Principal Issues: A corporation was incorporated in 2017. An individual is aged 30 and has been working on a full-time basis in the business of the corporation since its inception. The individual owns 5% (votes and value) of the common shares of the capital stock of the corporation. Whether the individual would be considered to be actively engaged on a regular, continuous and substantial basis in her 2020 taxation year in the following situations. Situation 1: the individual will give birth on December 31, 2019, will be on parental leave from January 1 to December 31, 2020 and intends to be back to work on January 1, 2021; Situation 2: the individual will suffer a work accident on January 1, 2020, will be on sick leave until December 31, 2020 and intends to be back to work on January 1, 2021; Situation 3: the individual will suffer a work accident on January 1, 2020, will become permanently disabled and will not be able to work for the rest of 2020 and the subsequent years. But for the accident, the individual would have intended to work full-time in the business of the corporation on a long-term basis.
Position: Situations 1, 2 and 3: no.
Reasons: Situations 1, 2 and 3: The business of the corporation would not constitute an excluded business of the individual for her taxation year 2020, under paragraph (a) of the definition of “excluded business” in subsection 120.4(1) because the individual will not be actively engaged on a regular, continuous and substantial basis in the activities of the business for the year (but for a portion of January 1, 2020 in Situations 2 and 3). The same conclusion would apply in Situation 3 for the subsequent taxation years. Whether an individual has been actively engaged in the activities of a business on a «regular, continuous and substantial basis» in a year will depend on the circumstances, including the nature of the individual’s involvement in the business and the nature of the business itself. Whether an individual is actively engaged in a business will generally turn on the time, work and energy that the individual devotes to the business. The more an individual is involved in the management and/or current activities of the business, the more likely it is that the individual will be considered to participate in the business on a regular, continuous and substantial basis. Likewise, the more an individual’s contributions are integral to the success of the business, the more substantial they would be. Furthermore, paragraph 120.4(1.1)(a) deems an individual to be actively engaged on a regular, continuous and substantial basis in the activities of a business in a taxation year of the individual if the individual works, on average, 20 hours per week or more in the business during the portion of the taxation year of the individual that the business operates.
FEDERAL TAX ROUNDTABLE OCTOBER 7, 2019
2019 APFF CONFERENCE
Question 18
Taxation of Split Income: Interpretation of the concept of " actively engaged on a regular, continuous and substantial basis” in the context of prolonged absence
Individual A is a "specified individual" within the meaning of subsection 120.4(1). Individual A is 30 years of age. Individual B is a "source individual" in respect of Individual A within the meaning of subsection 120.4(1).
Aco is a "small business corporation" as defined in subsection 248(1). Individual A owns 5% (by votes and value) of the shares of the capital stock of Aco. Individual B owns 95% (by votes and value) of the shares of the capital stock of Aco.
Aco has been in operation since January 2017. Since the founding of Aco, Individual A has worked full-time for Aco and has therefore been actively engaged on a regular, continuous and substantial basis in the activities of Aco (her "Engagement") such that Aco is an "excluded business" of Individual A within the meaning of subsection 120.4(1). Consequently, the dividend income received by Individual A on the shares held in the capital stock of Aco is an "excluded amount" of Individual A within the meaning of subsection 120.4(1) and, therefore, is not considered "split income" as defined in subsection 120.4(1).
Questions to the CRA
(a) Assuming that (i) Individual A is pregnant; (ii) the due date is December 31, 2019; (iii) Individual A will take maternity and parental leave from January 1, 2020 to December 31, 2020; and (iv) Individual A intends to resume her Engagement effective January 1, 2021: will the CRA consider that the time for Individual A's maternity and parental leave will count as Engagement of Individual A and that Aco will be an "excluded business" for Individual A within the meaning of paragraph 120.4(1) for the 2020 taxation year?
