2020-0869681E5 Specified Corporate Income

Principal Issues: Whether certain income would be specified corporate income as defined under subsection 125(7) of the Act and whether the receipt of specified corporate income limits the small business deduction available to a corporation.

Position: Based on the facts provided, the income would likely meet the conditions set out under subparagraph (a)(i) of the definition SCI under subsection 125(7). The two corporations would be required to "share" the SBD by assignment of the business limit under 125(3.2).

Reasons: See below.

Author: Wallace, Ryan
Section: 125(1), 125(3.1), 125(3.2), 125(7) "Specified corporate income"

XXXXXXXXXX                                                                             2020-086968

                                                                                                       R. Wallace, CPA

October 6, 2022

Dear XXXXXXXXXX:

Re: Specified Corporate Income

This is in reply to your letter received November 10, 2020, where you requested our views concerning whether certain income would be considered “specified corporate income” (SCI) as defined in subsection 125(7) of the Income Tax Act (“Act”) and if the small business deduction (SBD) of a corporation is impacted by having SCI.

You have provided the following hypothetical situation:

* An individual (Mr. A) owns 50% of a real estate management company (Hco) and the remaining 50% is owned by an unrelated third party.

* Mr. A’s spouse (Mrs. A) owns 100% of Wco, which invests capital in joint venture real estate development projects.

* Mr. A and Mrs. A are related and are not dealing at arm’s length by virtue of paragraphs 251(1)(a) and 251(2)(a) of the Act.

* Hco earns active income by providing services to Wco.

* Hco and Wco are both Canadian-controlled private corporations (CCPCs) as defined in subsection 125(7) of the Act.

* Mr. A does not control Hco.

* Hco and Wco are not associated with each other (within the meaning of 256(1) of the Act), and

* Hco derives all or substantially all of its income from Wco.

Issues

1. Whether Hco’s income earned from Wco would be considered SCI as defined in subsection 125(7) of the Act.

2. If so, whether Hco’s SBD is impacted by earning SCI.

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.

Under the SBD rules in subsection 125(1) of the Act, a CCPC can reduce its tax otherwise payable on income from carrying on an active business in Canada by an amount equal to the SBD rate multiplied by the least of three amounts. The first of these amounts determines the portion of the corporation’s active business income (ABI) for a taxation year that can be eligible for the deduction (paragraph 125(1)(a)). Clauses 125(1)(a)(i)(A) to (C) indicate the portions, if any, of a CCPC’s income from an active business that is not eligible for the SBD.

In particular, clause 125(1)(a)(i)(B) of the Act carves out income described in subparagraph (a)(i) of the definition SCI in subsection 125(7) from SBD eligibility. However, this carved out amount may be added back to the amount eligible for the SBD pursuant to subparagraph 125(1)(a)(ii.1), but only to the extent allowed by the definition of SCI.

A CCPC can have SCI for a taxation year if the CCPC has income from an active business carried on in Canada by it from the provision of property or services to a private corporation (directly or indirectly, in any manner whatever) and if the conditions in clauses (a)(i)(A) and (B) of the definition of SCI in subsection 125(7) of the Act are met.

Clause (a)(i)(A) of the definition of SCI in subsection 125(7)

For the condition in clause (a)(i)(A) of the definition SCI to be met, at any time in the year, the corporation (or one of its shareholders) or a person who does not deal at arm's length with the corporation (or one of its shareholders) must hold a direct or indirect interest in the private corporation.

It should be noted that “the corporation” referred to in the definition of SCI in subsection 125(7) of the Act is in reference to the corporation for which the SBD is being calculated (in this case, Hco), and “the private corporation” referred to in the definition of SCI is in reference to any private corporation to which the corporation provides services or property (in this case, Wco).

Paragraph 251(1)(a) of the Act deems related persons to not deal with each other at arm's length. This is the case regardless of how they actually deal with one another. Paragraph 251(2)(a) provides that individuals connected by blood relationships, marriage, common-law partnership or adoption are related persons. Therefore, Mr. A and Mrs. A are related and are considered to be not dealing at arm’s length by virtue of paragraphs 251(1)(a) and 251(2)(a). (footnote 1)

Since Mrs. A, who does not deal at arm’s length with Mr. A (a shareholder of Hco), holds a direct interest in WCo, the condition set out in clause (a)(i)(A) of the definition SCI is met. However, in order for income to meet the requirements of subparagraph (a)(i) of the definition of SCI in subsection 125(7), the condition in subclause (a)(i)(B)(I) or (a)(i)(B)(II) of the SCI definition must also be met.

Clause (a)(i)(B) of the definition of SCI

The condition in subclause (a)(i)(B)(I) of the definition SCI is met where it is not the case that “all or substantially all” of the corporation’s income for the year from an active business is from the provision of services or property to persons (other than the private corporation) with which the corporation deals at arm’s length. The phrase “all or substantially all” generally means 90% or more.

