Real Estate Tax Problems
People dealing in real estate have a lot of potential problems with CRA…
A lot of Canadians find themselves in the middle of some serious tax issues
When you think about making money in real estate, remember that CRA is your partner in the proceeds. They take no risks and get a huge slice of the pie. Depending on how things work out, the TaxMan can get more than you.
To learn more about the tax pitfalls of real estate, please see the section called Incorporation can be a tax quagmire.
Lets take the issue of active and passive income.
If you are not incorporated, taxes on real estate are a lot simpler. It is simply a matter of is the income passive or active. Passive being an investment and Active meaning you are running an active real estate business.
If you are incorporated and you sell a property, it can easily be seen as business income and as such it is not a reduced tax on capital gain, it is actually a higher tax rate than for a sole proprietor. If you don’t qualify for the small business tax deduction, then your corporate tax rate is higher than your personal tax rate.
Income from property that is employed or risked in a corporation’s business operations is considered to be active business income.
This must be distinguished from income from property, which is not connected to or is not necessary to sustain a corporation’s business operations.
It is a question of fact whether a property is used principally in an active business. Factors to be considered in determining whether a property is used in an active business include the actual use to which the asset is put in the course of the business, the nature of the business involved and the practice in the particular industry.
The issue of whether property was used or held by a corporation in the course of carrying on a business was considered by the Supreme Court of Canada in Ensite Limited v. Her Majesty
the Queen, 2 CTC 459, 86 DTC 6521.
The court held that the holding or using of property must be linked to some definite obligation or liability of the business and that a business purpose test for the use of the property was not sufficient.
The property had to be employed and risked in the business to fulfill a requirement which had to be met in order to do business.
In this context, risk means more than a remote risk.
If the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations, the property would generally be considered to be used in the course of carrying on a business.
In other words, the property has to be an integral part of the financing of the business or necessary to the overall business operations in order for income from the property to be part of the “income of the corporation … from an active business.”
As I see it, if the property could not be used for any other purpose other than to support the active business carried on by the corporation. It is not incidental, it is integral and the business could not operate without the property.
And if it is unlikely the property could be used for other purposes, as it exists today and profitably support the corp, then the corp existing primary purpose is to serve the business’s clients and not the corp.
If the property on its own does not make money… it is more of a tool of the business and is passive income when sold.
That is my thoughts on the matter.
If you are considering incorporation as some kind of tax advantage, you must understand the following information.
If you do not understand it, then make sure you have a tax specialist and a lawyer guide you. Otherwise, avoid the headache and just be a sole proprietor, it just may be a lot safer, and you just may pay less tax than if you incorporated.
Here we go…. keep in mind the experts … including CRA argue about this…
NO.: IT-73R6 DATE: March 25, 2002
SUBJECT: INCOME TAX ACT
The Small Business Deduction
REFERENCE: Section 125 (also subsections 14(1), 123.4, 129(4), and 129(6), the definitions “active business” and “specified
shareholder” in subsection 248(1), paragraph 18(1)(p), subparagraph 12(1)(e)(ii) of the Income Tax Act and
section 6701 of the Income Tax Regulations)
At the Canada Customs and Revenue Agency
(CCRA), we issue income tax interpretation bulletins
(ITs) in order to provide technical interpretations and
positions regarding certain provisions contained in
income tax law. Due to their technical nature, ITs are
used primarily by our staff, tax specialists, and other
individuals who have an interest in tax matters. For
those readers who prefer a less technical explanation
of the law, we offer other publications, such as tax
guides and pamphlets.
While the comments in a particular paragraph in an
IT may relate to provisions of the law in force at the
time they were made, such comments are not a
substitute for the law. The reader should, therefore,
consider such comments in light of the relevant
provisions of the law in force for the particular
taxation year being considered, taking into account
the effect of any relevant amendments to those
provisions or relevant court decisions occurring after
the date on which the comments were made.
Subject to the above, an interpretation or position
contained in an IT generally applies as of the date on
which it was published, unless otherwise specified. If
there is a subsequent change in that interpretation or
position and the change is beneficial to taxpayers, it
is usually effective for future assessments and
reassessments. If, on the other hand, the change is not
favourable to taxpayers, it will normally be effective
for the current and subsequent taxation years or for
transactions entered into after the date on which the
change is published.
If you have any comments regarding matters
discussed in an IT, please send them to:
Manager, Technical Publications and Projects Section
Income Tax Rulings Directorate
Policy and Legislation Branch
Canada Customs and Revenue Agency
Ottawa ON K1A 0L5
Most of our publications are available on our Web
site at: www.ccra.gc.ca
This version is only available electronically.
Contents
Application
Summary
Discussion and Interpretation
GENERAL COMMENTS (¶s 1-2)
INCOME FROM AN ACTIVE BUSINESS CARRIED
ON IN CANADA – PARAGRAPH 125(1)(a)
Active Business (¶ 3)
Income From an Active Business (¶s 4-8)
Cessation of a Business (¶ 9)
Meaning of “Carried On in Canada” (¶ 10)
Specified Investment Business (¶s 11-17)
Personal Services Business (¶s 18-19)
Specified Partnership Income (¶ 20)
Specified Partnership Loss (¶ 21)
TAXABLE INCOME LIMIT – PARAGRAPH
125(1)(b) (¶ 22)
BUSINESS LIMIT – PARAGRAPH 125(1)(c)
Amount of Limit (¶ 23)
Agreement Filed by Associated CCPCs (¶s 24-25)
Where Effective Agreement Not Filed (¶ 26)
Taxation Year Less Than 51 Weeks (¶ 27)
Multiple Taxation Years in the Same Calendar
Year (¶ 28)
Reduction of the Business Limit for Large
Corporations (¶ 29)
Revised Agreement (¶ 30)
IMPACT OF THE SMALL BUSINESS DEDUCTION
ON THE ACCELERATED TAX REDUCTION FOR
CCPCs AND ON ANY GENERAL TAX REDUCTION
CLAIMED BY A CCPC (¶ 31)
Explanation of Changes
Application
This bulletin cancels and replaces IT-73R5, dated
February 5, 1997.
