Principal Issues: [TaxInterpretations translation] In two situations, where the election under subsection 256(2) is made, does the income from property earned by an associated corporation retain its characterization or is it deemed to be income from an active business carried on in Canada?
Position: The election under subsection 256(2) affects only the application of section 125 and does not affect the application of subsection 129(6).
Reasons: Income Tax Act.
2005-016339 XXXXXXXXXX Lucie Allaire (613) 952-5803 February 26, 2007
Dear Sir,
Subject: Request for Technical Interpretation: Subsections 129(6) and 256(2) of the Income Tax Act
This is in response to your letter of November 28, 2005, requesting our comments on the effect of the election under subsection 256(2) of the Income Tax Act (the "Act") on the application of subsection 129(6).
Facts
This technical interpretation is based on the following facts from your letter of November 28, 2005, to the Income Tax Rulings Directorate of the Canada Revenue Agency ("CRA"). Please note that we have reworded the term "company" used in your letter as "corporation".
Example A:
- A, who holds 100% of the shares of Aco, and B, who owns 100% of the shares of Bco, are brothers.
- Aco and Bco both hold 50% of the shares of a property corporation ABco.
- Both Aco and Bco are associated with ABco. Since both Aco and Bco are associated with ABco, they are deemed by subsection 256(2) to be associated with each other for purposes of the Act.
- Both Aco and Bco carry on an active business in Canada and each pays rental amounts to ABco for the rental of 50% of a building owned by ABco in the course of carrying on their respective businesses.
- ABco elects under subsection 256(2) not to be associated with Aco and Bco. As a result of that election, the business limit of ABco is deemed to be nil.
In addition, we have assumed that Aco, Bco and ABco Canadian-controlled private corporations as defined in subsection 125(7) and that Aco and Bco claimed the cost of the rent as a deduction in computing their income from an active business carried on in Canada.
Example B:
- A, who holds 100% of the shares of Aco, B, who holds 100% of the shares of Bco, and C, are brothers.
- Aco, Bco and C each hold 33% of the shares of CDco.
- CDco carries on an active business in Canada
- Aco and Bco have provided financing to CDco and in exchange CDco pays them interest annually.
- CDco elects under subsection 256(2) not to be associated with A and B. As a result of the election, CDco's business limit is deemed to be nil.
In addition, we have assumed that Aco, Bco, and CDco, are Canadian-controlled private corporations as defined in subsection 125(7) and that CDco claims the cost of the interest in computing its active business income.
We have also assumed that all of the individuals in the two examples above are individuals resident in Canada, and that the shares issued by the relevant corporations in each of the situations were not shares of a specified class as defined in subsection 256(1.1).
Finally, we have assumed that the corporations involved in the two examples are not associated with each other because of the application of subsection 256(2.1) or subsection 256(5.1).
Questions
Your questions relate to the tax consequences of the application of the election made pursuant to subsection 256(2). More specifically, you asked:
(1) In the situation in Example A, does the income from the rental of property earned by ABco, which has made an election under subsection 256(2) to dissociate from Aco and Bco, qualify as active business income?
(2) In the situation in Example B, does the interest income earned by Aco and Bco qualify as active business income, given the election under subsection 256(2) by CDco?
Analysis
The situation described in your letter is an actual situation involving taxpayers. As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is our practice not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is primarily made first by our Tax Services Offices. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
As you noted, subsection 256(2) provides that two corporations that are associated with the same (third) corporation are deemed to be associated with each other. However, if, for the purposes of section 125, the third corporation is not a Canadian-controlled private corporation at that time or elects in prescribed form for the taxation year that includes that time not to be associated with either corporation, the third corporation is deemed not to be associated with either corporation in that year and to have a nil business limit for that year.
In Example A, pursuant to subsection 256(2), Aco and Bco are deemed to be associated with each other because they are both associated with ABco. Similarly, in Example B, Aco and Bco are deemed to be associated with each other under subsection 256(2) because they are both associated with CDco.
On the other hand, corporations that would be deemed to be associated under subsection 256(2) are not associated for the purposes of section 125 if a subsection 256(2) election is made by the third corporation (ABco in Example A and CDco in Example B). As a result, Aco and Bco in Examples A and B would each have a business limit determined under subsection 125(2).
We are of the view that the election under subsection 256(2) applies only for the purposes of section 125. Thus, notwithstanding the filing of that election, we are of the view that Aco, Bco and ABco would continue to be associated for the purposes of all other provisions of the Act, including subsection 129(6). Thus, subparagraph 129(6)(b)(i) would apply to deem the amounts paid to ABco as rent by Aco and Bco to be income from an active business carried on by it in Canada. The same reasoning would apply in the situation in Example B for Aco, Bco and CDco.
These comments are not advance income tax rulings and, as stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, are not binding.
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate