Principal Issues: In a given fact situation involving a group of corporations, for the taxation years 2003, 2004 and 2005, whether (1) the corporations of the group are entitled to the small business deduction for those years? (2) any corporation of the group would be entitled to small business deduction for those years if the third corporations of the group late filed the election not to be associated with other corporations under 256(2)?
Position: (1) No. (2) Yes for taxation years 2003 and 2004.
Reasons: The law.
January 17, 2007
Ms. Carole Bartolini Corporate Reorganization and Audit Specialist Resource Industries Section Montreal Tax Services Office 305 René-Lévesque Blvd. West Marc LeBlond Montreal QC H2Z 1A6 (613) 946-3261
2006-021633
Situations of several related and associated corporations involving section 125 and subsections 256(1) and 256(2)
This is in response to your fax of November 30, 2006, in which you asked for our comments on the above subject in relation to the situation described below. This letter is also in response to telephone conversations (M. LeBlond/C. Bartolini) in which additional information and/or changes to the present file were communicated to us.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
In this letter, the names and business names of the taxpayers, as well as certain terms, are replaced by the following names, business names and abbreviations:
XXXXXXXXXX o Mr. X
XXXXXXXXXX o Mr. Y
XXXXXXXXXX o Mr. Z
XXXXXXXXXX o Aco
XXXXXXXXXX o Bco
XXXXXXXXXX o Cco
XXXXXXXXXX o Dco
XXXXXXXXXX o Eco
XXXXXXXXXX o Fco
XXXXXXXXXX o Gco
Montreal Tax Services Office o TSO
"Canadian-controlled private corporation" as defined in subsection 125(7). o CCPC
Form T2, Schedule 23, "Agreement Among Associated Canadian-Controlled Private
Corporations to Allocate the Business Limit". o Sched. 23
Form T2, Schedule 28, "Election not to be Associated
Through a Third corporation" under subsection 256(2). o Sched. 28
The "small business deduction” under subsection 125(1). o SBD
Income tax return o T2
The Situation
The situation as we understand it can be summarized as follows.
- Mr. X is the father of Mr. Y and Mr. Z.
- Aco, Bco, Cco, Dco, Eco, Fco and Gco (the "Corporations") are all CCPCs.
- The "fiscal period", within the meaning of section 249.1, of Aco and Cco ends on XXXXXXXXXX, while that of Bco, Dco and Eco ends on XXXXXXXXXX, respectively.
- At all times, for the purposes of section 256, all of the outstanding shares of the capital stock of the Corporations are shares of a non-excluded class.
In 2003
- Mr. Y is the sole shareholder of Eco.
- Mr. X is the sole shareholder of Aco. and holds XXXXXXXXXX per cent of the outstanding shares of the share capital of Bco.
- Mr. X also holds XXXXXXXXXX per cent of the outstanding shares of the capital stock of Cco and Messrs.Y and Z each own XXXXXXXXXX per cent of the outstanding shares of the capital stock of Cco.
- In addition, until XXXXXXXXXX, Mr. X held XXXXXXXXXX per cent of the outstanding shares of the capital stock of Dco and Messrs. Y and Z each hold XXXXXXXXXX per cent of the outstanding shares of the capital stock of Cco and Dco.
- On XXXXXXXXXX, Dco repurchased the shares of its capital stock held by Mr. Z. Immediately after this share repurchase, Messrs. X and Y held XXXXXXXXXX per cent and XXXXXXXXXX per cent respectively of the outstanding shares of the capital stock of Dco.
T2 for the 2003 tax year
- In its T2for2003, Eco claimed a SBD. In calculating its SBD for that year, Eco determined its business limit under subsection 125(2). Eco determined its business limit for 2003 without any reduction pursuant to subsection 125(5.1).
- In its T2for 2003, Cco claimed a SBD. In calculating its SBD for that year, Cco reduced its business limit (which is determined under subsection 125(2)) by the amount of its Part I.3 tax for its 2002 taxation year, which was $1157, under subsection 125(5.1).
