In November, Ontario announced it would not implement the AAII clawback for the small business deduction (SBD). This creates an integration anomaly. If the federal clawback applies, the related income will be part of GRIP for federal and Ontario purposes even though the Ontario SBD might have applied to that income. The result is that income that has been subject to tax in Ontario at its small business rate could end up being paid out as eligible dividends. Jamie Golombek and Jay Goodis, “Ontario Announcement Throws a Wrench into Integration” 27:1 Canadian Tax Highlights (January 2019).
In Rocco Gagliese Productions Inc. v R, 2018 TCC 136, the corporate taxpayer employed an individual who wrote and recorded music on an active and continuous basis. The taxpayer received royalty income from SOCAN for this work. The CRA took the position that the “legal character” of the income (royalties) meant that the taxpayer was carrying on a “specified investment business” for the purposes of the small business deduction provisions. The Tax Court disagreed. It held that the principal purpose of the taxpayer’s business was to earn income from writing and recording music. See D Morrison, “Specified Investment Business Income Does Not Include Royalties” 18:4 Tax for the Owner-Manager (October 18, 2018).
In A Ghani, M Lee and M Kakkar, “The Passive Income Rules: New Ways To Grind the SBD” 18:4 Tax for the Owner-Manager (October 18, 2018), the authors note that
[R]egardless of whether a corporation has had multiple year-ends, these new passive income rules will aggregate all of the adjusted aggregate investment income of all of the taxation years ending in the preceding calendar year to compute the small business limit reduction.
The CRA accepts that a business carried on by a corporation as a member of a partnership is not a specified investment business if the partnership employs more than five full-time employees. The authors suggest that a corporation could earn ABI from rental properties “by creating a pooled ownership of multiple properties, or multiple interests in one large property” where the pooling is through a partnership that employs more than five full-time employees. A joint venture, however, will likely be less effective for this purpose because of Lerric Investments Corp. v Canada, 2001 FCA 14.
Jeanne Cheng and Tom Qubti, “Rental Income and ABI: Structuring Around the Five-Employee Test” Canadian Tax Focus 4:4 (May 2018).
From Jason Pisesky, “Incentive Effects of the New SBD Clawback” Canadian Tax Focus 4:4 (May 2018):
[Where a corporation earns ABI equal to its business limit] an extra $1,000 of rental income creates $1,307 of immediate tax in Alberta, as well as cash flow issues in certain situations. Changes in investment portfolios may be appropriate.
This harsh result is ameliorated by paying dividends, but that can be problematic because of the new split RDTOH rules.
Corporations might consider investing in less risky assets to generate less investment income or investing in growth assets to control better when returns are realized.
A CCPC might want to assign a portion of is small business deduction limit to another corporation because of the specified corporate income rules. The assignment will be problematic, however, if the assignor’s year-end occurs before that of the assignee. The assignor will not know the amount of the income earned by it from the assignee, and so the assignor will not know how much limit to assign. An excessive assignment might invalidate it. (Will an assignment be invalidated if a reassessment of the assignee reduces the income earned from the assignor?) Will amending returns help? Perhaps, but it will be a compliance nuisance.
Dino Infanti “Assignment of Small Business Limit Creates Filing Headaches” 18:1 Tax for the Owner-Manager (January 2018)
Postscript February 6, 2018: See also Tanya Budd and Trent Robinson, “Specified Corporate Income When Year-Ends Differ” 8:1 Canadian Tax Focus (February 2018).
Kenneth Keung, “Anti-Intermediary Rules in Section 125” , Canadian Tax Highlights 25:2 (February 2017) provides a handy summary of the carve-outs from income eligible for the small business deduction (SBD) as follows:
- ABI earned from a partnership in which the corporation or its shareholder holds a direct or indirect interest, or a person that holds such an interest is not dealing at arm’s length with the corporation, which does not earn all or substantially all of its income from arm’s-length customers (clause 125(1)(a)(i)(A); “the clause A carve-out”);
- ABI earned from another corporation in which the corporation, its shareholder, or a person not at arm’s length with either holds a direct or indirect interest, and the corporation does not earn all or substantially all of its income from arm’s-length customers (clause 125(1)(a)(i)(B); “the clause B carve-out”); and
- Deemed ABI under subsection 129(6) that is earned from a non-CCPC or a CCPC that elected under subsection 256(2) not to be associated (clause 125(1)(a)(i)(C)).
The article also provides examples of the intended and (probably) unintended application of the rules to multiple PC structures and supply chain structures (among others).
Jack Bernstein, “Buy-Sell Provisions and Association” Canadian Tax Highlights 24:11 (Nov 2016), is a useful supplement to my post on the subject.