Changes to the February 20 and May 24, 2007 Quebec budgets were published by the Quebec Ministry of Finance in Information Bulletin 2007-5, dated June 26, 2007. The bulletin includes a detailed description of the application of the restoration of the tax holiday for manufacturing small and medium-sized enterprises (SMEs) in remote resource regions, as well as the rates and allocation formulas of the income tax of flow-through entities, including income trusts. Among the few measures concerning individuals, the bulletin clarifies the taxation of the Universal Child Care Benefit, as well as the eligibility of the tax credit to support education savings where the trust resides in a province other than Quebec; as these changes do not represent significant tax reductions for taxpayers, they will not be summarized below. We will, rather, describe the changes which have an impact on businesses.

Tax treatment of flow-through entities

The Quebec Ministry of Finance has already announced that Quebec’s tax legislation will be harmonized with the federal tax legislation as concerns the new rules relating to the tax treatment of flow-through entities, but that a separate Quebec tax system would be introduced. More specifically, the ministry has specified that a flow-through entity having an establishment in Quebec at any time of a taxation year would be subject to this new Quebec tax for the year.

The June 26 information bulletin describes the other application details specific to Quebec, namely the tax rate and the business allocation formula that will apply to flow-through entities subject to Quebec tax.

Tax rate

In general, the Quebec tax rate for corporations is currently 9.9%, but will rise to 11.4% in 2008 and to 11.9% as of 2009. However, on June 1, 2007, the minister of finance announced a rise in the tax rate applicable as of that date for oil refining corporations and financial institutions. Accordingly, such corporations are now subject to an 11.9% tax rate applicable to all their income.

As is the case for corporations, the tax rates that will apply to non-portfolio earnings distributed to unitholders by flow-through entities subject to Quebec tax will vary depending on whether the entity qualifies, if it is a corporation, as an oil refining corporation or a financial institution according to the criteria set out in Information Bulletin 2007-3, dated June 1, 2007. Accordingly, the rates will be determined by the parameters indicated in the following table.

Tax rates applicable to flow-through entities
(%)

Flow-through entities	As of January 1, 2007	As of June 1, 2007	As of January 1, 2008	As of January 1, 2009
Oil refining and financial institutions(1)	9.9	11.9	11.9	11.9
Other	9.9	9.9	11.4	11.9

⁽¹⁾ For greater clarity, the tax rates stipulated for these flow-through entities apply to all the income otherwise covered by the tax on flow-through entities.

Where the taxation year of a flow-through entity includes periods straddling the rate change dates, the tax rate that effectively applies for such a taxation year will be a weighted rate reflecting the number of days of the taxation year included in each period.

Business allocation formula. A business allocation formula based on the gross income of a flow-through entity and the wages and salaries it pays, similar to the one used for the purposes of determining the tax payable by a corporation that has activities in Quebec and outside Quebec, will apply to determine the tax payable to Quebec by a flow-through entity that has an establishment, in a taxation year, both in and outside of Quebec.

For greater clarity, only the general business allocation formula will apply to flow-through entities, regardless of the category of activities they carry out. To illustrate, the specific rules relating to banks will not apply to a flow-through entity even if it were to qualify, if it is a corporation, as a financial institution.

Tax holiday for manufacturing SMEs in remote resource regions

Tax holiday for SMEs in remote resource regions remains at a 75% rate. There will be important changes to the tax holiday for manufacturing SMEs in remote resource regions. A gradual reduction in the tax holiday granted to manufacturing SMEs in remote resource areas was announced on February 20, 2007, in the form of amendments to reduce the tax holiday rate from 75% to 50% as of January 1, 2008, and to 25% as of January 1, 2009. The information bulletin provides that the gradual reduction announced earlier in the year will be withdrawn, which means that the 75% rate will continue to apply until December 31, 2010.

Introduction of a new tax holiday reduction factor. The higher tax credit rate will remain, but a new measure, to be implemented in order to limit the impacts arising from companies moving to remote resource regions, is the introduction of a new reduction factor for the tax holiday. To benefit from the tax holiday (at a 75% rate), a corporation must henceforth obtain an annual eligibility certificate from Investissement Québec which will establish whether a transfer of activities has been made from an establishment located outside the remote resource regions to an establishment located in one of these areas and, if that is the case, it will also establish the reduction factor for the tax holiday applicable to the eligible corporation for a given taxation year. This reduction factor will be set in relation to the employer payroll of an eligible corporation.

Tax credit for Quebec film and television production

Rate of the tax credit raised for French-language youth programs. The 2007-2008 budget presented in the National Assembly on May 24, 2007, had already announced an increase in the rate of the refundable tax credit for Quebec film and television production for French-language short and medium-length films. The higher tax credit of 39.375% will henceforth also apply to eligible labour expenditures relating to “youth programs,” provided they are French-language productions and for which an application for an advance ruling (or final certification application, if no application for advance ruling was previously filed) is filed with the Société de Développement des entreprises culturelles (SODEC) after June 26, 2007.

Streamlined special tax relating to flow-through shares

Quebec tax legislation contains specific provisions concerning public financing in the resource sector. An investor in a development corporation is allowed a tax deduction for a taxation year, generally a calendar year, on obtaining a waiver from that corporation for certain expenses relating to resources that it incurred during such calendar year or will incur no later than during the subsequent calendar year.

However, where a corporation has waived an amount for resource expenses to be incurred in Quebec (Quebec exploration expenses) no later than during the subsequent calendar year, that corporation must pay a special tax for the expenses that were not incurred during the subsequent calendar year.

Where the corporation does not allocate all the funds from the issue of flow-through shares to Quebec exploration expenses at the end of the subsequent calendar year, it must pay fees equal to 20% of half the unspent balance on that date (compensatory tax). These fees reflect the fact that establishing new assessments will involve costs for the government. In this case, the waiver made by a corporation in favour of an investor must be adjusted and the tax deduction the latter claims reduced accordingly, resulting in an increase in the tax payable.

This special tax, which has applied since 1997, was introduced in a context of harmonizing the Quebec flow-through share system with the corresponding federal system. However, the federal compensatory tax was then set at 10%. To allow for certain special situations and to better reflect the situation surrounding the administration, by the Ministry of Revenue, of the special tax relating to flow-through shares, the rate of Quebec’s compensatory tax will be lowered from 20% to 10% and the ministry will be given discretion to allow additional time, in certain circumstances, independent of the corporation’s will (as in the case of wind power projects) before a corporation is subject to the compensatory tax.

These changes will apply to a compensatory tax initially payable by a corporation as of calendar year 2006, without taking into account the discretion granted to the Ministry of Revenue which allows it to defer the corporation’s liability for such tax.

Scientific research and experimental development (R&D)

Recognition of an eligible public research centre. A new research centre will be recognized for the purposes of the refundable tax credit for university R&D of 35%, namely the Centre d’aide régional sur les aliments du Saguenay–Lac-Saint-Jean–Côte-Nord (CARA). This recognition will apply to R&D carried out after December 31, 2006, under an eligible research contract concluded after this date.

For more details on the changes, we refer you to the June 26, 2007 information bulletin published by the Quebec Ministry of Finance.

Jean-Luc Beauregard, Montreal
Marielle Domercq, Montreal
Pierre Giguère, Montreal
Annie Rhéaume, Montreal

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