A corporation can be deemed to have a year-end for income tax purposes, in the middle of its fiscal year, for a number of reasons.
One common reason is a change in control (or of 75% ownership) of the corporation (now called a “loss restriction event” in the Income Tax Act). If the corporation is sold to new owners, it will be deemed to have a year-end and start a new taxation year. (Business losses from previous years will then generally not be claimable unless the corporation continues to carry on the same or a similar business. Capital losses from previous years will not be claimable at all after the change in control.)
Another trigger for a year-end is if the corporation becomes or ceases to be a Canadian-controlled private corporation. Thus, for example, if the majority shareholder becomes non-resident, the corporation will be deemed to start a new taxation year.
There are several other such triggers, including becoming or ceasing to be exempt from tax, and becoming or ceasing to be a “financial institution”.
What happens when the corporation has a new taxation year and a resulting “short” year (or two)? Many things change, and there can be numerous negative side effects. For example:
- A corporate tax return must be filed for the “short” year, within 6 months of the deemed year-end.
- The due date for the current year’s tax balance is moved earlier (two or three months after the deemed year-end).
- A loss carryforward year will usually vanish due to the extra taxation year, as can other carryforward years such as for foreign tax credits, investment tax credits and certain reserves. This means that the carryforwards will expire sooner than they otherwise would. (Most business losses can now be carried forward for 20 years, but many other carryforwards are much shorter.)
- A loan to a shareholder may have to be repaid sooner to avoid being included in the shareholder’s income.
- Certain reserves, and certain accrued amounts that were deducted but have not been paid out, may be reincluded in income sooner than would otherwise be required.
As well, certain calculations that are based on the presumption that a taxation year has 365 days will now be different. A corporation’s monthly instalment requirements are based, for example, on the previous year’s tax payable, but prorated based on the length of that taxation year. Suppose a corporation has $100,000 of tax payable for the year but all of it was earned in the first three months of the year, and the corporation was sold after 3 months. The “instalment base” for the next year will be $100,000 but prorated to a 12-month year, so the corporation might have to remit instalments of $400,000 the next year (though it can pay lower instalments if it knows that its tax will be lower).
Similarly, most capital cost allowance claims will be prorated to the short taxation year, as will various other claims including those for the small business deduction, and limitations on investment tax credits for small corporations.
Any change to a taxation year-end must be very carefully analyzed for all the unexpected fallout.