Financial Institutions - Capital Tax

Bulletin TDLB 98-1
Published: February 1998
Content last reviewed: November 2010

Publication Archived

Notice to the reader: Capital Tax was fully eliminated on July 1, 2010. It was eliminated effective January 1, 2007 for Ontario corporations primarily engaged in manufacturing or resource activities.

This publication was archived and kept for historical purposes. Use caution when you refer to it, since it reflects the law in force at the time it was released and may no longer apply.

The 1997 Ontario Budget announced three important measures relating to the capital tax treatment of financial institutions.

  • Ontario is simplifying and modernizing its capital tax system to follow more closely the federal large corporations tax as it applies to financial institutions.
  • Ontario is harmonizing with the federal measure to extend the temporary surcharge on the capital tax of large deposit-taking financial institutions from November 1, 1997 to October 31, 1998.
  • A number of improvements are being made to the small business investment tax credit for financial institutions.

These and other 1997 Budget measures were implemented by The Tax Credits to Create Jobs Act, 1997 (Bill 164), which amended the Corporations Tax Act (CTA) and other provincial statutes. Bill 164 received royal assent on December 18, 1997. The amendments to Part III of the CTA are contained in sections 28 to 41 of Bill 164.

This tax legislation bulletin clarifies various details pertaining to these measures and refers to certain changes from the 1997 Budget that were made in Bill 164. These changes were described in a 1997 Budget Update released by the Ministry of Finance on November 25, 1997, entitled "Capital Tax Harmonization for Financial Institutions."

This bulletin is intended to be a guide only and does not purport to be a substitute for the legislation or regulations. For precise details, the reader should consult the legislation and corresponding regulations.

Capital Tax Harmonization for Financial Institutions

Prior to the capital tax harmonization initiative announced in the 1997 Budget, Ontario's capital tax system provided special rules for certain types of financial institutions: banks, corporations registered under the Loan and Trust Corporations Act, bank mortgage subsidiaries, mortgage investment corporations and credit unions. These corporations were subject to different methods of computing taxable paid-up capital as well as different capital tax rates.

Other corporations carrying on business in the financial services industry were subject to capital tax as ordinary corporations.

As a result of harmonization with the federal large corporations tax, financial institutions will be subject to uniform rules for the computation of adjusted taxable paid-up capital and will generally be subject to the same capital tax rates: 0.6% on adjusted taxable paid-up capital of $400 million and less, and 0.9% on adjusted taxable paid-up capital greater than $400 million.

  • The capital tax rate applicable to credit unions will be capped at 0.6% and the new regime will be phased in for credit unions over a five-year period.

Definition of Financial Institution

The term "financial institution" is now defined in subsection 58(2) of the CTA. A corporation will generally be a financial institution for Ontario capital tax purposes if the corporation is a financial institution for the purposes of the federal large corporations tax.

The following corporations qualify as financial institutions:

  • banks;
  • credit unions;
  • corporations that are authorized under the laws of Canada or a province to carry on the business of offering their services as trustee to the public;
  • corporations that are authorized under the laws of Canada or a province to accept deposits from the public and that carry on the business of lending money on the security of real estate or investing in mortgages on real estate;
  • registered securities dealers;
  • mortgage investment corporations; and
  • prescribed corporations.

Insurance Corporations

Unlike the federal system, insurance corporations are not included in the definition of financial institution. Insurance corporations do not pay Ontario capital tax, but pay a special premiums tax under Part IV of the CTA.

To recognize the investments that financial institutions make in insurance corporations, insurance corporations will be treated the same as financial institutions for certain purposes.

  • An investment in the shares or long-term debt of an insurance corporation will qualify for an investment allowance, provided that the conditions that apply to the calculation of the investment allowance are satisfied.
  • An insurance corporation will be included in a related group of financial institutions for the purpose of prorating the $2 million capital deduction in computing adjusted taxable paid-up capital, the $400 million threshold below which capital tax applies at a rate of 0.6%, and the $400 million threshold for the purposes of determining the temporary surcharge and the amount of capital tax that can be earned back through the small business investment tax credit for financial institutions.
  • An insurance corporation will be considered to be a financial institution for the purpose of determining whether a holding company is prescribed to be a financial institution.