- Bco, Cco and Eco filed a Schedule 23 with their T2 for 2003, in which they indicated that they were "associated", within the meaning of subsection 256(1), with each other and with Aco and Dco. Each of Cco and Eco filed a Schedule 23 containing different information for 2003. In effect, each of Cco and Eco attributed to itself a percentage of the business limit of 100% for the calendar year 2003.
- Neither corporation filed a Schedule 28 with its T2 for 2003.
- For their 2002 taxation year, Eco and Bco were liable for Part I.3 tax of approximately $XXXXXXXXXX and $XXXXXXXXXX, respectively.
- Aco, Bco and Dco did not claim any SBD for their 2003 taxation year.
- The T2 for 2003 of each of the Corporations was prepared by XXXXXXXXXX, Chartered Accountants (the "Representatives").
In 2004
- On XXXXXXXXXX, Mr. X transferred half of the shares of the capital stock of Aco that he held to Messrs. Y and Z in equal shares.
- On XXXXXXXXXX, Fco was incorporated and Mr. Y and Mr. Z subscribed to the same number of common shares of its capital stock.
- On XXXXXXXXXX, Mr. X transferred to Mr. Y the shares of the capital stock of Dco that he held. After that transfer, Mr. Y was the sole shareholder of Dco.
- On XXXXXXXXXX, Gco was incorporated and Mr. X, Mr. Y and Mr. Z subscribed for common shares of the capital stock of Gco in the proportions of XXXXXXXXXX%, XXXXXXXXXX% and XXXXXXXXXX% respectively.
- On XXXXXXXXXX, Mr. X transferred in equal parts all the shares of the capital stock of Cco that he held to Aco and Bco. On the same date, each of Messrs. Y and Z transferred in equal parts all the shares of the capital stock of Cco that they held to Gco and Fco. After these transfers, the capital stock of Cco was held in equal shares by Bco, Aco, Gco and Fco.
T2 for the 2004 taxation year
In its T2 for 2004, Eco claimed a SBD. In calculating its SBD for that year, E Inc. determined its business limit under subsection 125(2). Eco determined its business limit for 2004 without any reduction under subsection 125(5.1).
- In its T2 for 2004, Cco claimed a SBD. In calculating its SBD for that year, Cco reduced its business limit (which it determined under subsection 125(2)) by the amount of its Part I.3 tax for its 2003 taxation year, $1,796, pursuant to subsection 125(5.1).
- Cco and Eco filed a Schedule 23 with their T2 for 2004, in which they indicated that they were "associated", within the meaning of subsection 256(1), with each other and with Aco, Bco and Dco. Each of Cco and Eco filed a Schedule 23 containing different information for 2004. In effect, each of Cco and Eco allocated to itself a percentage of the business limit of 100% for the 2004 calendar year, pursuant to subsection 125(3).
- Neither corporation filed a Schedule 28 with its T2 for 2004.
- For their 2003 taxation year, Bco, Dco and Eco were liable for Part I.3 tax of approximately $XXXXXXXXXX, $XXXXXXXXXX and $XXXXXXXXXX, respectively.
- Aco, Bco, Dco, Fco and Gco did not claim any SBD for their 2004 taxation year.
- The T2 for 2004 for each of the Corporations was prepared by the Representatives.
T2 for the 2005 taxation year
In its T2 for 2005, Eco claimed a SBD of $XXXXXXXXX. In calculating its SBD for that year, Eco determined its business limit under subsection 125(3). Eco determined its business limit for 2005 without any reduction pursuant to subsection 125(5.1).
- In its T2 for 2005, D Inc. claimed a SBD of $XXXXXXXXXX. In calculating its SBD for that year, Dco determined its business limit under subsection 125(3). Dco determined its business limit for 2005 without any reduction under subsection 125(5.1).
- Aco, Cco, Dco and Eco have each filed a Schedule 23 with their T2 for 2005, in which they indicated that they are "associated", as defined in subsection 256(1), with each other. In Schedule 23 for 2005, a percentage for the year of the business limit was allocated to Dco and Eco for the year. The total of the percentages allocated to the associated corporations in the 2005 year according to Schedule 23 does not exceed 100%. The information contained in the Schedule 23 filed by each corporation is the same.
