2018-0771871E5 Passive Income Reduction and the Business Limit

Principal Issues: We have been asked to provide guidance on how the new passive income reduction will apply to the reduction of the business limit for associated corporations with differing taxation years.

Position: The passive income reduction will apply for taxation years that begin after 2018. A corporation’s adjusted aggregate investment income is the total of all amounts each of which is the adjusted aggregate investment income of the corporation or any corporation with which it is associated at any time in a particular taxation year for each taxation year of the corporation, or associated corporation that ended in the preceding calendar year.

Author: D'Angelo, Sandro
Section: 125(5.1)(b)

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                                                                                                                                       2018-077187
                                                                                                                                       S. D’Angelo, CPA, CMA

September 20, 2018

Dear XXXXXXXXXX:

Re:  Business Limit and the new Passive Income Reduction

This is in reply to your email of June 29, 2018, regarding your question with respect to the application of the new passive income reduction contained in paragraph 125(5.1)(b) of the Income Tax Act (“Act”).  You have provided the following example:

“Assume a Canadian-controlled private corporation (ACo) has a fiscal period ending December 31.  In all relevant taxation years (all ending on December 31), ACo’s taxable capital is less than $3,000,000, and it has earned $500,000 of taxable income from an active business (all derived from arm’s length persons).  ACo is allocated the entire business limit.

At all relevant times, ACo has only been associated with one other corporation, BCo, a Canadian-controlled private corporation.  BCo has a fiscal period ending on November 30.  Assume in all relevant taxation years (all ending on November 30), BCo has had taxable capital of less than $3,000,000, and earned $70,000 property income derived from arm’s length Canadian sources (e.g., interest).”

Based on the foregoing example, you have asked whether the Canada Revenue Agency can provide guidance on how the new passive income reduction in paragraph 125(5.1)(b) will apply and in which taxation year of ACo would it first be subject to a reduction to its business limit.

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.

A corporation’s entitlement to the small business deduction for a particular taxation year is determined by reference, among other things, to the business limit of the corporation for the particular taxation year that is otherwise determined under section 125 of the Act.

Subsection 125(5.1) of the Act is amended to provide an additional restriction to a corporation’s business limit based on the passive investment income of the corporation and its associated corporations.  The corporation’s business limit will now be reduced by the greater of the reduction provided under the existing rule (the taxable capital reduction), now contained in paragraph 125(5.1)(a), and the new passive income reduction, contained in paragraph 125(5.1)(b).

The passive income reduction reduces a corporation’s business limit for a taxation year (as otherwise determined) by five dollars for every dollar by which the corporation’s “adjusted aggregate investment income” (as newly defined in subsection 125(7)), and that of its associated corporations, for taxation years ending in the preceding calendar year exceeds $50,000.

The passive income reduction will apply to taxation years that begin after 2018.  However, the passive income reduction may also apply to a taxation year beginning before 2019, if certain planning is undertaken to defer the application of either the passive income reduction or the amendments to section 129.

As such, in the example provided, ACo would be first subject to the passive income reduction in its first taxation year beginning after 2018 (i.e., ACo’s taxation year ending December 31, 2019).  For its taxation year ending December 31, 2019, ACo would include the total of all amounts each of which is the adjusted aggregate investment income of ACo (for taxation year ending December 31, 2018) and BCo (for taxation year ending November 30, 2018) that ended in the preceding calendar year (calendar year ending December 31, 2018).

We trust these comments will be of assistance to you.

Yours truly,

Pamela Burnley, CPA, CA
Manager
Business Income and Capital Transactions Section
Business and Employment Division
Income Tax Rulings Directorate

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