Prescribed Corporations

The 1997 Budget also announced that certain prescribed corporations will be included in the definition of financial institution. It is the ministry's intention that the following corporations will be prescribed as financial institutions:

  • any holding company, provided that all or substantially all of the assets of the company are shares or indebtedness of related financial institutions or related insurance corporations; and
  • a corporation that applies to the Ministry of Finance to be so prescribed and whose application is accepted.

A corporation that wishes to be prescribed as a financial institution should apply in writing to the Ministry of Finance. The request should include a detailed description of the corporation's business, to establish that the corporation acts as a financial intermediary, and a copy of the corporation's latest financial statements.

If the application by a corporation to be prescribed is accepted, it is intended that any related corporations that are prescribed federally as financial institutions for the purposes of the large corporations tax will also be prescribed for Ontario purposes.

Where a corporation makes an application to be prescribed on or before the later of April 30, 1998 and 30 days following the end of the corporation's taxation year that includes May 7, 1997, and the application is accepted, it is intended that the corporation will generally be prescribed to be a financial institution as of May 7, 1997.

Other applications by corporations to be prescribed as financial institutions will be dealt with on a prospective basis. Where the application to be prescribed is accepted, the prescription will generally be effective for the taxation year in which the application is approved.

Calculation of Adjusted Taxable Paid-up Capital

A financial institution computes its capital tax liability using its adjusted taxable paid-up capital. The following table illustrates the manner in which a financial institution's adjusted taxable paid-up capital and capital tax liability is determined:

Computation of a Financial Institution's Adjusted Taxable Paid-up Capital and Capital Tax
Paid-up Capital (S. 62.1(2))
- Investment Allowance (S. 62.1(5))
= Taxable Paid-up Capital (S. 62.1(4))
+ 1/3 Canadian Tangible Property (S. 62.1(7), (8))
- $2 Million Capital Deduction (S. 62.1(10))
= Adjusted Taxable Paid-up Capital (S. 62.1(6))
× Capital Tax Rate (S. 66(4))
× Ontario Allocation (S. 66(4))
= Capital Tax Liability

Paid-Up Capital

A financial institution is first required to determine the amount of its paid-up capital under subsection 62.1(2). Its paid-up capital is generally computed in the same manner as its capital is determined under Part I.3 of the Income Tax Act (Canada) and is equal to:

  • the amount of its long-term debt;
  • the amount of its capital stock or, in the case of a financial institution incorporated without share capital, the amount of its members' contributions;
  • the amount of its retained earnings;
  • the amount of its contributed surplus and the amount of any other surpluses; and
  • the amount of its reserves for the taxation year, except to the extent that they were deducted in computing its income under Part II of the CTA for the taxation year,

less

  • the amount of its deferred tax debit balance;
  • the amount of any deficit deducted in computing its shareholders' equity;
  • any amount deducted under subsection 130.1(1) or 137(2) of the Income Tax Act (Canada), as made applicable by sections 47 and 51 of the CTA, in computing its income under Part II for the year, to the extent that the amount was included in computing the financial institution's paid-up capital; and
  • any amount, except to the extent that it has been deducted by the financial institution in computing its income under Part II of the CTA for the taxation year or any prior taxation year, deductible by the financial institution,

    • under subsection 37(1) of the Income Tax Act (Canada) in respect of scientific research and experimental development, or
    • under clause 11(10)(a) on account of the Ontario New Technology Tax Incentive.

Unlike the federal rules, a financial institution will be able to deduct, in computing paid-up capital for Ontario purposes, the amount of any R&D and Ontario New Technology Tax Incentive expenditures that are deductible under Part II of the CTA but that have not been deducted in computing income under that Part.

