Thank you, Mr. Chair.
This amendment delays provisions related to partnerships. Budget 2012 announced the extension of the thin capitalization rules in subsection 18(4) of the act to debts of a partnership of which a corporation resident in Canada is a member. As part of the implementation of this budget measure, proposed paragraph 12(1)(l.1) is introduced to include an amount in computing the income of a corporation in certain circumstances. The amount included in a partner's income is determined by reference to interest paid or payable by a partnership of which the corporation is a member on the portion of the debts of the partnership that is allocated to the corporation under proposed subsection 18(7). That exceeds the corporation's permitted debt-to-equity ratio under the thin capitalization rules. Since partnership income is calculated at the partnership level and allocated to its partners on a net basis, i.e., after any deduction of interest expense, a partnership's interest expense cannot be denied at the partner level.
This income inclusion effectively adds back the relevant portion of the interest that is deductible at the partnership level to the partner's income. The net effect is therefore similar to the interest restriction rule in subsection 18(4). For further information, please see commentary on subsection 18(4) and proposed subsection 18(7).
Further, the amount included in computing a taxpayer's income is the total of all amounts determined on a partnership-by-partnership basis by the formula A times B divided by C minus D. Variable A is the deductible interest on the taxpayer's share of the outstanding debts, of the particular partnership owing to specified non-residents. The taxpayer's share of the debts is determined by reference to its debt amount as defined by proposed paragraph 18(7)(a).
Now, consistent with the look-through approach to partnerships in proposed subsection 18(7), the taxation year of the corporation is the relevant period for determining what interest is included. Interest that is paid by the partnership in the corporation's taxation year or that is payable by the partnership in respect of the corporation's taxation year, depending on the method followed by the corporation in computing its income, is therefore included regardless of the fiscal period of the partnership. So B divided by C is the fraction if any of the taxpayer's debts, including its share of the partnership debt that exceeds the allowable debt-to-equity ratio specified in the thin capitalization rules....
Variable D effectively reduces proposed paragraph 12(1)(l.1) income inclusion by the amount of any foreign accrual property income of a controlled foreign affiliate of the taxpayer that is in respect of interest described in A. That is included in the taxpayer's income for the year or a subsequent year or included in computing the income of the partnership. This variable is the corollary in the partnership context of proposed subsection 18(8), which applies in respect of interest paid or payable to a corporation by the controlled foreign affiliate of the corporation. For further information, you can see the commentary on proposed subsection 18(8). This paragraph applies to taxation years that begin after March 28, 2012.
Further, Mr. Chair, according to the Introduction to Federal Income Taxation in Canada, the 31st edition, interest on loans used to earn income from business or property is deductible in computing taxable income of a Canadian corporation. The tax deductibility of interest creates preference for financing Canadian corporations through debt rather than equity, particularly where tax rates are lower in the lending jurisdiction.
The thin capitalization rules are a set of rules designed to prevent specified non-resident shareholders who hold significant equity positions, which would be 25%—