IT-73R6
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Summary
This bulletin deals with the rules concerning the small
business deduction that may be claimed by a
Canadian-controlled private corporation (CCPC) in respect
of its income from carrying on an active business in Canada.
Active business carried on by a CCPC in Canada does not
include a “specified investment business” or a “personal
services business”. These two types of businesses are
discussed in this bulletin. In addition, details of the
components of the calculation of the small business
deduction are provided.
Section 125 of the Income Tax Act provides for a corporate
tax reduction (commonly referred to as “the small business
deduction”) in respect of income of a CCPC from an active
business carried on by it in Canada. The small business
deduction is provided by way of an annual tax credit that is
calculated as 16 % of the least of the corporation’s:
(a) active business income for the year;
(b) taxable income for the year (subject to certain
adjustments); and
(c) business limit for the year (which is generally
$200,000).
The corporation must be a CCPC throughout the year to
qualify for the small business deduction for that year.
The special low rate of tax provided by the small business
deduction recognizes the special financing difficulties and
higher cost of capital faced by small businesses and is
intended to provide these corporations with more after-tax
income for reinvestment and expansion. As the small
business deduction is intended to benefit only small
corporations, a large corporation’s access to the deduction is
restricted on the basis of its taxable capital employed in
Canada.
This bulletin also discusses the impact of the small business
deduction on the accelerated tax reduction for CCPCs and on
any general tax reduction claimed by a CCPC.
Discussion and Interpretation
GENERAL COMMENTS
¶ 1. Subsection 125(1) provides a reduction (the “small
business deduction”) from Part I tax otherwise payable for a
taxation year by a corporation that was, throughout the
taxation year, a CCPC. “Canadian-controlled private
corporation” is defined in subsection 125(7). See also the
current version of IT-458, Canadian-Controlled Private
Corporation.
¶ 2. The small business deduction, for a particular
taxation year, is equal to 16 % of the least of (a), (b), and (c):
(a) the total of each amount of the corporation’s income for
the year from an active business carried on by it (other
than as a member of a partnership) in Canada (see
¶s 3-10); and
• the corporation’s “specified partnership income” for
the year (see ¶ 20);
Minus
• the total of each amount of the corporation’s loss for
the year from an active business carried on by it
(other than as a member of a partnership) in Canada;
and
• the corporation’s “specified partnership loss” for the
year (see ¶ 21);
(b) the corporation’s taxable income for the year minus any
portion thereof exempt from tax under Part I because of
an Act of Parliament and certain amounts pertaining to
foreign tax credits for the year (see ¶ 22); and
(c) the corporation’s business limit for the year (see ¶ 23).
INCOME FROM AN ACTIVE BUSINESS
CARRIED ON IN CANADA –
PARAGRAPH 125(1)(a)
Active Business
¶ 3. The term “active business carried on by a
corporation” is defined in subsection 125(7) as any business
carried on by a corporation other than a “specified
investment business” (see ¶ 11) and a “personal services
business” (see ¶ 18) and includes an adventure or concern in
the nature of trade (see the current version of IT-459,
Adventure or Concern in the Nature of Trade).
Income From an Active Business
¶ 4. “Income of the corporation for the year from an
active business,” as defined in subsection 125(7), means the
corporation’s income for the year from an active business
carried on by it, including any income for the year pertaining
to or incident to that business (see ¶s 5 and 6), as well as
amounts received from a “NISA Fund No. 2,” that are
included under subsection 12(10.2) in computing the
corporation’s income for the year. “NISA Fund No. 2,” as
defined in subsection 248(1), means the part of a taxpayer’s
net income stabilization account described in
paragraph 8(2)(b) of the Farm Income Protection Act.
“Income of the corporation for the year from an active
business” does not include any income for the year from a
source in Canada that is a property within the meaning
assigned by subsection 129(4). That subsection provides that
“income” or “loss” of a corporation for a taxation year from
a source that is a property
(a) includes the income or loss from a specified investment
business (see ¶ 11) carried on by the corporation in
Canada other than income or loss from a source outside
Canada,
(b) but does not include the income or loss from any
property
• that is incident to or pertains to an active business
carried on by the corporation (see ¶s 5 and 6), or
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• that is used or held principally for the purpose of
gaining or producing income from an active business
carried on by the corporation (see ¶s 5 and 6).
If the original gain on the sale of real property was
categorized in a previous year as income from an active
business, amounts included in income in subsequent years in
respect of the realization of the mortgage reserve pursuant to
subparagraph 12(1)(e)(ii), are considered to be income from
an active business. This also applies to any mortgage interest
received pertaining to such mortgage.
As discussed in ¶ 7, subsection 129(6) provides an exception
to these general rules for certain amounts received or
receivable from associated corporations.
¶ 5. Income of a corporation that “pertains to” or is
“incident to” the income of the corporation from an active
business is referred to in the definition of “income of the
corporation for the year from an active business” in
subsection 125(7) but those terms are not defined in the Act.
In examining the ordinary dictionary meaning of these
words, “incident to” generally includes anything that is
connected with or related to another thing, though not
inseparably, or something that is dependent on or
subordinate to another more important thing. “Pertains to”
generally includes anything that forms part of, belongs to or
relates to another thing.
The courts have found that, in interpreting the meaning of
“pertains to” or “incident to” in context, there has to be a
financial relationship of dependence of some substance
between the property in question and the active business
before the property is considered to be incident to or to
pertain to the active business carried on by the corporation.
In addition, the operations of the business have to have some
reliance on the property such that the property is a back-up
asset that could support the business operations either on a
regular basis or from time to time.