Taxable Paid-up Capital

A financial institution computes its taxable paid-up capital under subsection 62.1(4).

The taxable paid-up capital of a financial institution is the amount of its paid-up capital, less an investment allowance for its investments in the shares or long-term debt of a related financial institution or insurance corporation that has a permanent establishment in Ontario.

Investment Allowance

Financial institutions may claim an investment allowance, as determined under subsection 62.1(5), in respect of the amount of its investments in the shares or long-term debt of a related financial institution or insurance corporation that has a permanent establishment in Ontario. The amount of the allowance claimed is adjusted upwards or downwards, depending on whether the proportionate business carried on in Ontario by the corporation in which the investment is made is greater or less than the proportionate business carried on in Ontario by the corporation that made the investment.

The investment allowance that a financial institution (Parent) may claim in respect of a particular investment in a related financial institution or insurance corporation (Sub) is determined as follows:

Investment allowance = amount of investment × (% of Sub's business in Ontario × % of Parent's business in Ontario)

The percentage of a financial institution's business that is carried on in Ontario is determined in accordance with the existing rules in Part III of Regulation 183 under the CTA that apply to determine the proportion of a financial institution's taxable paid-up capital that is allocated to Ontario.

Example 1

  • FI#1 invests $100,000 in the shares of FI#2, a related financial institution, on July 1, 1998. FI#1 has a December 31 year-end. FI#2 has an October 31 year-end.
  • FI#1 has permanent establishments in Ontario and British Columbia. Under Part III of the CTA regulation, 40% of its taxable paid-up capital for its 1998 taxation year is deemed to be used in Ontario.
  • FI#2 has permanent establishments in Ontario and Quebec. Under Part III of the CTA regulation, 60% of its taxable paid-up capital for its 1998 taxation year is deemed to be used in Ontario.
  • FI#1 may deduct in computing its taxable paid-up capital the following amount in respect of its investment in FI#2:

    $100,000 × 60% / 40% = $150,000

Adjusted Taxable Paid-Up Capital

A financial institution's adjusted taxable paid-up capital, in respect of which its capital tax is calculated, is determined under subsection 62.1(6).

The adjusted taxable paid-up capital of a financial institution is equal to its taxable paid-up capital:

  • plus an amount in respect of its tangible property used in Canada, and
  • less its pro rata share of a $2 million capital deduction.

Tangible Property Used in Canada

The amount in respect of a financial institution's tangible property used in Canada that is included in the computation of adjusted taxable paid-up capital is a "specified percentage" of one-third of the amount of its tangible property used in Canada determined in respect of the financial institution under paragraphs 181.3(1)(a) and (b) of the Income Tax Act (Canada).

A corporation's Ontario capital tax liability is based on the proportion of the corporation's taxable paid-up capital used in Ontario to its total taxable paid-up capital. As a result, the amount of the financial institution's tangible property used in Canada will be grossed-up prior to allocation to Ontario in order to ensure that the proper result is achieved after provincial allocation (subsections 62.1(7) and (8)). The mechanism that determines this gross-up is the multiplication of the financial institution's tangible property used in Canada by a "specified percentage."

  • The grossed-up amount is determined by multiplying the amount of the corporation's tangible property used in Canada by the fraction (the "specified percentage") where the numerator is 100% and the denominator is the percentage of the corporation's taxable paid-up capital that is not deemed under the regulations to be used in a jurisdiction outside Canada.

    • The percentage of the corporation's taxable paid-up capital that is not deemed to be used in a jurisdiction outside Canada will be determined under the existing allocation rules contained in Part III of the CTA regulation.

One-third of this amount (i.e. one-third of the specified percentage of the corporation's tangible property used in Canada) is included in the financial institution's adjusted taxable paid-up capital. This reflects the fact that the capital tax rate applicable to ordinary corporations is one-third of the top rate applicable to financial institutions.

