A professional corporation (PC1), whose voting shares have been held by Dr. A (a physician) and whose non-voting participating shares have been held equally by Dr. A and Spouse A (who has had no involvement in the practice) has applied earnings to build up a large portfolio of publicly-traded securities, which is managed by a financial institution with little involvement of the couple. However, on December 30 of Year 1, PC1 ceased carrying on its medical services business, on December 31, Spouse A acquired 50% of Dr. A’s voting shares of PC1 for their fair market value, and on January 1 of Year 2, Dr. A commenced carrying on the medical services business in a newly- incorporated professional corporation (PC2) with the same ownership as prior to December 30.
Do PC1’s investment activities constitute a business, and does the “related business” exception apply to dividends paid by PC1 to Spouse A after December 30 in Year 1?
As to whether PC1’s investment activities constituted a business, CRA stated that the “courts have generally held that the level of activity required to conclude that a corporation has a business is low.” However, it was not necessary to address this question “because PC1 also carries on a medical services business in Year 1 which would be considered a “related business” in respect of Spouse A.” In finding that PC1 had a related business in respect of Spouse A (the specified individual), CRA stated:
[W]hether the “related business” exception is available does not turn on whether the dividends were paid out before or after December 30 on Year 1 … because the definition of “related business” specifically states that a business is a related business of a specified individual for a taxation year if at any time in the year, the source individual (Dr. A) in respect of the specified individual (Spouse A) is actively engaged on a regular basis in the activities of the corporation (PC1) that is related to earning income from business … . Furthermore, the definition of “related business” also includes a business of a corporation if at any time in the year, the source individual (Dr. A) in respect of the specified individual (Spouse A) owns, generally speaking, at least 10% of the fair market value of the corporation (PC1) … .
As such, if it can be determined that the dividends paid by PC1 are “derived directly or indirectly” from a related business, which is likely given that the capital invested in the Portfolio was wholly-derived from either after-tax earnings of PC1’s medical services business or reinvested investment income, the “related business” exception would not be available … .