If, for example, a corporation carrying on an active business
holds term deposits that are not used or connected to its
business operations, the term deposits are not property that is
incident to or pertains to an active business carried on by the
corporation, nor are the term deposits used or held
principally for the purpose of gaining or producing income
from an active business by the corporation. Accordingly, a
determination is required of whether the source of income
(e.g., term deposits) is a separable activity, apart from the
corporation’s main business activities.
The courts have held that when a corporation derived income
from an activity that was inseparable from its normal active
business, such income was properly classified as active
business income. If the income is part of the normal business
activity of the corporation, and it is inextricably linked with
an active business, it is considered active business income.
For example, in the 1981 case of Supreme Theatres Ltd. v.
The Queen, CTC 190, 81 DTC 5136, it was held by
the Federal Court – Trial Division that rental income from
hiring out the part of a building that was a motion picture
theatre auditorium constituted active business income
derived from the company’s normal business activity of
operating motion picture theatres, while the rental income
from hiring out a portion of a parking lot was not.
¶ 6. As indicated in ¶ 4, for the purpose of the small
business deduction, income from property does not include
income “from any property that is incident to or pertains to
an active business carried on by the corporation” or “from
any property that is used or held principally for the purpose
of gaining or producing income from an active business
carried on by the corporation.” Income from property that is
employed or risked in a corporation’s business operations is
considered to be active business income. This must be
distinguished from income from property, which is not
connected to or is not necessary to sustain a corporation’s
business operations. It is a question of fact whether a
property is used principally in an active business. Factors to
be considered in determining whether a property is used in
an active business include the actual use to which the asset is
put in the course of the business, the nature of the business
involved and the practice in the particular industry. The issue
of whether property was used or held by a corporation in the
course of carrying on a business was considered by the
Supreme Court of Canada in Ensite Limited v. Her Majesty
the Queen, 2 CTC 459, 86 DTC 6521. The court held
that the holding or using of property must be linked to some
definite obligation or liability of the business and that a
business purpose test for the use of the property was not
sufficient. The property had to be employed and risked in the
business to fulfil a requirement which had to be met in order
to do business. In this context, risk means more than a
remote risk. If the withdrawal of the property would have a
decidedly destabilizing effect on the corporate operations,
the property would generally be considered to be used in the
course of carrying on a business. In other words, the property
has to be an integral part of the financing of the business or
necessary to the overall business operations in order for
income from the property to be part of the “income of the
corporation … from an active business.”
For example, although a mortgage receivable is an asset
whose existence may be relevant to the equity of a
corporation, it is not generally an asset used in an active
business because the funds tied up in the mortgage are not
available for the active business use of a corporation.
However, if the corporation could establish that the
mortgages are employed and risked in the business such that
the mortgages are inextricably tied to or vitally connected
with the business, they could be considered to be used in an
active business carried on by the corporation.
¶ 7. A corporation may derive income from holding
property in Canada (e.g., income in the form of real estate
rentals, interest, or royalties). If such income is received or
receivable from an associated company and the amount is or
may be deductible in determining the associated company’s
income from an active business carried on by it in Canada,
then paragraph 129(6)(b) deems the income in the recipient’s
hands to be income from an active business carried on by it
in Canada.
IT-73R6
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If subsection 129(6) deems rental income to be active
business income and capital cost allowance on the rented
building was deducted in calculating active business income,
any recapture of capital cost allowance on the disposition of
the building would also be considered to be active business
income.
¶ 8. If a corporation is incorporated to earn income by
doing business, there is a general presumption that profits
arising from its activities are derived from a business (or
from separate businesses as discussed in the current version
of IT-206, Separate Businesses). Thus, from the time that the
activities contemplated commence (see the current version of
IT-364, Commencement of Business Operations) until they
permanently cease, most corporations carry on or will have
carried on one or more businesses. However, in some
circumstances, a corporation’s entire profits can be
characterized as income from property, as might be the case
where the corporation is formed for the sole purpose of
holding shares of a second corporation or holding a property
to be rented with limited landlord responsibilities. It is, of
course, quite possible that a corporation will earn income
from property as well as income from a business carried on,
if such property income is not income from another separate
business.
Cessation of a Business
¶ 9. Income related to a business that arises after cessation
of that business cannot qualify as income from a business
except when it arises from:
(a) bad debt recoveries;
(b) the recapture of various reserves;
(c) the sale of the inventory of the business;
(d) the disposition of eligible capital property of the
business and the income is the amount of the excess
described in subsection 14(1);
(e) the recapture of capital cost allowance; or
(f) a similar item to those described in any of (a) to (e)
above.
Income that does qualify as income from a business because
it arises from a source described in (a) to (f) above will be
considered to be income from the same category of business
as that to which the source originally related. For (e) above,
however, this does not apply to situations in which the
depreciable property is subsequently treated as a rental
property and capital cost allowance is claimed against the
rental income since the rental property would give rise to
income from property that is not income from an active
business. If the property was only rented or leased for a short
time during which it was listed for sale and no capital cost
allowance was claimed against the rental or lease income, the
income would still be considered to be income from the same
category of business before the rental or lease. It is a
question of fact whether or not a corporation has ceased to
carry on a business.
A temporary period of inactivity does not necessarily mean
that a corporation has ceased (and subsequently
recommenced) to carry on a business. For example, the
nature of a real estate development business is such that no
real estate may be held at certain times or real estate that is
held may not be actively developed for a significant period
of time. Unless it is evident that the corporation does not
intend to recommence its development activities, it is
considered to be carrying on business throughout the
dormant period. In any event, a corporation ceases to carry
on a business before (but not necessarily immediately before)
the time when it:
• commences to distribute its assets to its shareholders in
the course of winding up the corporation; or
• sells or otherwise disposes of the business.