Example 2

  • The amount of FI#1's tangible property used in Canada for its 1998 taxation year, as determined under paragraphs 181.3(1)(a) and (b) of the Income Tax Act (Canada), is $1,000,000.
  • FI#1 has permanent establishments in Ontario, Quebec and New York. Applying the rules in sections 319 to 322 of the CTA regulation, FI#1 would allocate its taxable paid-up capital for the 1998 taxation year to these jurisdictions as follows:

    Ontario - 50%
    Quebec - 30%
    New York - 20%
  • The percentage of FI#1's taxable paid-up capital that is deemed under Part III of the CTA regulation to be used in Canada is 80%.
  • FI#1 includes, in computing its adjusted taxable paid-up capital for the 1998 taxation year, the following amount in respect of its tangible property used in Canada:

    100% / 80% × $1,000,000 × 1/3 = $416,667

  • After allocation to Ontario, FI#1 pays Ontario capital tax on 50% of $416,667, or $208,334.

Capital Deduction

Financial institutions are entitled to a $2 million deduction in computing adjusted taxable paid-up capital (subsection 62.1(10)).

  • This deduction is prorated among related financial institutions and insurance corporations that have permanent establishments in Canada, based on the proportionate amount of taxable capital employed in Canada of each corporation as determined under Part I.3 of the Income Tax Act (Canada) for the taxation year or, if a related financial institution or insurance corporation has a different year-end, for its last taxation year ending before the end of the financial institution's taxation year.

Capital Tax Rate

A two-tier rate of capital tax applies to financial institutions (subject to the exceptions described below): 0.6% on the first $400 million of adjusted taxable paid-up capital and 0.9% on the amount in excess of $400 million.

  • The threshold amount of $400 million of adjusted taxable paid-up capital is prorated among related financial institutions and insurance corporations with permanent establishments in Canada on the basis of each corporation's proportionate amount of taxable capital employed in Canada as determined under Part I.3 of the Income Tax Act (Canada) for the taxation year or, if a related financial institution or insurance corporation has a different year-end, for its last taxation year ending before the end of the financial institution's taxation year.

The capital tax rate applicable to credit unions is capped at 0.6% and is phased-in over a five-year period (S. 66(6)):

  • 0.05% on adjusted taxable paid-up capital allocated to Ontario, effective after December 31, 1997 and before January 1, 1999;
  • 0.1% on adjusted taxable paid-up capital allocated to Ontario, effective after December 31, 1998 and before January 1, 2000;
  • 0.2% on adjusted taxable paid-up capital allocated to Ontario, effective after December 31, 1999 and before January 1, 2001;
  • 0.4% on adjusted taxable paid-up capital allocated to Ontario, effective after December 31, 2000 and before January 1, 2002; and
  • 0.6% on adjusted taxable paid-up capital allocated to Ontario, effective after December 31, 2001.

The above capital tax rates for credit unions are prorated for taxation years that straddle the effective dates.

The rate of capital tax payable by a financial institution that is not a deposit-taking institution, and that is not related to a deposit-taking institution, on adjusted taxable paidup capital above $400 million is 0.72%.

  • This acknowledges that these institutions cannot take advantage of the small business investment tax credit to reduce their capital tax liability on adjusted taxable paid-up capital above $400 million.

Effective Date

Credit unions are subject to the new rules for financial institutions after December 31, 1997.

Other financial institutions that are members of a related group of financial institutions and insurance corporations with taxable capital employed in Canada as determined under Part I.3 of the Income Tax Act (Canada) greater than $10 million are subject to the new rules after May 6, 1997. These financial institutions are required to calculate their capital tax liability for a taxation year straddling May 6, 1997 under two methods: firstly, under the rules in effect before May 7, 1997 and, secondly, under the rules in effect after May 6, 1997. Their liability for capital tax under each of these methods is then prorated, as the case may be, for the number of days in the taxation year before May 7, 1997 and the number of days in the taxation year after May 6, 1997.

Remaining financial institutions will be subject to the new rules for taxation years commencing after May 6, 1997.