(b) Assuming that (i) Individual A is temporarily off work as a result of a workplace accident that occurred in connection with her Engagement on January 1, 2020; (ii) Individual A intends to resume her Engagement upon the end of her work stoppage; and (iii) Individual A's temporary disability runs from January 1, 2020 to December 31, 2020: will the CRA consider that the leave due to a temporary disability will count as an Engagement of Individual A and that Aco will be an "excluded business" of Individual A within the meaning of paragraph 120.4(1) for the 2020 taxation year?
(c) Assuming that (i) Individual A is permanently off work as a result of a work-related accident that occurred as part of her Engagement on January 1, 2020; (ii) but for that work-related accident, Individual A intended to continue her Engagement over the long term; and (iii) due to her permanent disability, Individual A will not be able to resume her Engagement in the future, will the CRA consider Aco to be an "excluded business" of Individual A within the meaning of paragraph 120.4(1) for the 2020 and subsequent taxation years?
CRA Response
Subparagraph (e)(ii) of the definition of "excluded amount" in subsection 120.4(1) provides that an amount is excluded in respect of an individual for a taxation year if the amount is derived directly or indirectly from an excluded business of the individual for the year.
Subsection 120.4(1) defines the expression "excluded business" of a specified individual for a taxation year as a business if the individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in either the taxation year (footnote 1), or any five prior taxation years of the individual.
The question of whether an individual is actively engaged, on a regular, continuous and substantial basis, in the activities of the business for a particular taxation year, is a question of fact that can only be resolved as a result of an exhaustive analysis of all the facts and circumstances of a particular situation, including the nature of the individual's interest in the business and the nature of the business itself. The fact that an individual is actively engaged in a business in a particular taxation year will generally depend on the amount of time, work and energy the individual devotes to the business during that year. The more an individual is involved in the management and/or day-to-day operations of the business, the more likely it is that the individual will be considered to be actively engaged in the business, on a regular, continuous and substantial basis. Similarly, the more an individual's involvement is integral to the success of the business, the more it would be considered important.
Furthermore, and without limiting the generality of the foregoing, paragraph 120.4(1.1)(a) provides that an individual is deemed to be actively engaged on a regular, continuous and substantial basis in the activities of a business in a taxation year of the individual if the individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates.
Based on the statement in this question, Individual A has been working full-time for the Aco business since January 2017. We therefore have assumed that Individual A works for Aco for an average of at least 20 hours per week for each of its 2017, 2018 and 2019 taxation years. Therefore, Individual A is deemed, pursuant to paragraph 120.4(1.1)(a), to be actively engaged on a regular, continuous and substantial basis in the activities of Aco. Thus, Aco's business is an excluded business for Individual A, for each of those taxation years, under paragraph (a) of the definition of "excluded business" in subsection 120.4(1).
According to the statement in this question, Individual A will be absent for her entire 2020 taxation year (with the exception of part of the day on January 1 in the leave scenario for temporary or permanent disability). Assuming that, during this period of absence, Individual A will not have engaged in any way in the Aco business, Individual A's time during such a period cannot count towards being actively engaged on a regular, continuous and substantial basis in the activities of Aco. As a result, Aco's business will not be an excluded business in respect of Individual A for her 2020 taxation year, as well as for subsequent taxation years in the permanent disability scenario.
That said, the various exclusions, including those respecting an excluded business, are not intended to apply in all circumstances. Where the exclusions do not apply in a particular situation, the underlying logic is that, in such circumstances, the most appropriate test, in determining whether the income from a related business respecting a specified individual should be excluded from the calculation of split income, should be based on the general test as to whether the amount constitutes a "reasonable return" based on the specific criteria applicable in the circumstances, including the work performed, the property contributed, the risks assumed, the total amounts paid or payable and such other factors as may be relevant.
Given that the statement in this question only briefly describes a hypothetical particular situation, it is impossible for us to make a final determination as to whether Individual A could benefit from the exclusion respecting reasonable returns.
Yvon Beaudoin
(514) 496-6688
October 11, 2019
2019-0812771
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Except in respect of an amount described in paragraph (e) of the definition "split income" in subsection 120.4(1).