Unlike a corporation, a partnership is not a separate taxpayer. Rather, a partnership's income or loss is generally calculated at the partnership level and allocated to its partners, who then include it in calculating their own income for tax purposes. For corporate partners, partnership income is included as income in the corporation's tax year-end ("CTYE") in which the partnership's fiscal year ends ("PFYE"). Under the current tax provisions, if a corporation carries on business through a partnership that has a PFYE after the CTYE, taxation of the partnership income can be deferred by up to one year. In tiered partnerships, this can lead to multiple deferrals. Where the annual corporate tax rate is expected to be lower in a later year, this deferral results in tax savings to the corporate partner.

For instance, if ABC Inc. has an October 31 CTYE and is a partner in a partnership with a November 30 PFYE, ABC Inc.'s share of partnership income from the November 30, 2010 PFYE would be included in ABC Inc.'s income for its October 31, 2011 CTYE.

Miller Thomson Analysis

Stub Period Proposals

The 2011 Federal Budget first introduced on March 22, 2011, and reintroduced June 6, 2011, with some amendments, contained proposals to eliminate this tax deferral. Under the proposals, corporate partners must accrue income from the beginning of a partnership's fiscal period to the end of the corporation's taxation year (the "Stub Period"). A corporate partner must include the Stub Period income and any income allocated from the last PFYE that ends in the CTYE in its income for the CTYE. For instance, under the proposed rules, ABC Inc. from the above example would be required to include in its October 31, 2011 CTYE income equal to 11/12ths of its share of partnership income from the partnership's November 30, 2011 PFYE.

Certain resource expenses incurred by partnerships in the Stub Period, such as Canadian exploration expenses, Canadian development expenses, and Canadian oil and gas property expenses, can be used to offset Stub Period income inclusion. Partnership losses for the Stub Period, however, cannot be accrued. Rather, these losses are recognized in the corporation's following tax year in the same manner as they are under the current rules.

The proposed rules will apply to a corporate partner if: (i) it is a member of a partnership at CTYE; (ii) the last PFYE ends in a subsequent CTYE; (iii) together with affiliated and related parties, it is entitled to more than 10% of the income allocation from a partnership in the last PFYE; and (iv) it is not a professional corporation.

The Stub Period accrual amount will generally be a pro-rated amount of the corporate partner's income from the partnership in its PFYE. However, corporate partners may choose to include a lower amount as Stub Period accrual. This is useful where the corporation expects income from the partnership for the PFYE that includes the Stub Period to be less than the share of partnership income for the previous year. Corporate partners should be cautious, however, because if the designated Stub Period accrual is lower than the least of (i) the actual pro-rated income and (ii) the pro-rated income excluding dividends, the corporation will be subject to an additional income inclusion equal to the shortfall multiplied by a prescribed interest rate. Furthermore, if the shortfall exceeds 25% of the lesser of (i) or (ii) above, 50% of the shortfall in excess of the 25% threshold is added to the corporation's income. Limited exceptions are provided for this punitive income inclusion provision.

Under the proposed rules, single-tiered partnerships can elect to change their PFYE to align with the CTYE of one or more corporate partnerships, thereby eliminating the need to accrue income.

Multi-Tiered Partnerships

Partnerships that are part of a tiered partnership structure, on the other hand, will be required to have the same PFYE. However, that PFYE does not need to align with the CTYE of any of the partnerships' corporate partners. Tiered partnerships can elect a common PFYE before March 22, 2012 ("MTA Election"). The elected fiscal period must be no more than 12 months in duration. The MTA election must be filed before the earliest of all filing-due dates for the return of income of any corporate partner of any of the partnerships. If no fiscal period is elected, the PFYE will automatically default to December 31, 2011, and subsequent fiscal periods will end on December 31. The alignment of partnerships will result in multi-tier alignment income ("MTAI") equal to the income that would otherwise have been deferred.

Corporate partners of a multi-tier partnership may have a Stub Period accrual amount in addition to MTAI. A corporation's Stub Period accrual amount will be calculated at the CTYE that includes the first aligned PFYE. No accrual will occur, however, if the CTYE and PFYE are aligned.

Transitional Rules

To mitigate the potential cash-flow impact to corporate partners during the corporation's first taxation year under the proposed rules, the new proposals generally permit corporate partners to spread the Stub Period accrual amount and MTAI for 2011 incrementally over the next five years as follows: CTYE for 2011 - 0%; CTYE for 2012 - 15%; CTYE for 2013 - 20%; CTYE for 2014 - 20%; CTYE for 2015 - 20%; and CTYE for 2016 - 25%.

Partnership structures should be reviewed to determine what action, if any, is required.