Temporary Capital Tax Surcharge on Large Deposit-Taking Financial Institutions

The temporary capital tax surcharge, which was first imposed on large banks in the 1996 Ontario Budget, was extended in the 1997 Budget to all large deposit-taking financial institutions (other than credit unions). The surcharge was also extended to October 31, 1998, consistent with the measure announced in the 1997 Federal Budget.

The surcharge now applies to a deposit-taking institution's adjusted taxable paid-up capital over $400 million (subsection 66.1(2)).

  • This $400 million capital deduction must be prorated among related financial institutions and insurance corporations with permanent establishments in Canada on the basis of each corporation's proportionate amount of taxable capital employed in Canada as determined under Part I.3 of the Income Tax Act (Canada) for the taxation year or, if a related financial institution or insurance corporation has a different year-end, for its last taxation year ending before the end of the financial institution's taxation year.
  • Effective May 7, 1997, a financial institution calculates its liability for the surcharge in respect of the new, harmonized capital tax base.
  • The surcharge is equal to 10% of a deposit-taking institution's capital tax liability on adjusted taxable paid-up capital over $400 million.

    • Since the capital tax rate on adjusted taxable paid-up capital over $400 million is 0.9%, the rate of the surcharge on capital over $400 million is now 0.09%.

A deposit-taking institution is a financial institution that is (subsection 66.1(1.2)):

  • a bank;
  • a corporation that is authorized under the laws of Canada or a province to carry on the business of offering its services as a trustee to the public;
  • a corporation that is authorized under the laws of Canada or a province to accept deposits from the public and that carries on the business of lending money on the security of real estate or investing in mortgages on real estate;
  • a credit union; or
  • a corporation all or substantially all of the assets of which are shares or indebtedness of related financial institutions that are deposit-taking institutions.

Small Business Investment Tax Credit for Financial Institutions

The small business investment tax credit for financial institutions allows financial institutions to reduce their capital tax liability where they make certain types of investments in small businesses.

As originally announced in the 1996 Ontario Budget, only banks were allowed to reduce their capital tax where they made eligible investments in qualifying small businesses.

  • Eligible investments were defined by regulation to mean "patient capital" investments (i.e. common shares, five-year preferred shares, and long-term subordinated debt).
  • Banks were able to use the credit to earn back the amount of the temporary capital tax surcharge that they paid under subsection 66.1(1) of the CTA.

The 1997 Ontario Budget announced significant changes to the tax credit.

  • More financial institutions may use the tax credit to reduce their capital tax liability.
  • The amount of capital tax that a financial institution may earn back under the tax credit is increased.
  • The tax credit is now available not only for patient capital investments in small businesses, but also for below-prime loans made to small businesses and investments in Community Small Business Investment Funds.

The remainder of this Bulletin summarizes the operation of the small business investment tax credit for financial institutions.

Who may claim the tax credit?

A financial institution, other than a credit union, may claim the tax credit if it is a member of a related group of financial institutions and insurance corporations that has aggregate adjusted taxable paid-up capital in excess of $400 million. In addition, at least one member of the related group must be a deposit-taking institution, i.e. banks, trust and loan companies and credit unions (subsections 66.1(2) - (3.2)).

A credit unions may also claim the tax credit, regardless of the amount of its adjusted taxable paid-up capital (subsection 66.1(3.3)).

A financial institution may claim the tax credit for an eligible investment made by it (if it is a deposit-taking institution), or by a related deposit-taking institution, insurance corporation, or specified corporation (clause 66.1(4)(a)).

  • If a financial institution claims the tax credit for an eligible investment made by a related corporation, no other financial institution may claim a credit in respect of that investment.

As a result, a financial institution does not itself have to be qualified to make the types of investments that are eligible for the tax credit in order to take advantage of the credit to reduce its capital tax.

How much capital tax can be earned back under the tax credit?

The amount of capital tax that a financial institution (other than a credit union) may earn back under the tax credit for a taxation year is the amount of its temporary surcharge plus 20% of its capital tax liability on adjusted taxable paid-up capital over $400 million (subsection 66.1(3.2)).