Meaning of “Carried On in Canada”
¶ 10. Whether or not a particular business is carried on in
whole or in part in Canada is a question of fact. However, as
a general rule, a business that involves the sale or leasing of
goods is usually carried on in the country where the
corporation is resident, unless the business (or a part of it) is
conducted by a virtually autonomous branch operation
outside Canada. When a corporation’s business involves the
rendering of services, that business is carried on in Canada
only to the extent that services are rendered in Canada,
necessitating an apportionment of net business income on a
reasonable basis. Income derived from property, ancillary to
the activities involved in carrying on a business, that is
categorized as income from an active business may also have
to be apportioned on a reasonable basis having regard to the
place where the related business is carried on.
Specified Investment Business
¶ 11. A “specified investment business” carried on by a
corporation in a taxation year is defined in subsection 125(7)
to be a business the principal purpose (see ¶s 12 to 14) of
which is to derive income from property. Such income
includes interest, dividends, rentals from real estate
(including subrentals) and royalties. Specifically excluded
from the definition is any business carried on by a credit
union or a business of leasing property other than real
property. However, the business of the corporation will
generally be considered to be an active business rather than a
specified investment business when either:
(a) the corporation employs in the business throughout the
taxation year more than five full-time employees (see
¶s 15 to 17); or
(b) an associated corporation, in the course of carrying on
an active business, provides managerial, administrative,
financial, maintenance or other similar services to the
corporation in the year and it is reasonable to assume
that the corporation would have required more than five
full-time employees in its business if those services had
not been provided.
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The exceptions in (a) and (b) above do not apply to a
business carried on by a prescribed labour-sponsored venture
capital corporation where the principal purpose of the
business is to derive income from property. Section 6701 of
the Regulations contains the meaning of “prescribed
labour-sponsored venture capital corporation” for the
purposes of this rule in the definition of “specified
investment business” in subsection 125(7).
Investment activities of a corporation cannot constitute a
“specified investment business” if such activities are not
• the main business of the corporation, or
• a separate business of the corporation (see the current
version of IT-206, Separate Businesses).
¶ 12. “Principal purpose” is not a defined term in the Act
for the purposes of the definition of “specified investment
business” in subsection 125(7), but it is considered to be the
main or chief objective for which the business is carried on.
¶ 13. A corporation that operates a business may buy real
property for the purpose of using the site in the future as a
business premise. In the interim, if rental income is derived,
such income would probably be considered to be active
business income rather than income from a specified
investment business. In such cases, it is presumed that the
principal purpose test referred to in the definition of
“specified investment business” in subsection 125(7) would
not be met for as long as the corporation’s principal purpose
in owning the site is not to derive rental income from it.
A corporation that operates a hotel is generally considered to
be in the business of providing services and not in the
business of renting real property. Accordingly, the business
is normally considered to be an active business rather than a
specified investment business.
¶ 14. The principal purpose of a corporation’s business
must be determined annually after all the facts relating to that
business carried on by that corporation in that year have been
considered and analyzed. Included in this evaluation should
be such things as:
(a) the purpose for which the business was originally
commenced;
(b) the history and evolution of its operations, including
changes in its mode of operation and purpose of
existence; and
(c) the manner in which the business is conducted.
¶ 15. The phrase “the corporation employs in the business
throughout the (taxation) year more than five full-time
employees” is considered to mean that an employer has six
or more employees working a full business day (or a full
shift) on each working day of the year, subject to normal
absences due to illness or vacation. Employees working
part-time cannot qualify as full-time employees. A part-time
employee is generally a person employed for irregular hours
of duty or specific intermittent periods, or both, during a day,
week, month, or year and whose services are not required for
the normal work day, week, month, or year. Vacancies
caused by terminations that temporarily reduce the staff to
less than six employees will normally not disqualify the
corporation provided immediate action is taken to restore the
staff to normal strength and there is no undue delay in filling
the vacant positions.
¶ 16. In the following situations, employees of a
corporation would not be considered to be full-time
employees throughout a taxation year:
(a) Mr. A is employed two days a week, does all the
bookkeeping, but is available whenever his services are
required;
(b) Mr. B’s only activity is to attend board of directors
meetings, although he is always available whenever his
services are required; and
(c) a corporation employs ten employees full-time for six
months in a taxation year and for the remaining six
months employs no one as it is inactive.
¶ 17. If a corporation carries on a business as a member of
a joint venture, employees working for the joint venture are
the employees of its members collectively, but not of any of
them individually. In other words, such employees, if
full-time, cannot be counted as the full-time employees of the
corporation, either in whole or in proportion to its interest in
the joint venture. Only those persons (if any) who are
employed full-time in the business directly and solely by the
corporation can be counted as its full-time employees for the
purpose of the “more than five full-time employees”
exception in the definition of “specified investment
business”. The same would apply for other forms of
co-ownership of a business. See Lerric Investments Corp. v.
The Queen, 2 CTC 84, 2001 DTC 5169. In the case
of partnerships, however, see ¶ 20.
Personal Services Business
¶ 18. Pursuant to the definition of “personal services
business” in subsection 125(7), a corporation is carrying on a
“personal services business” in a taxation year if it is in the
business of providing services and:
(a) an individual who performs the services provided to
another person or partnership (the entity) on behalf of
the corporation (referred to as an “incorporated
employee”) would, if it were not for the existence of the
corporation, reasonably be regarded as an officer or
employee of the entity to which the services were
provided;
(b) the incorporated employee or any person related to the
incorporated employee is a “specified shareholder” of
the corporation (see below);
(c) the corporation employs in the business in the year
(subject to the comments in ¶ 15) fewer than six
full-time employees (see ¶s 15 to 17) including
incorporated employees and other employees; and
(d) the fee for the services is not received or receivable by
the corporation from a corporation with which it was
associated in the year.
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A personal services business does not qualify for the small
business deduction and is therefore subject to tax at full
corporate rates. In addition, paragraph 18(1)(p) limits the
deductions permitted in computing a corporation’s income
for a taxation year from a personal services business.
