Principal Issues: In a given situation, whether rental income from the rental of a portion of a property is (1) from a specified investment business, (2) aggregate investment income, and (3) income of the corporation for the year from an active business.
Position: No position taken, general comments provided.
Reasons: Question of fact.
FEDERAL TAX ROUNDTABLE, OCTOBER 7, 2022
APFF CONFERENCE 2022
Question 12
"Ancillary" income from building on an immovable
ABC Inc., a Canadian-controlled private corporation, carries on a manufacturing business. In particular, it owns a building, 65% of which is used in the course of its manufacturing business, and the remaining 35% is leased to a third party. This excess space could be used in the future in the manufacturing business if ABC Inc. were to require additional space.
Paragraph (a) of the definition of "income" in subsection 129(4) provides that a corporation's income for a taxation year from a source that is property includes income from a specified investment business carried on by it in Canada. Paragraph (b) of that definition, however, specifies that it does not include income from property that is incident to or pertains to an active business carried on by the corporation or income from property that is used or held principally for the purpose of earning income from an active business carried on by the corporation. This definition of "income" is relevant, among other things, for the purposes of computing "aggregate investment income", which is also defined in subsection 129(4).
Subsection 125(7) defines a "specified investment business" (subject to certain exceptions that do not apply in this case) as a business the principal purpose of which is to derive income from property, including interest, dividends, rents and royalties.
In addition, subsection 125(7) defines "active business carried on by a corporation" as any business carried on by the corporation, other than a specified investment business or a personal services business, but including an adventure or concern in the nature of trade.
In light of these definitions, it appears that rental income (from the rental of 35% of the building's floor space) is not "income" within the meaning of subsection 129(4), as it is income from property that is used or held principally for the purpose of gaining or producing income from an active business carried on by it (65% of the building is used in the manufacturing business). This result seems to us to be the same whether or not there is a "specified investment business".
Furthermore, if the rental income is not from a "specified investment business", then it would qualify as income from an "active business carried on by a corporation" and thus qualify for the small business deduction pursuant to subsection 125(1). Even if there were a "specified investment business", paragraph 6 of Interpretation Bulletin IT-73R6 (footnote 1) indicates that income from property that is employed or risked in the corporation's business operations is considered to be active business income.
Questions to the CRA
a) Can the CRA clarify whether or not the rental income in the above example is from a "specified investment business", whether it is income that falls within the definition of "aggregate investment income", and whether it qualifies as "income of the corporation for the year from an active business" for purposes of the small business deduction?
b) Would the CRA's conclusions be the same if the space leased to third parties were residential units and, as a result, that portion of the building could never be used in carrying on ABC Inc.'s manufacturing business?
CRA Response
Specified investment business
As can be seen from the definition of a "specified investment business" cited in the statement of the question, the principal purpose of such a business is to derive income from property, including rents from real property.
Income from the rental of real estate is generally considered to be income from property. It can only be considered as business income where the landlord provides tenants or makes available to them services of some kind that take the rental activity beyond the mere rental of real property. The distinction between business income and income from property must be made in light of the facts of each situation. Interpretation Bulletin IT-434R (footnote 2) provides criteria that must be considered in order to conclude whether a taxpayer's rental of real property results in income from property or income from a business.
Since the statement in this question only briefly describes a hypothetical situation, the CRA cannot make a definitive or final determination on this issue. In order to provide comments on the hypothetical situation submitted, the CRA assumes in the situation described in the statement of the question that the rental income from the building is income from property.
In such case, the rental activities of ABC Co. may constitute a specified investment business if the corporation's principal business is to earn rental income or if the rental activities result in a separate business of the corporation. In this case, the question of whether a particular business is a specified investment business must be answered for each business carried on by ABC Co.
Since the statement of the question only broadly describes a hypothetical situation, the CRA cannot make a definitive determination as to whether there is a specified investment business.
However, general information on the concepts of specified investment business and separate businesses can be found in Interpretation Bulletin IT-73R6 and Interpretation Bulletin IT-206R (footnote 3), respectively.
Income of the corporation for the year from an active business
For purposes of commenting on the characterization of the rental income of ABC Inc. in the situation described in the statement of the question as "income of the corporation for the year from an active business" as defined in subsection 125(7), the CRA has assumed that ABC Inc. has as its principal business a manufacturing business and that this business is an "active business" within the meaning of subsection 125(7)
The concept of "income of the corporation for the year from an active business" is defined in subsection 125(7) as, inter alia, 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, other than income for the year from a source in Canada that is a property (within the meaning assigned by subsection 129(4)).
The concept of "income" in subsection 129(4) provides, inter alia, that a corporation's income from a source that is property does not include the income or loss from any property that is incident to or pertains to an active business carried on by it, or that is used or held principally for the purpose of gaining or producing income from an active business carried on by it.
Consequently, the income of ABC Inc. for the year from an active business carried on by it includes not only its business income from its manufacturing activities, but also any income from a source that is property:
- that is incident to or pertains to that business (subparagraph (b)(i) of the definition of "income" in subsection 129(4)); or
- from property used or held principally for the purpose of gaining or producing income from that business (subparagraph (b)(ii) of the definition of "income" in subsection 129(4)).
In determining whether income from property is incident to or pertains to the carrying on of the business, the comments in paragraph 5 of IT-73R6 may be helpful:
“5.[…] 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. […]”
Although it is not possible to make a definitive statement on this issue, it seems difficult for ABC Inc. to argue that it uses the entire building in its manufacturing business and that the rental income is incidental to that business.
Rental income may constitute incidental income of a business if, for example, the excess space was rented on a temporary basis, i.e., with the intention of using that portion of the building for the very near future expansion of the business's activities, or because the rental is related to the business's activities. However, there is nothing in the facts submitted in the statement of the question to support such a conclusion.
In determining whether income is derived from property that is used or held principally for the purpose of gaining or producing income from an active business, the comments in paragraph 6 of IT-73R6 may be helpful:
“6. […] 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, [1986] 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.[…]"
Although it is not possible to reach a definitive conclusion on this issue, the CRA is of the view that there are arguments to support the contention that the building used 65% by ABC Inc. in its manufacturing activities could be a property used or held principally for the purpose of earning income from its manufacturing business under subparagraph (b)(ii) of the definition of "income" in subsection 129(4) In such case, the rental income of ABC Inc. would qualify as "income of the corporation for the year from an active business" within the meaning of subsection 125(7).
Aggregate investment income
Finally, income from property that is not "income" within the meaning of subsection 129(4) is not included in computing "aggregate investment income" as defined in subsection 129(4).
Isabelle Landry
October 7, 2022
2022-095069
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Interpretation Bulletin IT-73R6, (archived), "The Small Business Deduction", March 25, 2002.
2 CANADA REVENUE AGENCY, Interpretation Bulletin IT-434R, (archived), "Rental of Real Property by Individual", April 30, 1982.
3 CANADA REVENUE AGENCY, Interpretation Bulletin IT-206R, (archived), "Separate businesses", October 29, 1979.