2016-0651831E5 Small Business Deduction

Principal Issues: Subject to the allocation of the BL in subsection 125(3) of the Act, is Landco able to claim SBD on 100% of its deemed active business income received from Opco even though Holdco only owns 51% of the shares of Opco?

Position: Question of fact, but appears yes in this case

Reasons: See below

Author: Couvrette, Amanda
Section: 125(1); 125(2); 125(3); 125(7); 129(6); 256(1)

XXXXXXXXXX                                                                                                                        2016-065183
                                                                                                                                                Amanda Couvrette
September 13, 2016

Dear Mr. XXXXXXXXXX,

Subject: Small Business Deduction (“SBD”)

We are writing in response to your recent inquiry concerning the claiming of a SBD under the rules in the Income Tax Act (“the Act”) in the following fact situation.

Briefly, as we understand the facts, Holdco owns 51% of the issued and outstanding shares of Opco and 100% of the issued and outstanding shares of Landco.  Each of Holdco, Opco and Landco is a corporation that is a “Canadian controlled private corporation” (“CCPC”) as that term is defined in subsection 125(7) of the Act.  Since Holdco controls both Landco and Opco such corporations are associated to each other pursuant to subsection 256(1) of the Act.  Landco owns land and a building that is rented to Opco and used by Opco in its active business carried on in Canada.  Pursuant to subsection 129(6) of the Act, the rental income received by Landco from Opco is deemed to be income from an active business carried on by Landco for the purposes of that subsection and section 125 of the Act.

You want to know if Landco is able to claim a SBD on all of its income received from Opco even though Holdco only owns 51% of the shares of Opco.

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 a particular transaction 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 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Where two or more CCPCs are associated with one another in a taxation year, the SBD is effectively shared, by allocating the annual business limit between the associated corporations for the taxation year by filing an agreement in prescribed form, pursuant to subsection 125(3) of the Act.  For the purpose of section 125, subsection 125(2) of the Act defines the “business limit” (“BL”) of a corporation for a taxation year as being $500,000 unless the corporation is associated in the taxation year with one or more other CCPCs, in which case, except as otherwise provided, the BL is Nil.  Information with respect to the sharing of the annual BL among associated corporations can be found in paragraphs 23 to 26 of Interpretation Bulletin IT-73R6, The Small Business Deduction.

In the above-noted situation since Holdco, Opco and Landco are associated they must allocate the annual BL between them under subsection 125(3).  Landco could claim the SBD on all or a portion of its deemed active business income it received from Opco, provided the associated group of corporations has a BL equal to or greater than such income and such BL is allocated to Landco pursuant to subsection 125(3) of the Act.

We would also like to draw your attention to the proposed amendments to the Act released by the Department of Finance on July 29, 2016, as part of the 2016 federal budget (Legislative proposals Relating to Income Tax, Sales Tax and Excise Duties) that may impact the claiming of the SBD (the “proposed rules”) in this situation.

Generally speaking, under the proposed rules, a CCPC’s active business income from providing services or property (directly or indirectly, in any manner whatever) in its taxation year to a private corporation will be ineligible for the SBD where, at any time during the year, the CCPC, one of its shareholders or a person who does not deal at arm’s length with such a shareholder has a direct or indirect interest in the private corporation.  This type of income is referred to as “specified corporate income” (“SCI”) under the proposed definition in subsection 125(7) of the Act.  However, a private corporation that is a CCPC will be entitled to assign all or a portion of its unused BL to one or more CCPCs having SCI that would otherwise be ineligible for the SBD under the proposed rules.

In the above-noted situation, since Holdco, Opco, and Landco are associated they must first allocate the annual BL between them under subsection 125(3).  Assuming a sufficient BL is assigned to Opco, Opco could then assign, under proposed subsection 125(3.2) of the Act, a portion of its BL to Landco.  However, the assignment of a portion of Opco’s BL to Landco under subsection 125(3.2) does not appear to increase Landco’s BL under the proposed rules.  As such, in order for Landco to be able to claim a SBD, a portion of the associated group’s BL must still be allocated to Landco pursuant to subsection 125(3).  This is best explained by way of a numerical example.

Assume Landco earns $500,000 of SCI during the year from the provision of property to Opco.  Also assume an initial allocation of 50% of the BL under subsection 125(3) is made to Landco and Opco such that the total of the percentages assigned does not exceed 100%.

Under the proposed rules, in order to allow Landco to claim the SBD pursuant to subsection 125(1), Opco must assign its $250,000 BL to Landco under subsection 125(3.2).  After the assignment, Opco’s BL is reduced to nil under subsection 125(3.1) of the Act with no corresponding increase to Landco’s BL.  Accordingly, Landco could only claim the SBD on $250,000 which represents the least of the amount assigned from Opco under subsection 125(3.2) and the BL initially allocated to it pursuant to subsection 125(3).  This result appears to be unintended since $250,000 of the BL is lost.

The Canada Revenue Agency is responsible for administering the tax system and applying current legislation, whereas the Department of Finance is responsible for developing tax policy and legislation.  Therefore, we have referred this matter to the Department of Finance for their consideration.

We trust these comments will be of assistance.

Yours truly,

Michael Cooke, C.P.A., C.A.
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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