2024-1003831E5 Active assets - intangible assets

Principal Issues: Whether intangible assets of an active business carried on by a corporation, such as goodwill, customer list, licenses, franchises and quotas would be “active assets” as defined in subsection 125(7) of the Income Tax Act.

Position: Whether a particular asset is used principally in an active business is a question of fact, which must be determined with reference to the circumstances of the case under review. The relevant circumstances include the actual use to which the asset is put in the course of the business, the nature of the business and the practice in the particular industry. If the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations, the property would generally be considered to be used in the course of carrying on a business.

Reasons: Position based on previous ITRD positions and the decision in Ensite Limited v. Her Majesty the Queen.

Author: Wallace, Ryan
Section: 125(1), 125(5.1), 125(7) “active asset”, "adjusted aggregate investment income", 129(4) "aggregate investment income"

XXXXXXXXXX                                                   Income Tax Rulings Directorate
                                                                            Ryan Wallace, CPA
                                                                            2024-100383

May 2, 2024

Dear XXXXXXXXXX:

We are writing in response to your email of January 9, 2024, wherein you requested our views on whether intangible assets such as goodwill, customer lists, licenses, franchises and/or quotas would each be considered an “active asset,” as that term is defined in subsection 125(7) of the Income Tax Act (“Act”), of a Canadian-controlled private corporation (“CCPC”).

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.

Section 125 of the Act provides the rules for the calculation of the small business deduction (“SBD”) available to a CCPC on its income from carrying on an active business in Canada. Using the SBD, a CCPC may reduce its tax otherwise payable on such income by an amount equal to the SBD rate multiplied by the least of three amounts. These amounts may be described in very general terms as:

* active business income (paragraph 125(1)(a) of the Act);

* taxable income (paragraph 125(1)(b) of the Act); and

* the business limit (paragraph 125(1)(c) of the Act).

Subsection 125(5.1) of the Act provides, inter alia, a reduction to a corporation's business limit based on the investment income of the corporation and its associated corporations. The corporation's business limit will be reduced by the greater of the reduction provided under “the taxable capital reduction” (contained in paragraph 125(5.1)(a) of the Act), and the “investment income reduction”, also sometimes referred to as the “passive income reduction,” (contained in paragraph 125(5.1)(b) of the Act).

The investment 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” (“AAII”) and that of its associated corporations, for taxation years ending in the preceding calendar year, exceeds $50,000.

The term adjusted aggregate investment income is defined in subsection 125(7) of the Act. It is calculated similarly to a corporation’s aggregate investment income as defined in subsection 129(4) of the Act, but with some differences. One of these differences is to generally exclude taxable capital gains and allowable capital losses of the corporation from what was an “active asset” of the corporation at the time of disposition.

The term “active asset” is defined, inter alia, in subsection 125(7) of the Act as follows:

“active asset, of a particular corporation at any time, means property that is

(a) used at that time principally in an active business carried on primarily in Canada by the particular corporation or by a Canadian-controlled private corporation that is related to the particular corporation,”

For the purposes of the SBD, the expression “active business carried on by a corporation” is defined in subsection 125(7) and means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure in the nature of trade. (footnote 1)  

Whether an asset is used, at a particular time, principally in an active business is a question of fact and must be resolved based on the facts of the particular case. Generally, an asset is considered to be used principally (i.e., more than 50%) in an active business if its primary or main use is in that business. The relevant factors include the actual use to which the asset is put in the course of the business, the nature of the business and the practice in the particular industry. This determination is made on a property by property basis, and in our view, applies to both tangible and intangible assets, regardless of whether the asset has been recorded on the corporate balance sheet.

As noted in paragraph 6 of IT-73R6, The Small Business Deduction, the issue of whether property was used or held by a corporation in the course of carrying on a business was considered by the Supreme Court of Canada in Ensite Limited v. Her Majesty the Queen [86 DTC 6521]. The court held that the holding or using of property must be linked to some definite obligation or liability of the business and that a business purpose test for the use of the property was not sufficient. The property had to be employed and risked in the business to fulfil a requirement which had to be met in order to do business. In this context, risk means more than a remote risk. If the withdrawal of the property would have a decidedly destabilizing effect on the corporate operations, the property would generally be considered to be used in the course of carrying on a business. In other words, the property has to be an integral part of the financing of the business or necessary to the overall business operations in order for income from the property to be part of the “income of the corporation ... from an active business.”

Generally, the goodwill of a business, whether purchased or internally generated, is an asset which represents the expectation of future earnings, returns or other benefits in excess of what would be expected in a comparable business, as well as the whole advantage of the reputation of the business built over time. Goodwill cannot be separated from the business itself, and can only be sold with the business to which it relates.

Whether the goodwill or other intangible assets (such as customer lists, franchises, licenses or quotas that can be sold separately) of an active business could be considered active assets is a question of fact, which can only be determined after a careful review of the circumstances in each case. In our view, where a business relies on such intangible assets to fulfill a requirement which had to be met in order to do business, are integral to the overall operations of the business, and selling or otherwise disposing of that property would have a “decidedly destabilizing” effect on the business operations, then it would be reasonable to conclude that those intangible assets were used in the active business.

As such, intangible assets could be active assets, as defined in subsection 125(7) of the Act, provided that at the time of determination, they are used principally in the active business which is carried on primarily in Canada by the particular corporation (or by a CCPC that is related to the particular corporation).

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 The terms “specified investment business” and “personal services business” are also defined in subsection 125(7) of the Act.

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