Subject to various deeming provisions in the definition of
“specified shareholder” in subsection 248(1), a “specified
shareholder” of a corporation in a taxation year is a taxpayer
who owns directly or indirectly at any time in the year not
less than 10% of the issued shares of any class of the capital
stock of the corporation or of any other corporation that is
related to the corporation.
¶ 19. The condition stipulated in ¶ 18(a) is not met if, in the
absence of the corporation, there would be no common law
master-servant relationship and the individual who
undertakes to perform the services would be viewed as a
self-employed individual carrying on a business. The
determination of whether an incorporated employee would
otherwise be regarded as self-employed or as an officer or
employee of the entity to which the services were provided is
a question of fact. The following list of factors, although not
exhaustive, are indications of employee status:
(a) the entity to which the services are provided has the
right to control the amount, the nature and the direction
of the work to be done and the manner of doing it;
(b) the payment for work is by the hour, week or month;
(c) payment by the entity of the worker’s travelling and
other expenses incidental to the payer’s business;
(d) a requirement that a worker must work specified hours;
(e) the worker provides services for only one payer; and
(f) the entity to which the services are provided furnishes
the tools, materials and facilities to the worker.
Specified Partnership Income
¶ 20. As noted in ¶ 2, one of the amounts that enters into
the calculation of a corporation’s small business deduction is
its “specified partnership income” (if any) for the year.
This term is defined in subsection 125(7). A corporation’s
specified partnership income is the aggregate of two
components, which are identified as variables A and B.
In general terms, variable A represents the corporation’s
eligible share of income from partnerships from active
businesses carried on in Canada.
More precisely, variable A is the total of separate amounts,
each of which is an amount with respect to a particular
partnership of which the corporation was a member in the
year. With respect to each partnership, this amount is the
lesser of two amounts:
(i) The first amount is the total of separate amounts,
each of which is an amount (if positive) with
respect to a particular active business which the
corporation carried on in Canada as a member of
the partnership. With respect to each business,
this amount is equal to the corporation’s share of
the income (if any) of the partnership from the
business for the fiscal period (or fiscal periods)
ending in the year plus any amount included in
the corporation’s income for the year from the
business because of subsection 34.2(5) minus all
amounts deducted at the partner level in
computing the corporation’s income for the year
from the business (other than amounts deducted
in computing the income of the partnership from
the business).
(ii) The second amount with respect to each
partnership is determined by dividing the
corporation’s share of all the amounts of income
of the partnership from active businesses carried
on in Canada for fiscal periods ending in the year
by the total of all such amounts of income of the
partnership for such fiscal periods, and
multiplying the result by $200,000 (or a
proportionately smaller amount when the number
of days in any such fiscal period is less than 365).
The second component, variable B, of a corporation’s
specified partnership income is an additional amount to
ensure that any losses of the corporation for the year from
active businesses carried on by it in Canada are offset first
against business income that is not eligible for the small
business deduction before reducing the income that would
otherwise qualify for the small business deduction.
Variable B is the lesser of two amounts:
(i) the total of all amounts each of which is the
corporation’s loss for the year from an active
business carried on by it (other than as a member
of a partnership) in Canada plus the corporation’s
“specified partnership loss” for the year (see
¶ 21); and
(ii) the total of all amounts each of which is any
positive amount for the year that results when
amount (ii) for variable A above with respect to
any partnership of which the corporation was a
member in the year is subtracted from amount (i)
for variable A with respect to that partnership.
Variable B is relevant only if the corporation has both losses
for the year from an active business carried on by it in
Canada (whether as a member of a partnership or otherwise)
and income for the year from an active business carried on
by it in Canada as a member of a partnership.
For purposes of determining whether a corporation has
carried on an active business as a member of a partnership,
as referred to in the subsection 125(7) definitions of
“specified partnership income” and “specified partnership
loss” (see ¶ 21), the following rules should be taken into
consideration:
• the subsection 125(7) definition of “active business
carried on by a corporation” (see ¶ 3);
• the subsection 125(7) definition of “income of the
corporation for the year from an active business” (see ¶s 4
to 6);
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• the meaning, in subsection 129(4), of “income” or “loss”
of a corporation for a taxation year from a source that is
property (see ¶s 4 to 6); and
• the subsection 125(7) definition of “specified investment
business” (see ¶s 11 to 15 and ¶ 17) and the exclusion of a
business from that definition if there are more than five
full-time employees throughout the year (as discussed
in ¶s 11, 15 and 17).
A business carried on by a corporation as a member of a
partnership is not a “specified investment business” if the
partnership employs more than five full-time employees. In
other words, the corporation’s share of income from the
business can be included in the calculation of its “specified
partnership income”.
Specified Partnership Loss
¶ 21. If a corporation has a “specified partnership loss” for
a taxation year, it is used in the calculations in ¶s 2 and 20.
The term “specified partnership loss” is defined in subsection
125(7). A corporation’s specified partnership loss consists of
the following:
• the corporation’s share of all the losses from partnerships
of which the corporation was a member in the year, for
fiscal periods ending in the year, from active businesses
carried on in Canada by the corporation as a partnership
member;
plus
• the total of all amounts each of which is any positive
amount-with respect any particular business carried on
by the corporation in Canada as a member of a
partnership-that results when the amounts deducted at
the partner level in computing the corporation’s income
for the year from that particular business (other than any
amount deducted in computing the income of a
partnership) are reduced by the corporation’s share of the
income from that business for the fiscal period or periods
ending in the year and by any amount included in the
corporation’s income for the year from that business
because of subsection 34.2(5).
TAXABLE INCOME LIMIT –
PARAGRAPH 125(1)(b)
¶ 22. In computing the small business deduction of a
CCPC, paragraph 125(1)(b) requires the determination of the
corporation’s taxable income for the taxation year in excess
of the total of:
• 10/3 of the corporation’s foreign tax credit deductible
under subsection 126(1) for the year without reference to
sections 123.3 and 123.4;
• 10/4 of the corporation’s foreign tax credit deductible
under subsection 126(2) for the year without reference to
section 123.4; and
• any portion of the corporation’s taxable income for the
year that is exempt from tax under Part I because of an
Act of Parliament.