- None of the corporations filed a Schedule 28 with their T2 for 2005.
- For their 2004 taxation year, Bco, Dco, Eco and Fco are required to pay Part I.3 tax of approximately $XXXXXXXXXX, $XXXXXXXXXX, $XXXXXXXXXX and $XXXXXXXXXX respectively.
- Aco, Bco, Cco, Fco and Gco did not claim any SBD for their 2005 taxation year.
- The T2 for 2005 for each of the corporations was prepared by the Representatives.
Ongoing audit of Corporations
- In October 2006, the TSO informed the Corporation's Representatives that it intended to adjust the T2s for 2003 and 2004 for Cco and Eco and deny the SBD claimed by them. Furthermore, the TSO also planned to deny the SBD claimed for 2005 by Dco and Eco. The Corporation's Representatives agreed with the proposed adjustments in respect of Cco. The TSO and the Representatives are still discussing the proposed adjustments for Eco and Dco.
For the purposes of this letter, we have assumed that the Corporations are not all associated with each other by virtue of the application of subsections 256(2.1) (presumption of association in case of avoidance) or 256(5.1) (control in fact).
Your Questions
You asked whether, in the situation you have presented, the Corporations were associated with each other in 2003, 2004 and 2005. If so, you wish to know whether Cco, Eco and Dco would have been entitled to the SBD for the 2003, 2004 and 2005 taxation years if all the third corporations had made the election under subsection 256(2) (the "Election") for each of those years.
Our Comments
We are of the view that, in the absence of a subsection 256(2) Election, all of the Corporations are associated, within the meaning of section 256, with each other for the 2003, 2004 and 2005 taxation years and that no SBD for those taxation years could be claimed by any of them because of the application of subsection 125(5.1) to the Corporations. That would not be the case if all the third-party corporations were to make an election for the 2003 and 2004 years.
We understand that it has been the policy of the Compliance Programs Branch since October 21, 1993, to administratively accept a late-filed election from a third corporation where the following two conditions are satisfied:
(a) the T2 return of the electing corporation for the particular year is not statute-barred or, if statute-barred, the corporation did not claim any amount as a business limit for the year; and
(b) where the T2 return for the particular year of any other corporation to which the election applies is statute-barred, there will be no revision to the amount of the business limit allocated to that corporation for the taxation year.
(See document E9335545)
General Comments
For the purposes hereof, the relevant parts of section 125(1) are as follows:
There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation that was, throughout the year, a Canadian-controlled private corporation, an amount equal to 16% of the least of
(a) the amount, if any, by which the total of
(i) the total of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada (other than the income of the corporation for the year from a business carried on by it as a member of a partnership),
[...]
(b) the amount, if any, by which the corporation’s taxable income for the year exceeds the total of ...
(c) the corporation’s business limit for the year.
[emphasis added]
Paragraph 23 of Interpretation Bulletin 73R6 - "Small Business Deduction" provides, in part, that:
23. … [I]f 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. …
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).
[emphasis added]
Sections 125(2) and (3) read as follows (ignoring the transitional rules)
Section 125(2)
For the purpose of this section, a corporation’s business limit for a taxation year is $300,000 unless the corporation is associated in the year with one or more other Canadian-controlled private corporations in which case, except as otherwise provided in this section, its business limit for the year is nil.
Section 125(3)
Notwithstanding subsection (2), if all the Canadian-controlled private corporations that are associated with each other in a taxation year file with the Minister in prescribed form an agreement that assigns for the purpose of this section a percentage to one or more of them for the year, the business limit for the year of each of the corporations is
(a) if the total of the percentages assigned in the agreement does not exceed 100%, $300,000 multiplied by the percentage assigned to that corporation in the agreement; and
(b) in any other case, nil.
[emphasis added]
Pursuant to subsection 256(1), two corporations are associated with each other in a taxation year "if, at any time in the year ..." the corporations are in any of the situations described in paragraphs 256(1)(a) to (e).
