Principal Issues: 1. Whether two corporations that are related but not associated may be considered to have earned income that is described in subparagraph (a)(i) of the definition “specified corporate income” in subsection 125(7) of the Act. 2. Whether two corporations that are related but not associated are required to aggregate their taxable capital employed in Canada pursuant to paragraph 125(5.1)(a) of the Act.
Position: 1. Question of fact. 2. No.
Reasons: 1. See below. 2.
XXXXXXXXXX 2021-088766 Matthew Ross, CPA, CA
January 26, 2023
Dear XXXXXXXXXX:
Re: Small Business Deduction – Related Corporations
We are writing in response to your email of April 3, 2021 in which you requested our views regarding certain aspects of the small business deduction (“SBD”) rules found in section 125 of the Income Tax Act (“the Act”). We apologize for the delay in responding.
The issues raised may be illustrated by the following example:
- Mr. X is married to Mrs. X.
- ACo and BCo are Canadian-controlled private corporations (“CCPC”), as that term is defined in subsection 125(7) of the Act.
- All of the shares of ACo are owned by Mr. X and all of the shares of BCo are owned by Mrs. X.
- ACo and BCo are not associated under section 256 of the Act.
- There are no transactions of any kind between ACo and BCo. That is, neither of the companies provide services or property, directly or indirectly, in any manner whatever, to the other.
You would like to know if either ACo or BCo could be considered to have earned income that is described in subparagraph (a)(i) of the definition “specified corporate income” in subsection 125(7) of the Act. You have also asked whether ACo and BCo must aggregate their taxable capital employed in Canada (footnote 1) for the purposes of paragraph 125(5.1)(a) of the Act.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.
Section 125 of the Act provides the rules for the calculation of the SBD available to a CCPC on its income from carrying on an active business in Canada. Using the SBD, a CCPC may reduce its tax otherwise payable on such income by an amount equal to the SBD rate multiplied by the least of three amounts. These amounts may be described in general terms as:
- active business income (paragraph 125(1)(a) of the Act);
- taxable income (paragraph 125(1)(b) of the Act); and
- the business limit (paragraph 125(1)(c) of the Act).
The amount described in paragraph 125(1)(a) of the Act is, generally speaking, equal to the sum of the portion of the CCPC’s income from an active business carried on in Canada for a taxation year excluding certain income and exceeding certain losses. Clauses 125(1)(a)(i)(A) to (C) of the Act indicate the portions, if any, of a CCPC’s income from an active business that are not eligible for the SBD.
In particular, clause 125(1)(a)(i)(B) of the Act refers to the portion of a CCPC’s income that is described in subparagraph (a)(i) of the definition of “specified corporate income” (“SCI”) in subsection 125(7) of the Act for the year. Generally speaking, where a CCPC earns income that would otherwise be considered to be income from an active business is from the provision of services or property to another private corporation (directly or indirectly, in any manner whatever) and it (or one of its shareholders) or a person who does not deal at arm’s length with the CCPC (or one of its shareholders) holds a direct or indirect interest in that other private corporation, such income would not be considered as being eligible for the SBD unless one of the following conditions is met:
- all or substantially all of the CCPC’s income for the year from an active business is from the provision of services or property to persons (other than that private corporation) with which the CCPC deals at arm’s length, or partnerships with which the CCPC deals at arm’s length, other than a partnership in which a person that does not deal at arm’s length with the CCPC holds a direct or indirect interest; or
- the particular private corporation described above is able to (and does) assign all or a portion of its business limit to the CCPC under subsection 125(3.2) of the Act.
In summary, clause 125(1)(a)(i)(B) of the Act carves out income described in subparagraph (a)(i) of the SCI definition in subsection 125(7) of the Act from a CCPC’s SBD eligibility. However, this carved out amount may be added back to the amount eligible for the CCPC’s SBD pursuant to subparagraph 125(1)(a)(ii.1) of the Act, but only to the extent that an amount is assigned to the CCPC under subsection 125(3.2) of the Act.
Whether a particular CCPC has income that is described in subparagraph (a)(i) of the SCI definition in subsection 125(7) of the Act is a question of fact. In the example, as there is no income that is received (directly or indirectly, in any manner whatever) from the provision of services or property between ACo and BCo, there would not be any income that would be as described in subparagraph (a)(i) of the SCI definition in subsection 125(7) of the Act.
Generally, a CCPC’s business limit for a taxation year is $500,000, subject to subsections 125(3) to 125(5.1) of the Act. A CCPC’s access to the SBD may be restricted by paragraph 125(5.1)(a) of the Act through a reduction of its business limit. This reduction is calculated by the formula A x (B/$90,000), where A is the CCPC’s business limit and B is determined by the formula 0.225% x (C - $10 million). (footnote 2) Variable C is the CCPC’s taxable capital employed in Canada for the preceding taxation year or the current taxation year, depending on the circumstances. In addition, pursuant to subparagraph 125(5.1)(a)(iii) of the Act, if, in the particular taxation year, the CCPC is associated with one or more particular corporations, Variable C is the total of all amounts each of which is the taxable capital employed in Canada of the CCPC or of any of the particular corporations for its last taxation year that ended in the preceding calendar year.
Whether two corporations are associated is a question of fact. In the example, as ACo and BCo are not associated in the taxation year, the two corporations would not be required to aggregate their taxable capital employed in Canada for the purpose of paragraph 125(5.1)(a) of the Act.
We trust our comments will be of assistance.
Yours truly,
Amanda Couvrette, CPA, CA
Manager
Business Income and Capital Transactions
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Canada Revenue Agency
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Within the meaning assigned by subsection 181.2(2) or 181.3(1) or section 181.4 of the Act, as the case may be.
2 For taxation years ending before April 8, 2022, this formula is A x (B/$11,250).