The amounts deducted from the corporation’s taxable income
represent income on which no Canadian income tax was paid
because the income is exempt from tax or because of the
foreign tax credit.
BUSINESS LIMIT – PARAGRAPH 125(1)(c)
Amount of Limit
¶ 23. Generally, under subsection 125(2), the business limit
for a CCPC is $200,000 if the corporation is not associated
in the year with one or more other CCPCs and its taxation
year is not less than 51 weeks. If two or more CCPCs are
associated with one another in a taxation year, the small
business deduction must be shared, by allocating the annual
business limit of $200,000 amongst the corporations for the
taxation year. Corporations may file an agreement (T2,
Schedule 23, Agreement Among Associated Canadian-
Controlled Private Corporations to Allocate the Business
Limit) annually making this allocation (see ¶ 24). If the
taxation year of the CCPC is shorter than 51 weeks in
duration, see ¶s 27 and 28. In addition, if a CCPC has a
Part I.3 large corporations tax liability for the preceding year,
the corporation’s business limit for the year may be reduced
or eliminated (see ¶ 29).
In calculating a CCPC’s business limit, the provisions of
section 125 should be applied in the following order:
• subsections 125(2) to (4) (subsections 125(3) and (4) are
discussed in ¶s 24 to 26);
• subsection 125(5) (see ¶s 27 and 28); and
• subsection 125(5.1) (see ¶ 29).
Agreement Filed by Associated CCPCs
¶ 24. All CCPCs that, under section 256, are associated
with each other in a taxation year, may in accordance with
subsection 125(3) allocate amongst themselves, the annual
business limit amount. If this allocation is made in
accordance with the requirements described in ¶ 25, and the
total of the amounts allocated is $200,000, the business limit
for the taxation year of each corporation is the amount
allocated to it, as indicated on the agreement filed in
prescribed form.
¶ 25. In order to allocate the $200,000 business limit for a
taxation year amongst the corporations referred to in
subsection 125(3), the following must be done:
(a) an agreement in prescribed form (T2, Schedule 23) must
be filed by each corporation in the group of associated
corporations; and
(b) the duly completed agreement must be signed on behalf
of each corporation in that group.
A new agreement must be filed for each taxation year. If
another corporation that is not an initial signatory to the
agreement is considered to be associated with the
corporations that did sign the agreement, that corporation
must also sign the agreement. If an agreement has not been
signed by all the corporations that originally filed as being
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associated, or if it is not signed (upon request) by another
corporation that is considered to be associated, subsection
125(4) may be applied. Normally, an assessment will not be
made based on an incomplete agreement.
Where Effective Agreement Not Filed
¶ 26. If any one of the CCPCs that are associated with each
other in a taxation year fail to file or refuse to be a signatory
to an agreement under subsection 125(3) (T2, Schedule 23)
within 30 days after written notice has been issued to any of
them of such a requirement, the Minister shall, under
subsection 125(4), allocate $200,000 in total to one or more
of them and the amount so allocated to any particular
corporation shall be the corporation’s business limit for the
year.
Taxation Year Less Than 51 Weeks
¶ 27. The business limit for a CCPC for a taxation year of
less than 51 weeks duration is, under paragraph 125(5)(b),
that proportion of the corporation’s business limit as
otherwise determined that the number of days in the taxation
year is of 365.
Multiple Taxation Years in the Same
Calendar Year
¶ 28. A CCPC may have two or more taxation years ending
in a calendar year in which it is associated with another
CCPC. In this situation, the CCPC’s business limit (for
purposes of paragraph 125(1)(c)), for each second or
subsequent taxation year that ends in the calendar year, is
determined under paragraph 125(5)(a)-subject to the rule in
paragraph 125(5)(b) (see ¶ 27)-to be the lesser of the
following two amounts:
• subparagraph 125(5)(a)(i)-the amount allocated to the
corporation under subsection 125(3) or (4), as its business
limit for its first taxation year that ended in that calendar
year; and
• subparagraph 125(5)(a)(ii)-the amount allocated to the
corporation under subsection 125(3) or (4), for that
particular taxation year ending in that calendar year.
The intent of subparagraph 125(5)(a)(ii) is to ensure that the
total determined for the business limit for a group of
associated CCPCs does not exceed $200,000 for any second
or subsequent taxation year.
Example
At all relevant times, Y Ltd. and Z Ltd. were associated
CCPCs. Both had taxation years ending September 30, 2001,
neither of which was a short taxation year. Of the business
limit of $200,000, Y Ltd. and Z Ltd. allocated to themselves
$50,000 and $150,000, respectively, pursuant to subsection
125(3), for the year ended September 30, 2001.
On October 1, 2001, X Ltd. became associated with Y Ltd.
and Z Ltd. X Ltd. had a fiscal year end of November 30,
2001, and this was not a short taxation year. Y Ltd. and
Z Ltd. changed their fiscal year end to November 30. The
associated group of companies allocated the $200,000
business limit, pursuant to subsection 125(3), for the year
ended November 30, 2001, as follows:
• $150,000 to X Ltd.,
• $25,000 to Y Ltd., and
• $25,000 to Z Ltd.
However, because Y Ltd.’s year ended November 30, 2001
was its second taxation year in the 2001 calendar year,
paragraph 125(5)(a) limited Y Ltd.’s business limit for that
taxation year to the lesser of the following two amounts:
• $50,000 (subparagraph 125(5)(a)(i)); and
• $25,000 (subparagraph 125(5)(a)(ii)).
The result, $25,000, was then subject to the rule in paragraph
125(5)(b) (see ¶ 27): $25,000 × 61/365 = $4,178.