  • The $400 million threshold is prorated among related financial institutions and insurance corporations with permanent establishments in Canada, based on each corporation's proportionate amount of taxable capital employed in Canada as determined under Part I.3 of the Income Tax Act (Canada) for the taxation year or, if a related financial institution or insurance corporation has a different year-end, for its last taxation year ending before the end of the financial institution's taxation year.

A credit union may earn back all the capital tax that it pays for a taxation year (subsection 66.1(3.3)).

The amount of capital tax and surcharge that a financial institution can earn back under the credit for a taxation year is called its "eligible tax."

A financial institution may earn back its eligible tax for a taxation year through investments made before the end of the second calendar year following the calendar year in which the taxation year ends (subsections 66.1(3) and (3.1)).

A bank subject to the temporary surcharge announced in the 1996 Budget still has until December 31, 1999 to earn back the amount of its temporary surcharge for the period between May 8, 1996 and May 6, 1997.

  • A bank may earn this amount back, to the extent that it was not already earned back through investments made before May 7, 1997, under the new rules announced in the 1997 Budget.

What investments qualify for the tax credit?

An eligible investment for the purposes of the tax credit is (subsection 66.1(4.9):

  • a patient capital investment in a qualifying small business or qualifying small business corporation;
  • a below-prime loan to a qualifying small business or qualifying small business corporation; and
  • a Class A share issued by a corporation registered as a community small business investment fund corporation under the Community Small Business Investment Funds Act.

Patient Capital Investments

A patient capital investment is an investment that would have qualified as an eligible investment for the purposes of the tax credit before the changes announced in the 1997 Budget (subsection 66.1(4.14)).

A patient capital investment is defined by regulation to mean a "qualifying share" issued by a qualifying small business corporation and a "qualifying obligation" issued by a qualifying small business or qualifying small business corporation (sections 1 and 5 of CTA Regulation 318/97).

  • A qualifying share is a common share or a 5-year preferred share.
  • A qualifying obligation is a loan that is made for a period of 5 years and that is subordinate to the rights of other creditors.

For an investment to qualify as a patient capital investment, the qualifying small business corporation or qualifying small business must use the invested funds in an active business carried on primarily in Ontario and must not use the funds for certain specific purposes that are generally unrelated to the carrying on of an active business (section 6 ofCTA Regulation 318/97).

Where the patient capital investment is a loan to a qualifying sole proprietor, the loan will not be an eligible investment unless the sole proprietor provides certain financial information to the investing bank and undertakes to use the investment for business purposes and to keep business assets separate from personal assets (subsections 5(3) and (4) of CTA Regulation 318/97).

Below-Prime Loans

A below-prime loan is a loan made after May 6, 1997 to a qualifying small business or qualifying small business corporation for an amount not exceeding $50,000, provided that the rate of interest payable in respect of the loan is less than the average bank prime rate (subsection 66.1(4.10)).

  • The average bank prime rate will have the same meaning as the term "average prime rate", which is defined in subsection 503(1) of the CTA regulation.

In addition, the following conditions must be satisfied:

  • The total assets or gross revenue, whichever is greater, of the small business and any associated businesses must not exceed $500,000 at the time the loan is made.
  • The qualifying small business corporation or qualifying small business must use the invested funds in an active business carried on primarily in Ontario and must not use the funds for certain specific purposes that are generally unrelated to the carrying on of an active business (section 6 of CTA Regulation 318/97).
  • The proceeds of the loan must not be used in a prescribed business.

    • A prescribed business for this purpose means the professions of accounting, dentistry, law and medicine.

To simplify the due diligence process for financial institutions making below-prime loans, a small business may certify to the lender that the business meets the size test and that the proceeds of the loan will be used for a permitted purpose and will not be used in an prescribed business (subsection 66.1(4.11)).