Subsection 256(2) provides, inter alia, that two corporations that would not be associated with each other at any time, but for subsection 256(2), and are associated with the same third corporation or deemed to be associated with each other under subsection 256(2), are deemed to be associated with each other at that time. Alternatively, the presumption of association in subsection 256(2) may not operate, for the purposes of section 125, if, for example, the third corporation elects, in filing a Schedule 28 for the taxation year that includes that time, not to be associated with either corporation. Where a third corporation makes that election, it is deemed not to be associated with either corporation in that taxation year and its business limit for that taxation year shall be deemed to be nil.
Under subsection 125(5.1), the business limit of a CCPC for a particular taxation year ending in a calendar year is reduced in whole or in part by the amount of Part I.3 tax payable by the corporation and corporations with which it is associated.
In that regard, paragraphs 23 and 29 of IT-73R6 state, inter alia, the following:
23. ... 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).
29. ... 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.
[emphasis added]
Response to Your Questions
We are of the view that, in the absence of a subsection 256(2) election, all of the Corporations are associated, within the meaning of section 256, with each other during the 2003, 2004, and 2005 taxation years and that no SBD can be claimed by any of them because of the application of subsection 125(5.1) to the Corporations.
In our view, if all of the third corporations among the Corporations were to elect under subsection 256(2) for the 2003 and 2004 taxation years to avoid the association of corporations held XXXXXXXXXX% or XXXXXXXXXX% by Mr. X and Mr. Y, and held XXXXXXXXXX% by Mr. X and equally by Mr. Y and Mr. Z, Cco (a third company) would not be entitled to the SBD for those years. In addition, for 2003, Eco would be entitled to a SBD that should be determined, inter alia, on the basis of the amount of the business limit for that year under subsection 125(2) and after the application of subsection 125(5.1). In 2004, Eco would be entitled to a SBD based on its percentage pursuant to subsection 125(3) and its business limit for that year after the application of subsection 125(5.1). For the 2005 taxation year, none of the Corporations would be entitled to a SBD, regardless of whether or not elections were made by all of the third corporations among the Corporations for the 2005 taxation year because of the application of subsection 125(5.1). Our conclusions are based on the following observations.
For the year 2003
We agree with your analysis that the Corporations are associated with each other in the 2003 taxation year pursuant to section 256.
By virtue of subsection 256(2), Aco and Eco as well as Bco and Eco are deemed to be associated with each other at some time in the 2003 taxation year because each of them is associated with the same third corporation, either Cco or Dco, in that year pursuant to paragraph 256(1)(d).
By virtue of subsection 256(2), only for the purposes of section 125, third corporations Cco and Dco could elect, by filing a Schedule 28 for the 2003 taxation year, not to be associated with the other two corporations (namely Aco and Eco, as well as Bco and Eco).
The election, if made by Cco and Dco, would result in Aco and Eco as well as Bco and Eco not being associated with each other for the purposes of section 125. Furthermore, each of Cco and Dco would be deemed to have a nil business limit for that year.
It follows that Cco would not be entitled to a SBD for 2003 since its business limit for that year would be deemed to be nil pursuant to subsection 256(2).
In addition, if Cco and Dco both exercised the election, Aco and Bco could allocate to themselves a percentage of the business limit for the 2003 taxation year under subsection 125(3), since they were associated with each other at some time in the 2003 taxation year under paragraph 256(1)(b). However, based on the information provided, it appears to us that the business limit of each of them for the year would be nil because of the application of subsection 125(5.1).
Finally, a significant effect of an election made by Cco and Dco is that Eco would not be associated with any other of the Corporations during 2003 for the purposes of section 125. Consequently, Eco would be entitled to a SBD for 2003. The amount of the business limit for the 2003 taxation year would, however, have to be reduced pursuant to subsection 125(5.1) to take into account its Part I.3 tax payable for 2002.
For the 2004 year
We agree with your conclusions that, in the absence of a subsection 256(2) election, the Corporations are associated, within the meaning of section 256, with each other during the 2004 taxation year and that no SBD can be claimed by any of them because of the application of subsection 125(5.1) to the Corporations.
The Corporations are associated with each other in the 2004 taxation year pursuant to section 256.