Therefore, Y Ltd.’s business limit for the year ended
November 30, 2001 was $4,178.
Similarly, the business limit for Z Ltd. for the year ended
November 30, 2001 was $4,178 (i.e., the lesser of $150,000
and $25,000, multiplied by 61/365).
The $150,000 allocated under subsection 125(3) to X Ltd. as
its business limit for the year ended November 30, 2001 did
not change, for these reasons:
• Since X Ltd.’s taxation year ended November 30, 2001
was its only taxation year in the 2001 calendar year,
paragraph 125(5)(a) had no application to it.
• Since X Ltd.’s taxation year ended November 30, 2001
was not a short taxation year, paragraph 125(5)(b) had no
application to it.
Reduction of the Business Limit for Large
Corporations
¶ 29. A CCPC’s access to the small business deduction is
restricted by subsection 125(5.1) through the reduction of its
annual business limit. The amount of the reduction is
calculated as follows:
the corporation’s
business limit for
the year (before
reduction)
×
its Part I.3 tax liability
for the preceding year
———
$11,250
The calculation of the corporation’s Part I.3 tax liability
referred to above excludes any deduction provided under
subsection 181.1(2) or (4) from Part I.3 tax otherwise
payable.
Any reduction in the business limit under the rule in
subsection 125(5.1) would increase proportionately with any
increase in tax payable under Part I.3. For a discussion of
Part I.3 tax, see the current version of IT-532, Part I.3 – Tax
on Large Corporations.
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If the corporation is associated with one or more
corporations (whether CCPCs or not) in the year, it is
required to take into account, in the numerator of the above
fraction, its own Part I.3 tax liability and that of each
associated corporation (in all cases, calculated without any
deduction under subsection 181.1(2) or (4)), for the last
taxation year ending in the preceding calendar year.
Example
At all relevant times XYZ Ltd. was a CCPC and was not
associated with any other corporation. For the taxation year
ended September 30, 2001, XYZ Ltd.’s business limit was
$200,000 and its Part I.3 tax liability (before any deduction
under subsection 181.1(2) or (4)) was $4,000. XYZ Ltd.
changed its fiscal period end to December 31. For the
taxation year ended December 31, 2001, XYZ’s business
limit was calculated as follows:
STEP 1: Since this was a short taxation year, paragraph
125(5)(b) reduced the business limit for this year to the
following amount:
92
$200,000 × —- =
$50,411
STEP 2: The application of subsection 125(5.1) further
reduced the $50,411 business limit by the following amount:
$4,000
$50,411 × ——- =
$11,250
$17,924
XYZ Ltd.’s business limit for the taxation year ended
December 31, 2001 was therefore $50,411 – $17,924 =
$32,487.
Revised Agreement
¶ 30. After associated CCPCs have filed a valid agreement
under subsection 125(3) allocating the $200,000 business
limit among themselves for a particular taxation year, there
may be a change in the taxable income for the year of one or
more of the corporations, which might cause the corporations
to want to revise the allocation. The Canada Customs and
Revenue Agency (CCRA) will accept a revised allocation
agreement as long as it does not change the amount allocated
to any corporation for a taxation year that is statute-barred
for purposes of an assessment, reassessment or additional
assessment.
Example
At all relevant times CCPCs A Ltd., B Ltd., C Ltd., D Ltd.
and E Ltd. were associated with each other and no other
corporations were associated with any of them.
The five corporations filed a valid agreement under
subsection 125(3) allocating the $200,000 business limit for
a particular taxation year as follows:
A Ltd. – $ nil
B Ltd. – $50,000
C Ltd. – $50,000
D Ltd. – $50,000
E Ltd. – $50,000
A Ltd. was not assessed any tax for the year, based on its
return reporting no taxable income for the year. Each of the
other corporations was assessed for the year on the basis that
its business limit was the amount allocated to it under the
agreement.
Subsequently, A Ltd. filed an amended return reporting an
amount of taxable income for the year, and the five
corporations filed a revised agreement allocating the
$200,000 business limit as follows:
A Ltd. – $40,000
B Ltd. – $40,000
C Ltd. – $40,000
D Ltd. – $40,000
E Ltd. – $40,000
The CCRA indicated, however, that it would not accept the
revised agreement so filed because a reassessment for E Ltd.
for the year in question was by that time statute-barred (its
year-end being different from that of the other corporations).
Instead, the CCRA accepted a revised agreement filed by the
five corporations allocating the $200,000 business limit for
the year as follows:
A Ltd. – $37,500
B Ltd. – $37,500
C Ltd. – $37,500
D Ltd. – $37,500
E Ltd. – $50,000
The revised agreement on this basis was accepted by the
CCRA because there was no change to the amount allocated
to E Ltd.
IMPACT OF THE SMALL BUSINESS
DEDUCTION ON THE ACCELERATED
TAX REDUCTION FOR CCPCs AND ON
ANY GENERAL TAX REDUCTION
CLAIMED BY A CCPC
¶ 31. Subsection 123.4(3) provides for a reduction
(referred to in this bulletin as the “accelerated tax reduction”)
from a CCPC’s tax otherwise payable under Part I of the Act.
Generally, a CCPC’s accelerated tax reduction is 7% (after
2000) on up to an additional $100,000 of its income-
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between $200,000 (the paragraph 125(1)(c) “business limit”
for the small business deduction) and $300,000-from an
active business carried on in Canada. More specifically, the
base that is used for a CCPC’s accelerated tax reduction is
calculated by means of a “least of” formula, taking into
account the amounts (subject to certain adjustments)
determined under paragraphs 125(1)(a), (b) and (c) with
respect to the CCPC’s small business deduction. The base for
the CCPC’s accelerated tax reduction is then reduced by the
base used for its subsection 125(1) small business deduction
as well as other portions of its taxable income that have
benefited from various special effective tax rates provided
under the Act, such as, for example, the base for its
subsection 125.1(1) manufacturing and processing profits
(M&PP) deduction (if any). If two or more CCPCs are
associated with one another, they must effectively share the
above-mentioned additional $100,000 limit-because the
upper limit for each CCPC is actually 3/2 of its paragraph
125(1)(c) “business limit”, which is subject to the rules for
the allocation thereof among associated CCPCs as discussed
in ¶s 23 to 30.
