2018-0780031C6 2018 CTF - Q16 - Passive Income Reduction Rules

Principal Issues: We have been asked to provide guidance on how the new passive investment income business limit reduction rules will apply in a specific fact situation.

Position: The passive income reduction rules 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 year for each taxation year of the corporation, or associated corporation that ended in the preceding calendar year.

Reasons: Consistent with income tax policy.

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

2018 CTF Annual Conference

CRA Roundtable

Question 16: Passive Investment Income Business Limit Reduction Rules

For a corporation’s taxation year that ends December 31, 2018 or straddles December 31, 2018, assuming the taxation year is an ordinary 12-month year that is not shorter than it would have been because of a transaction or event or a series of transactions or events, is the “adjusted aggregate investment income” (“AAII”) for that year end necessarily $0, given that the definition of AAII only applies to taxation years beginning after 2018?

Consider the following scenario:

1.    Holdco and Opco are associated at all relevant times.  There are no other corporations in the associated group.

2.    Opco had a June 30, 2019 year end which was a full 12-month year end.  Its next year end is on June 30, 2020.

3.    Holdco also had a June 30, 2019 year end which was a full 12-month year end.  In that June 30, 2019 year end, it had $150,000 of investment income.

4.    The new business limit reduction that is based on AAII, found in paragraph 125(5.1)(b) is applicable to Opco for its June 30, 2020 year end, since that is the first taxation year that begins after 2018.  The calculation of the reduction would bring Opco’s business limit down to $0 if Holdco has AAII of $150,000 in the year ending in the previous calendar year (June 30, 2019 year-end).

5.    Although Holdco has investment income totaling $150,000 in 2019, arguably Holdco does not have any AAII for its June 30, 2019 year end because of the definition of AAII in subsection 125(7).  This is because in Bill C-74, the application for the definition of AAII is to taxation years that begin after 2018.  Since Holdco’s June 30, 2019 year end did not begin after 2018, the definition does not apply.

6.    Therefore, although paragraph 125(5.1)(b) applies to Opco’s June 30, 2020 year end, the first year in which the new passive investment income rules could affect Opco’s business limit is its June 30, 2021 year end.

Does the CRA agree?

CRA Response

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, Opco would be first subject to the passive income reduction in its first taxation year beginning after 2018 (that is, Opco’s taxation year ending June 30, 2020).  For its taxation year ending June 30, 2020, Opco would include the total of all amounts each of which is the adjusted aggregate investment income of Opco (for taxation year ending June 30, 2019) and Holdco (include the $150,000 of investment income for the taxation year ending June 30, 2019) that ended in the preceding calendar year (calendar year 2019).

Sandro D’Angelo
2018-078003
November 27, 2018

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