  • The financial institution may rely on the certification and will not lose the credit for the loan if the certification turns out to be false.
  • Where the small business makes an incorrect certification, it will be subject to a penalty unless the business can establish that the individual making the certification believed it to be true (subsections 66.1(4.12) and (4.13)).

The CTA regulation for the small business investment tax credit will be amended to include these rules with respect to below-prime loans.

Community Small Business Investment Funds

An investment in Class A shares issued by a community small business investment fund corporation in accordance with the Community Small Business Investment Funds Act is an eligible investment.

  • To claim the tax credit for an investment in a community small business investment fund corporation, a financial institution must apply to the Minister of Finance for the tax credit (subsection 66.1(4.6)).
  • An application should be sent in writing to the following address:

    Ministry of Finance
    Manager, Business Investment Plans Section
    33 King St. W.
    Oshawa, Ont.
    L1H 8H5
    Tel.: 1 866 668-8297; Fax: 905 436-4496

What tax credit rate is available for the different types of investments?

Patient Capital Investments

Several tax credit rates apply in respect of patient capital investments, depending on both the size of the investment and the size of the business in which the investment is made.

The tax credit rates applicable to patient capital investments are as follows (subsection 66.1(4.8)):

Credit Rate Size of Investment Size of Business
75%

Investments under $50,000

Rate is phased out to 20% for investments between $50,000 and $100,000.

The total amount of the financial institution's eligible investments in the small business must not exceed $100,000.

Rate phased out to 20% where between $500,000 and $750,000.

Also phased out to zero where group assets or revenue are between $1 million and $5 million.

20%

Investments between $100,000 and $250,000.

Rate is phased out to 10% for investments between $250,000 and $1 million.

Rate is phased out to zero where group assets or revenue are between $1 million and $5 million.
10% Investments above $1 million, with no cap. Rate is phased out to zero where group assets or revenue are between $1 million and $5 million.

Below-Prime Loans

A 4% credit is available for below-prime loans made by a financial institution, calculated annually in respect of the average outstanding balance of the loan for each year (subsection 66.1(4.3)).

  • Tax credits in respect of below-prime loans may only be claimed by a financial institution for a taxation year to reduce up to 75% of its eligible tax for that year (subsection 66.1(4.4)).

Unlike the tax credit claimed by a financial institution for a patient capital investment, the credit claimed by a financial institution for a below-prime loan will not be recaptured where the loan is considered to be disposed of under the rules contained in the regulations.

Example 3

FI#1's eligible tax for the 1998 taxation year that can be earned back under the tax credit is $30,000. Its year-end is December 31.

FI#1 makes three below-prime loans in the 1998 taxation year.

  1. $40,000 to Business A, which is outstanding from April 1 to October 31.
  2. $30,000 to Business B, which is outstanding from May 1 to December 31.
  3. $20,000 to Business C, which is outstanding from July 1 to September 30.

The tax credit that FI#1 can claim in 1998 for each below-prime loan is determined as follows:

  1. 4% × $40,000 × 214/365 = $938
  2. 4% × $30,000 × 245/365 = $805
  3. 4% × $20,000 × 92/365 = $202

Investments in Community Small Business Investment Funds

An investment by a financial institution in a corporation registered as a Community Small Business Investment Fund Corporation (CSBIF) under the Community Small Business Investment Funds Act qualifies for a tax credit of up to 60%.

The 60% credit is available as follows: 30% for the taxation year in which the financial institution invests in Class A shares of the CSBIF and 30% in a taxation year to the extent that the CSBIF re-invests the amount of the financial institution's investment in eligible investments as defined in the Community Small Business Investment Funds Act (subsections 66.1(4.5) to (4.7) of the CTA). The up-front credit may be claimed for investments made after May 6, 1997 and before January 1, 1999.

Example 4

On July 1, 1998, FI#1 acquires Class A shares from a CSBIF for the amount of $300,000.

On July 1, 1999, the CSBIF reinvests $200,000 of the amount invested by FI#1 in eligible investments in small businesses in accordance with the CSBIF Act.