Subsection 123.4(2) provides for a general reduction to a
corporation’s tax otherwise payable under Part I, by a
percentage-which increases in stages from 1% in 2001 to
7% after 2003-of the corporation’s “full rate taxable
income”. In general terms, a corporation’s “full rate taxable
income” is that part of its taxable income that has not
benefited from any of various special effective tax rates
provided under the Act. Thus, a CCPC’s “full rate taxable
income” (the calculation of which differs from the “full rate
taxable income” of other corporations) does not include,
among other things, the base used for its subsection 125(1)
small business deduction or the base used for its subsection
123.4(3) accelerated tax reduction.
Example 1
At all relevant times, A Ltd. was a CCPC and was not
associated with any other corporation. A Ltd.’s taxable
income for the year ended December 31, 2001 was
$400,000, all of which was derived from the manufacturing
in Canada of goods for sale.
A Ltd.’s subsection 125(1) small business deduction for the
year was 16% of $200,000 (its paragraph 125(1)(c) business
limit for the year) = $32,000.
A Ltd.’s subsection 125.1(1) M&PP deduction for the year
was 7% of the difference between $400,000 (its
manufacturing and processing profits) and $200,000 (the
base for its small business deduction) = 7% of $200,000 =
$14,000.
A Ltd. had no subsection 123.4(3) accelerated tax reduction
or subsection 123.4(2) general tax reduction for the year,
because the full amount of its $400,000 taxable income had
already received the benefit of tax reductions, the first
$200,000 having been used in the base for the small business
deduction and the next $200,000 having been used in the
base for the M&PP deduction.
Example 2
At all relevant times, B Ltd. was a CCPC and was not
associated with any other corporation. B Ltd.’s taxable
income for the year ended December 31, 2001 was
$400,000, all of which was derived from carrying on a
business as a wholesaler of goods in Canada.
B Ltd.’s subsection 125(1) small business deduction for the
year was 16% of $200,000 (its paragraph 125(1)(c) business
limit for the year) = $32,000.
B Ltd.’s subsection 123.4(3) accelerated tax reduction for the
year was 7% of the difference between $300,000 (i.e., 3/2 of
its paragraph 125(1)(c) “business limit”) and $200,000
(i.e., the base used for its subsection 125(1) small business
deduction) = 7% of $100,000 = $7,000.
B Ltd.’s subsection 123.4(2) general tax reduction for the
year was 1% of the difference between $400,000 (its taxable
income) and $300,000 (i.e., the $200,000 base used for the
small business deduction and the $100,000 base used for the
accelerated tax reduction) = 1% of $100,000 = $1,000.
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Explanation of Changes
Introduction
The purpose of the Explanation of Changes is to give the
reasons for the revisions to an interpretation bulletin. It
outlines revisions that we have made as a result of changes
to the law, as well as changes reflecting new or revised
interpretations of the CCRA.
Reasons for the Revision
We have revised the bulletin primarily to reflect the impact
of the Lerric Investment Corp. case and to expand the scope
of the bulletin to cover the subject of a revised agreement to
allocate the business limit among associated CCPCs.
Legislative and Other Changes
¶ 1 was revised to delete the comments on the meaning of
“Canadian-controlled private corporation” and instead refer
to the current version of IT-458, Canadian-Controlled
Private Corporation, which covers this topic.
In ¶ 2, clarifying changes were made in (a) and more general
wording was used in (b) because the details of the rules
described therein are covered in ¶ 22.
In ¶ 4 and ¶ 6, historical rules were removed and clarifying
changes were made.
¶ 11 was revised to reflect the fact that the proposed
amendments previously referred to in a note at the end of
that paragraph were enacted as law. Also, clarifying changes
were made in ¶ 11.
The comments in ¶ 17 (formerly ¶ 16) on the “more than
five full-time employees” rule in a situation involving a joint
venture or co-ownership of a business were revised because
of the Federal Court of Appeal’s decision in the Lerric
Investments Corp. case. The discussion of the “more than
five full-time employees” rule with respect to a business
carried on by a corporation as a member of a
partnership has been moved from former ¶ 16 (now ¶ 17) to
the end of ¶ 20.
In ¶ 18, a minor wording change was made in (c) for
purposes of clarification.
¶s 20 and 21 were considerably revised for purposes of
clarification and to remove historical coming-into-force
rules. Also, the discussion of the “more than five full-time
employees” rule with respect to a business carried on by a
corporation as a member of a partnership has been moved
from former ¶ 16 (now ¶ 17) to the end of ¶ 20.
In ¶ 22, historical rules were removed, changes were made
to reflect amendments consequential on the addition to the
Act of section 123.4, and other minor rewording changes
were made for purposes of clarification.
¶s 23, 25 and 26 were revised to refer to the correct form
that associated CCPCs should currently be using for
purposes of allocating the business limit. Minor wording
changes were also made in ¶s 23 and 26, for purposes of
clarification.
In ¶ 28, clarifying changes were made in the text and the
example. The example was also revised to reflect current
dates.
¶ 29 was revised to delete historical coming-into-force rules,
and to delete the explanation of Part I.3 tax and instead refer
to the current version of IT-532, Part I.3 – Tax on Large
Corporations, which covers this topic. Also in ¶ 29,
clarification changes were made and the example was
revised to reflect more realistic facts and current dates.
¶ 30 was added to cover the subject of a revised agreement
to allocate the business limit among associated CCPCs.
¶ 31 was added to cover the impact of the small business
deduction on the accelerated tax reduction for CCPCs and
any general tax reduction claimed by a CCPC.