Financial institutions

Budget closes loophole for financial institutions trading dividend-paying stocks

The federal government plans to change tax laws to remove relief for large financial institutions that benefit from complicated hedging strategies on dividend-paying stocks.

The budget released Thursday calls it the “double dip loophole,” which allows certain Canadian financial institutions to use “hedging and short-selling arrangements in aggressive tax planning strategies.” By closing the loophole, the government says, it can add $635 million to federal coffers over five years starting in 2022-23, and $150 million per year thereafter.

Here’s what happens: A financial institution sells a stock short, which means it borrows it, sells the stock, and keeps the proceeds, promising to repay the stock later. At the same time, the financial institution holds the same number of shares and receives the dividends.

An entity that sells a stock short can deduct the interest it pays for the loan as an expense. And a company that receives dividends from another company can offset its income with those dividends.

Budget 2022 proposes to amend the Income Tax Act to deny the deduction for a dividend received when the taxpayer has entered into these paired short sale transactions.

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The Canadian government’s view appears to be that financial institutions that engage in this combined short-long strategy receive two tax benefits in an economically neutral transaction, said Joseph Micallef, KPMG’s national tax chief in its financial services practice. .

“I think in their view these types of transactions are inconsistent with the spirit of tax policy that currently exists in the law,” he said. “You have a long position and a short position, and effectively they eliminate [each other]. And therefore the ability to recognize [deductions on] both sides of this transaction, they don’t like it.

Tara Benham, national tax manager for Grant Thornton LLP, said this proposal and others in the federal budget “are not wealth taxes. But they kind of are, where they’ve turned to industries or entities that make a lot of money and have the means to really plan for taxes.

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