Canada: Budget 2016: Small Business Gets Smaller

A long-standing policy underlying the Income Tax Act (the "Tax Act") has been to subject the first $500,000 of active business income earned by a "Canadian-controlled private corporation" (a "CCPC") to a reduced rate of taxation (the "small business deduction").

The low rate of federal tax on the first $500,000 of active business income earned by a CCPC was scheduled to be reduced to 9% by 2019. However, in Budget 2016, the Government announced that the low rate would be frozen at 10.5% for the foreseeable future.

When initially introduced, the low tax rate was not limited to small businesses; in fact, it was available to any CCPC, regardless of its income earned or the size of its business. Over time, the availability of the small business deduction has been reduced. For instance, it is no longer available to CCPCs with taxable capital in excess of $15 million.

Budget 2016 continues the trend of increasingly restricting access to the small business deduction.

Under the existing rules in the Tax Act, corporate partners in a partnership are required to share the small business limit of $500,000, so that if there are four equal partners in a partnership, each corporate partner is only eligible to claim the low rate of tax on up to $125,000 of the partnership income allocated to it. This can be contrasted with the tax impact if the four corporations carried on business as a joint venture instead of a partnership, which would permit each corporate participant to claim the reduced tax rate on up to a full $500,000 of income from the joint venture.

As a result of these restrictions on partnerships, many partners (including a large number of lawyers and accountants), have used a variety of structures to conduct business with a partnership in an effort to maintain access to the low rate of tax on a full $500,000 of income.

One structure, described in the Budget papers, involved an accountant that was a member of a partnership forming a corporation (the "service corporation") to provide accounting services to the partnership of which he was a partner. If the service corporation were a partner of the partnership, the service corporation would have to share the $500,000 business limit with all the other partners of the partnership. However, as the service corporation only provides services to the partnership and is not a partner, the service corporation is not subject to the "specified partnership income" rules, which force the small business limit to be shared amongst corporate partners.

Budget 2016 seeks to nullify this type of planning by amending the definition of "specified partnership income" and adding the concept of a "designated member" of a partnership. A CCPC will be a "designated member" of a partnership if it provides services "directly or indirectly in any manner whatever" to the partnership, and a shareholder of the CCPC holds a direct or indirect interest in the partnership or a person that the CCPC does not deal with at arm's length holds a direct or indirect interest on the partnership. If a CCPC is a designated member of a partnership, it will be able to claim the small business deduction only in respect of income connected with the partnership to the extent of its proportionate share of the $500,000 business limit to be divided amongst all the partners and designated partners of the partnership.

Outside of the partnership context, Budget 2016 also imposes further restrictions on the ability of corporations to access the small business deduction.  Aside from the special rules for partnerships, under the existing rules in the Tax Act, a corporation is required to share the $500,000 business limit with corporations that are "associated" with it within the meaning of section 256 of the Tax Act. Generally, corporations that control one another, or are subject to common control, are considered to be associated with one another.

Under the new rules, in addition to sharing the small business limit with associated corporations, a corporation (the "supplier corporation") will generally be limited in claiming the small business deduction on any income it earns from providing property or services directly or indirectly to another private corporation if the supplier corporation, a shareholder of the supplier corporation, or a person that does not deal at arm's length with the supplier corporation, or one of its shareholder holds a direct or indirect interest in the private corporation receiving the property or services (in this bulletin, referred to as the "loosely connected private corporation"). The supplier corporation will generally be able to claim the small business deduction only against income earned from the supply of services or property in this circumstance to the extent that the loosely connected private corporation allocates a portion of its small business limit to the supplier corporation.

Prior to the introduction of these proposed amendments, a common structure adopted by two individuals operating a business was as follows: Mr. "A" owns all the shares of ACo. Mr. "B" owns all the shares of BCo. Each of ACo and BCo owns 50% of the shares of Opco, which operates a small business (see Figure 1). Each of ACo and BCo provide services to Opco. As there is no common control, none of the corporations are associated and each of ACo, BCo and Opco could claim the small business deduction on the first $500,000 of income connected with the subject enterprise, for a total of $1,500,000 of income eligible for the small business deduction.

Under the new rules, only Opco will be eligible for the small business deduction on $500,000 of income connected with the subject enterprise unless it elects to share its business limit with ACo and/or BCo, thus limiting the total amount of income eligible for the low rate of tax amongst all three corporations to $500,000.

(An exception to the new restriction will apply if all or substantially all of the active business income of a supplier corporation for a taxation year is earned from providing services or property to arm's length persons other than the loosely connected private corporation.)

A disturbing wrinkle in the new rules is that any claim to the small business deduction with respect to income from services or property provided to a loosely connected private corporation will not be allowed, notwithstanding compliance with all the provisions of the Tax Act, that is in excess of "an amount that the Minister determines to be reasonable in the circumstances". No guidance is given in the Budget proposals as to how the Minister will determine if an amount is reasonable.

Granting such a broad discretion to the Minister is not in accordance with the rule of law and is out of place in a statute which is based on the application of detailed rules to facts to determine taxes payable. Even the General Anti-Avoidance Rule in the Tax Act is based on the interpretation by the court of a misuse of the provisions of the Tax Act and not on the Minister's view as to what is reasonable.

Associated Corporation Anti-Avoidance Rule

The Government has become concerned that taxpayers have been making use of the elective provisions in subsection 256(2) of the Tax Act in a manner not intended by the legislature in order to effectively permit two corporations to not be considered to be associated with one another for the purpose of maximizing access to the small business deduction, while retaining the ability to characterize investment income that one corporation receives from the other as active business income (by virtue of the corporations continuing to be considered to be associated for this particular purpose). The Government proposes to amend subsection 256(2) of the Tax Act to counteract such planning.

Personal Services Business Tax Increase

To prevent employees from gaining access to the deductions available to the self employed and the lower tax rate available to small business corporations, the Tax Act has created a set of rules that deny these benefits to persons that form corporations that engage in the business (a "personal services business") of providing the services of a shareholder of the corporation or a related person in circumstances where, in the absence of the corporation, the person providing those services would be considered an employee. Under these rules, a corporation that operates a personal services business is not eligible for the small business deduction or the general tax rate reduction. However, with the increase in the top personal marginal tax rate, in the absence of other changes, the Government felt that too large a deferral benefit would be available to a corporation that carried on a personal services business over the taxation rate that would be imposed on an employee. Consequently, Budget 2016 proposes an additional tax on income from a personal services business of 5% to increase the federal tax rate on this income from 28% to 33%.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2016

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.