for (the five years ending with the taxation year ending in 2013) it is likely that this will have a negative impact on your corporation. If you will never use the additional attributes, you will effectively have paid for something for which you will never see a benefit.

More Details on the Transitional Credit

If your corporation’s aggregate Ontario attributes exceed your federal attributes at the transition time, this difference is also multiplied by the general Ontario corporate tax rate of 14%. However, in this instance, your corporation will be eligible for a tax credit that can be applied against Ontario corporate tax, to compensate your corporation for the fact that the Ontario tax attributes have been reduced. This transitional credit must be used over a five year period beginning with the taxation year that ends in 2009 – if it is not used over this five year period, it will be lost.

Again, whether this is positive or negative for your corporation depends on your specific facts. If you can utilize the transitional credit within the 5 year period, you will very likely achieve a benefit. However, if you will not be able to fully utilize the credit within that time, you will have lost Ontario attributes for which you will effectively not be compensated.

Other Issues to Think About

Corporate Instalment Payments

Beginning in February 2008, corporations with January 31st year-ends (who will file their first combined corporate tax return for the year ending January 31, 2009) will no longer pay corporate tax instalments to the province of Ontario. Instead, they will have to make a combined corporate tax instalment to the Canada Revenue Agency (CRA), as February 2008 is the first month of their 2009 taxation year. Similarly, corporations with February year-ends will start paying combined tax instalments to the CRA in March 2008.

Instructions on how to calculate and remit combined instalment payments are provided in 2008 T7B-CORP, Corporation Instalment Guide issued by the CRA. This guide includes 2009 worksheets for Ontario and is currently available on the CRA’s website.

Combined instalment payments include all Ontario taxes that the CRA will begin to administer on behalf of the province for taxation years ending in 2009. Specifically, these include corporate income tax, corporate minimum tax, capital tax and the special additional tax on life-insurers.

Transition to a Single Return

The Ontario Ministry of Revenue will retain responsibility for processing CT23 returns, instalments and related matters for taxation years ending up to December 31, 2008. For taxation years ending after December 31, 2008, the CRA will be responsible for all administrative matters relating to the combined corporate return.

The CRA and Ontario Ministry of Revenue are currently making arrangements to transfer the responsibility for the audit of CT23 returns before 2009. This means that the CRA will audit both the CT23 and the T2 returns in one visit, a big advantage for corporate taxpayers. To ensure a smooth transition for taxpayers to a single audit, the CRA and Ontario Ministry of Revenue are also discussing the early transfer of activities related to a single audit, such as objections and appeals, interpretations and enquiry services. Ontario corporations will be informed of the transition plans as they are finalized.

Research and Development Companies

Companies engaged in Research and Development (R&D) activities will frequently have differences between federal and Ontario tax attributes, in particular with respect to the R&D tax pools that are available for deduction. To alleviate the hardship of a transitional debit for an R&D performer, an elective seven year deferral has been provided for. If the taxpayer makes the election, generally the transitional debit that a corporation would otherwise have paid that relates to R&D pools will be deferred until the taxation year ending in 2016. However, these rules are complicated and you should consult with your BDO advisor.

R&D performers will also benefit from a new non-refundable 4.5% R&D tax credit in Ontario effective for taxation years that end after 2008. The purpose of this credit is to compensate Ontario R&D companies for the fact that federal R&D investment tax credits are now subject to Ontario corporate income tax (under current rules these tax credits are effectively not taxable in Ontario).

Capital Tax

Under the harmonization process, the CRA will continue to collect the Ontario capital tax until it is eliminated in 2012. However, the base for the tax will change to the federal definitions that were used for the Large Corporations Tax. Most concepts are similar, but there are differences. Note that the capital tax was eliminated for manufacturing and processing corporations (including mining, agriculture, logging and fishing activities) on January 1, 2008.

CMT Corporations with Ontario Corporate Minimum Tax (CMT) issues will often avoid paying CMT by backing off discretionary Ontario tax deductions creating differences between federal and Ontario tax attributes. This will result in a transitional credit under the harmonization rules (as Ontario attributes will exceed federal attributes). These corporations will have to consider if they prefer a transitional credit, which must be used in five years, over a CMT carryforward, which can now be carried forward for 20 years.

Ontario Addback for Non-Arm’s Length Payments to Non-Residents

Ontario currently disallows as a deduction from a corporation's income a specified fraction (5/14ths) of management fees, rents, royalties and other similar payments that are made to a non-resident person with whom the paying corporation was not dealing at arm's length. This addback will no longer apply for taxation years ending after 2008.

Amalgamations and Wind-ups

For purposes of the transitional debits and credits, a successor corporation formed as part of an amalgamation during the amortization period will be treated as a continuation of each of its predecessor corporations provided that the successor corporation has a permanent establishment in Ontario immediately after the amalgamation and neither the amalgamation nor any other prior event is considered a tainting transaction. Essentially a tainting transaction is an attempt to reduce transitional debits or increase transitional credits for either itself or a successor corporation. Similar rules apply where there has been a wind-up of a corporation.

Summary

The move to a harmonized corporate tax system for Ontario companies is a move in the right direction to help reduce the compliance burden on corporations. However, it’s important that you understand how the transition will impact your corporation.