2018-0780081C6 2018 CTF - Q.10 – TOSI – Excluded Shares & Related Business

Principal Issues: Comparison of CRA’s response to question 7 of the 2018 STEP CRA Roundtable (2018-074403) and examples 8 and 12 of the Guidance on the Application of the Split Income Rules for Adults.

Position: General comments provided. Answer to question 7 of the 2018 STEP CRA Roundtable was based on the assumption provided in the question that the corporation was not carrying on a business while in examples 8 and 12 of the Guidance it was assumed that the corporations in both examples were carrying on a business. Under the Income Tax Act, a corporation can carry on a business the purpose of which is to derive income from property.

Reasons: According to the law and previous positions.

Author: Lafrenière, Jean
Section: 84(2), 120.4(1), 120.4(1.1), 125(7), 248(1)

CRA Roundtable

Question 10: TOSI – Excluded Shares and Related Business

In question 7 of the 2018 CRA Roundtable of the Society of Trust and Estate Practitioners (“STEP”) the following question was asked:

“Assume that a corporation has no business income because it derives income from property (possibly rental income from real property where the activities are not sufficient to constitute business income).  In this case, can the shares of the corporation be excluded shares?”

The CRA answered the question in the negative. Relying on paragraph (a) of the definition “excluded shares” in subsection 120.4(1), the CRA mentioned that if a corporation has no business income, its shares cannot qualify as excluded shares.

However, in examples 8 and 12 of the Guidance on the Application of the Split Income Rules for Adults (“Guidance”) released by the CRA on December 13, 2017, shares of the capital stock of a corporation earning income from passive investment assets qualified as excluded shares. 

Question

Can the CRA confirm whether shares of an investment corporation could qualify as excluded shares?

CRA Response

CRA’s response to question 7 of the 2018 STEP CRA Roundtable (“Question 7”) was based on the assumption provided in the question that the corporation was not carrying on a business, while in examples 8 and 12 of the Guidance it was assumed in both examples that the corporations were carrying on a business.

As such, since the condition in subparagraph (a)(i) (footnote 1) of the definition “excluded shares” in subsection 120.4(1) was not met in Question 7, the shares of the capital stock of the corporation could not qualify as excluded shares.  Consequently, our response was based on the precise set of facts submitted in the question.

With respect to the Guidance, it is intended to provide, among others, general guidance on how the CRA will administer the different exclusions described in the definition “excluded amount” in subsection 120.4(1).

As for the above-mentioned examples of the Guidance, both were aimed at illustrating the exclusion for excluded shares.  Example 12 was also aimed at illustrating the deeming rule in subparagraph 120.4(1.1)(c)(i) which provides an exclusion for a business owner’s spouse in the case where the owner meaningfully contributed to the business and is aged 65 or over (footnote 2).

Also, in order to demonstrate that the different exclusions were not only applicable to entities carrying on an active business (e.g. a manufacturing corporation) but also to entities carrying on a business the principal purpose of which is to derive income from property (footnote 3) such as an investment management corporation, the CRA has made the assumption that the corporations in examples 8 and 12 of the Guidance maintained a sufficient level of activity to support the view that their income may be considered to be from such a business.

That being said, the income or loss from a business or property is computed under Subdivision b of Division B of Part I of the Income Tax Act (the “Act”).  Nevertheless, they are two distinct sources of income for the purposes of the Act.

In this regard, it is a question of fact as to whether the income is from a business or property which can only be resolved after the review of all the facts and circumstances.

The term “business” is not defined in the Act.  Subsection 248(1) only broadens the meaning of the term “business” to include, among others, an undertaking of any kind whatever.

Furthermore, the Act considers that the principal purpose of a business may be to derive income from property, including interest, dividends, rents and royalties (footnote 4).

On that basis, if the assumption in Question 7 was modified such that the corporation does carry on a business, the condition in subparagraph (a)(i) of the definition “excluded shares” in subsection 120.4(1) would have been met.

Yet, even if it has been determined – taking into account the assumption made in Question 7 – that the shares of the capital stock of the corporation could not qualify as excluded shares, an amount received from this corporation by a specified individual would nevertheless be an excluded amount in respect of the specified individual.

For example, subparagraph (e)(i) of the definition “excluded amount” in subsection 120.4(1) states that, in respect of a specified individual for a taxation year who has attained the age of 17 years before the year, an amount is an excluded amount if it is not derived directly or indirectly from a related business in respect of the specified individual for the year.

The expression “related business” in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means, in the case of a corporation either: 1) a business carried on by the corporation if a source individual (footnote 5) in respect of the specified individual at any time in the year is actively engaged on a regular basis in the activities of the corporation related to earning income from the business; or 2) a business of a corporation if a source individual in respect of the specified individual owns shares of the capital stock of the corporation or property that derives, directly or indirectly, all or part of its fair market value (“FMV”) from shares of the capital stock of the corporation and the total FMV of the shares and property equals at least ten per cent or more of the total FMV of all of the issued and outstanding shares of the capital stock of the corporation.

As such, if it is determined that a corporation does not carry on a business, and the corporation pays a dividend to a specified individual, the amount of the dividend, if it is not derived, directly or indirectly, from a related business in respect of the specified individual (footnote 6), could be an excluded amount in respect of the specified individual.  Consequently, the amount of the dividend would not be added to the specified individual’s split income and the specified individual would not be subject to the tax on split income in respect of the amount of the dividend.

Jean Lafrenière
2018-078008
November 27, 2018

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Which is that less than 90% of the business income of the corporation is from the provision of services.
2  Briefly, under this subparagraph, an amount received by a specified individual is deemed to be an excluded amount if: 1) the spouse or common-law partner has attained the age of 64 before the year; and 2) the amount would be an excluded amount in respect of the specified individual’s spouse or common-law partner, if the amount were included in computing the spouse or common-law partner’s income for the year.
3  Among others, interest, dividends, rents and royalties.
4  See the definition of the expression “specified investment business” in subsection 125(7).
5  The expression “source individual” in respect of a specified individual for a taxation year is defined in subsection 120.4(1) and means an individual (other than a trust) who, at any time in the year, is a resident of Canada and is related to the specified individual.
6  Paragraph 120.4(1.1)(d) clarifies for greater certainty that certain amounts are included, for the purposes of section 120.4, in what is an amount derived, directly or indirectly, from a business.

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