The Minister allows FI#1's application for a tax credit in respect of its investment in the CSBIF. FI#1's year-end is Dec. 31.

The tax credit that FI#1 can claim in its 1998 taxation year is:

$300,000 × 30% = $90,000

The tax credit that FI#1 can claim in its 1999 taxation year is:

$200,000 × 30% = $60,000

How does a financial institution calculate the tax credit that it can claim in a taxation year?

A financial institution may deduct in computing its tax under Part III of the CTA for a taxation year the lesser of three amounts (subsection 66.1(2)):

  • the amount of its "tax earn-back account" for the taxation year;
  • the amount of its "small business investment tax credit account" for the taxation year (or nil, if this is a negative amount); and
  • the amount of its capital tax and surcharge payable under Part III for the taxation year.

Tax Earn-back Account

The tax earn-back account of a financial institution for a taxation year refers to the amount of capital tax paid by the financial institution for the taxation year and the three previous taxation years that can be earned back in the taxation year under the tax credit, i.e. the amount of eligible tax paid by the financial institution for those years less the amount of that tax that the financial institution has already earned back under the credit.

A financial institution's tax earn-back account for a taxation year (ss. 66.1(3), (4)) is the amount by which:

  • the financial institution's eligible tax for the taxation year and the three preceding taxation years exceeds
  • the total tax credits deducted by the financial institution in the three preceding taxation years in respect of the eligible tax paid for those years.

A financial institution must therefore keep records of the amount of eligible tax for a particular year that it earns back in the year and in the three subsequent years.

Example 5

FI#1 wants to determine the amount of its tax earn-back account for the 2002 taxation year. Its year-end is October 31.

FI#1's eligible tax for 2002 and the three preceding taxation years is as follows:

2002 - $500,000
2001 - $500,000
2000 - $450,000
1999 - $350,000

FI#1 earned back all of its eligible tax for the 1999 taxation year through eligible investments made in the 2001 taxation year. FI#1 has not earned back any other part of its eligible tax.

FI#1's tax earn-back account for the 2002 taxation year is the following amount:

$500,000 + $500,000 + $450,000 + $350,000 − $350,000 = $1,450,000

Small Business Investment Tax Credit Account

A financial institution's small business investment tax credit account is effectively the aggregate amount of unclaimed tax credits for eligible investments made by the financial institution or a related corporation and allocated to the financial institution.

The small business investment tax credit account of a financial institution for a taxation year (subsection 66.1(4)) is the total of:

  • all tax credit amounts allocated to the financial institution in respect of eligible investments made at any time before the end of the taxation year by the financial institution, if it is a deposit-taking institution, or by a related deposit-taking institution, insurance corporation or specified corporation, and
  • tax credit repayments made by the financial institution under subsection 66.1(12) of the CTA for prior taxation years,

less

  • tax credits claimed for prior taxation years, and
  • tax credits claimed in respect of patient capital investments that have been subject to a disposition as defined in the regulations.

Example 6

FI#1 wants to determine the amount of its small business investment tax credit account for the 2002 taxation year. FI#1 is a deposit-taking institution. FI#1 is related to one other corporation (FI#2), that is also a financial institution that is a deposit-taking institution.

The total of all tax credit amounts in respect of eligible investments made by FI#1 and FI#2 before the end of the 2002 taxation year that are allocated to FI#1 is $5,000,000.

FI#1 has claimed for prior taxation years small business investment tax credits in the amount of $2,000,000.

FI#1 and FI#2 have not disposed of any patient capital investments. FI#1 has not made any tax credit repayments under subsection 66.1(12) of the CTA.

FI#1's small business investment tax credit account for the 2002 taxation year is the following:

$5,000,000 − $2,000,000 = $3,000,000

How does a financial institution claim the tax credit?

A financial institution claims the tax credit on its Ontario corporate tax return (CT-23).

  • A schedule is provided to financial institutions that indicates the information that must be provided to support a claim for the credit.
  • Supporting documentation regarding eligible investments must be kept on file.
 
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