The condition set out in subclause (a)(i)(B)(I) of the definition SCI is intended to ensure that the corporation will not be considered to have SCI where the services or property it provides to the private corporation form a small part of its bona fide business of providing property or services to arm’s length persons.

Since in the hypothetical situation described above, all or substantially of Hco’s ABI is derived from providing services to Wco, it is not the case that all or substantially all of Hco’s ABI is from the provision of services or property to persons (other than Wco) with which Hco deals at arm’s length. As a result, the condition in clause (a)(i)(B) in the definition of SCI is met by virtue of meeting the condition in subclause (a)(i)(B)(I) .

Determination of SCI

If the conditions in subparagraph 125(7)(a)(i) of the definition of SCI are met, a CCPC’s SCI for the year is the lesser of the following two amounts:

a) An amount that is the lesser of:

i. the total amounts, each of which is income from an active business of the CCPC for the year from the provision of services or property (directly or indirectly, in any manner whatever) to the private corporation, provided the conditions under clause (a)(i)(A) and (a)(i)(B) of the definition SCI are met [this is the amount carved out of ABI under clause 125(1)(a)(i)(B)] and

ii. the total of all amounts each of which is the portion, if any, of the business limit of the private corporation that it assigns to the CCPC under subsection 125(3.2).

b) An amount per paragraph 125(7)(b) of the definition SCI that the Minister determines to be reasonable in the circumstances.

Under subsection 125(3.2) of the Act, a CCPC (the “first CCPC”) can assign all or any portion of its business limit (generally determined under subsections 125(2) and (3)) to another CCPC (the “second CCPC”) if the second CCPC has an amount of income for its taxation year that is referred to in subparagraph 125(7)(a)(i) of the definition SCI. Paragraph 125(3.2)(a) provides that the income of the second CCPC must be from the provision of services or property directly to the first CCPC, as referred to in subparagraph 125(7)(a)(i) of the definition SCI. This is also conditional on the first CCPC’s taxation year ending in the second CCPC’s taxation year.

The assignment by the first CCPC of its business limit to the second CCPC allows income of the second CCPC from the first CCPC to be eligible for the SBD, where that income would otherwise be ineligible under clause 125(1)(a)(i)(B). This is accomplished through the add back of SCI pursuant to subparagraph 125(1)(a)(ii.1).

The maximum business limit amount that the first CCPC can assign to the second CCPC is determined under paragraph 125(3.2)(c). It cannot exceed the amount determined by the formula A – B where:

* A is the income that the second CCPC has for its taxation year from the first CCPC referred to in paragraph 125(3.2)(a), and

* B is the portion of the amount described in A that is deductible by the first CCPC in respect of the amount of income of the first CCPC referred to in clauses 125(1)(a)(i)(A) or (B) for the year. This reduction is intended to ensure that any portion of income of the first CCPC that would not be eligible for the SBD under the constraints of the specified partnership income rules or specified corporate income rules does not become eligible for the small business deduction in the hands of a second CCPC by way of the assignment mechanism.

Impact of SCI on the Small Business Deduction

As noted, in the calculation of the SBD, an amount described in subparagraph (a)(i) of the definition of SCI in subsection 125(7) of the Act for the year is carved-out of ABI by clause 125(1)(a)(i)(B). However, the SBD may be available on an amount, which is determined to be SCI, that is added back to ABI under subparagraph 125(1)(a)(ii.1).

Because SCI is the lesser of the two amounts described in paragraph (a) of that definition (notwithstanding an amount the Minister determines to be reasonable in the circumstances), if no business limit is assigned under subsection 125(3.2), the amount determined under the “lesser of” calculation, in the definition of SCI, will be nil. This assignment mechanism allows a single business limit to be shared, but not multiplied, by two corporations when the conditions in clause 125(1)(a)(i)(B) are met.

Subsection 125(3.1) of the Act provides that a CCPC’s small business limit for the year must be reduced by any portion of the CCPC’s business limit for the year that is assigned to another CCPC under subsection 125(3.2).

In the situation presented, the amount of income of Hco from the provision of services to Wco would be carved out from the calculation of ABI under clause 125(1)(a)(i)(B) of the Act because the income is an amount described under subparagraph (a)(i) of the definition of SCI in subsection 125(7). As previously noted, the conditions under clauses 125(7)(a)(i)(A) and (a)(i)(B) of the definition of SCI are met. For the income to otherwise be included in the calculation of Hco’s ABI under subparagraph 125(1)(a)(ii.1), Wco would be required to assign all or a portion of its business limit to Hco under subsection 125(3.2). Subsection 125(3.1) would reduce the business limit of Wco by any amount that is assigned to Hco by virtue of subsection 125(3.2).

We trust our comments will be of assistance.

Yours truly,

Pamela Burnley, CPA, CA
Manager
Business and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

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

1 Income Tax Folio S1-F5-C1, Related Persons and Dealing at Arm's Length provides detailed discussion on rules surrounding related persons and dealing at arm’s length.

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