By virtue of subsection 256(2), Bco and Dco, as well as Bco and Fco, are deemed to be associated with each other at any time in the 2004 taxation year because they are associated with the same third corporation (either Aco, Cco or Gco). In addition, Bco and Eco are deemed to be associated with each other at any time in the 2004 taxation year pursuant to subsection 256(2) because they are associated with the same third-party corporation, Dco, until XXXXXXXXXX.
Under subsection 256(2), third corporations Aco, Cco, Gco and Dco could each elect on Schedule 28 for the 2004 taxation year not to be associated with the other corporations (i.e., Bco and Eco as well as Bco and Fco, as the case may be).
As a result of those elections, Bco and Eco as well as Bco and Fco would not be associated with each other for the 2004 taxation year. In addition, Aco, Cco, Dco and Gco would be deemed to have a nil business limit for 2004.
However, although B Inc. would not be associated with any of the Corporations during 2004, based on the information provided, its business limit for 2004 would be nil due to the application of subsection 125(5.1).
In addition, Eco and Fco would be required to allocate a percentage of the 2004 business limit pursuant to subsection 125(3) because they were associated with each other at some point in the 2004 taxation year. Indeed, Eco and Fco are associated with each other pursuant to paragraph 256(1)(d).
It follows that Eco and Fco would be entitled to a SBD for that year, which would be determined by taking into account the Part I.3 tax payable by Eco and Fco for the year 2003.
For the 2005 year
Like you, we are of the view that, in the absence of a subsection 256(2) election, the Corporations are associated, within the meaning of section 256, with each other during the 2005 taxation year and that no SBD could be claimed by any of them because of the application of subsection 125(5.1) to the Corporations.
By virtue of subsection 256(2), Bco and Dco, Bco and Eco, and Bco and Fco are deemed to be associated with each other at any time in the 2005 taxation year because they are associated with the same third corporation (either Aco, Cco or Gco). Bco, Dco, and Eco are associated with Aco, Cco and Gco pursuant to paragraphs 256(1.2)(d) and 256(1)(d). Fco is associated with Aco, Cco and Gco pursuant to paragraphs 256(1.2)(d) and 256(1)(e).
Under subsection 256(2), third corporations Aco, Cco and Gco could each elect on Schedule 28, for the 2005 taxation year, not to be associated with the other two corporations (i.e., Bco, Dco, Eco and Fco).
As a result of those elections, Bco and Dco, Bco and Eco, and Bco and Fco would not be associated with each other. In addition, Aco, Cco and Gco would be deemed to have a nil business limit for the year 2005.
In this case, although Bco would not be associated with any of the Corporations during 2005, and based on the information provided, its business limit for 2005 would be nil due to the application of subsection 125(5.1).
Also in 2005, Dco, Eco and Fco would be required to allocate a percentage of the business limit for that year pursuant to subsection 125(3) because they would be associated with each other at some time in that taxation year. Indeed, Dco and Fco as well as Eco and Fco would be associated with each other pursuant to paragraph 256(1)(d), and Dco would be associated with Eco pursuant to paragraph 256(1)(b).
However, regardless of the business limit that Dco, Eco and Fco could allocate to each other for 2005 pursuant to subsection 125(3), and based on the information provided, none of them would be entitled to a SBD for that year since their business limit would be reduced to zero as a result of subsection 125(5.1).
XXXXXXXXXX
Conclusion
We are of the view that in the situation described in your request, all of the corporations are associated with each other for the 2003, 2004 and 2005 taxation years subject to the application of subsection 256(2). Furthermore, even if all the third corporations were to make the election for the 2003, 2004 and 2005 taxation years, no amount in respect of a SBD could be claimed by any of the corporations for the 2005 taxation year, nor by Aco, Bco, Cco, Dco and Gco for the 2004 taxation year, nor by Aco, Bco, Cco and Dco for the 2003 taxation year. Therefore, based on the information provided and assuming that all third parties filed an election, only Eco would be entitled to a SBD for its 2003 taxation year and only Eco and/or Fco could be entitled to a SBD for its 2004 taxation year.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope you find our comments of assistance and thank you for bringing these issues to our attention. Should you require any additional information regarding this matter, please do not hesitate to contact us.
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industries Section
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch