Canada: New Limits On The Small Business Deduction

This article is part of a series dealing with draft legislation released for comment by the Department of Finance on July 29th.

New limits proposed for the small business deduction (SBD) are raising concerns about the broad discretion granted to the minister to override existing tax rules. 

The SBD results in a preferential federal tax rate of 10.5 per cent on the first $500,000 of active business income earned by a Canadian-controlled private corporation (CCPC). Section 125 of the Income Tax Act (Canada) (ITA) sets out the circumstances in which the SBD is available, and also includes rules intended to limit the ability of taxpayers to multiply the benefit of the SBD. Over time, various corporate and partnership structures evolved which were not subject to these limitations.

In Budget 2016, the Government of Canada proposed enacting new rules to further limit the use of the SBD in the name of enhancing domestic tax integrity. The new rules would specifically target active business income earned by CCPCs through partnerships and corporations in which the CCPC or a shareholder of a CCPC held a direct or indirect interest.

This article discusses noticeable concerns raised by the 2016 Legislative Proposals. We encourage the Department of Finance to address these concerns before the draft legislation is passed into law.

Ministerial Discretion

A remarkable feature of the 2016 Legislative Proposals is the conferral of a broad discretion on the Minister to determine "specified corporate income", which is a key element of the SBD. In particular, the new definition in subsection 125(7) states that "specified corporate income" may be an amount the Minister determines to be reasonable in the circumstances. Since the new rules have yet to be implemented, it is unclear how aggressively the Minister will use this new discretionary power to override the usual calculation of specified corporate income set out in the ITA.

Although detailed explanatory notes were provided to accompany the 2016 Legislative Proposals, no explanation for granting this discretionary power was given. The notes relating to the new definition "specified corporate income" just state that the purpose of this addition is to "address structures that avoid the specified partnership income rules and to prevent the inappropriate multiplication of the small business deduction." With this broad mandate, the discretion granted to the Minister may end up being used as essentially another new anti-avoidance provision, in addition to proposed subsection 125(9) discussed below, thereby creating further uncertainty for taxpayers.


Proposed subsection 125(9) is a new anti-avoidance rule applicable to the SBD. The new rule may apply where a corporation earns active business income from providing services or property to a person who holds a direct or indirect interest in a particular partnership or corporation.  That active business income will not be eligible for the SBD if one of the reasons for the provision of the services or property to that person, instead of to the particular partnership or corporation, is to avoid the application of the rules limiting the use of the SBD contained in subparagraphs 125(1)(a)(ii) or (ii.1).

Given the potentially broad interpretation of "indirect interest", this new anti-avoidance rule could apply to a very wide range of situations.

Indirect Interest

References in the 2016 Legislative Proposals to parties holding an "indirect interest" in a partnership or corporation are not completely clear and this will give rise to uncertainty. For example, does an "indirect interest" refer to an indirect interest via an agent or nominee, or does it have a broader meaning, such as the economic interest through an intermediary holding company, or the interest of (i) a creditor of a corporation or partnership, (ii) a holder of stock options or phantom equity or interest in a corporation or partnership, (iii) a guarantor of debt of a partnership or corporation, or (iv) a beneficiary of a trust that is a member of a partnership or a shareholder of a corporation?

Although this issue is not addressed in the explanatory notes, third party commentary on the 2016 Legislative Proposals leans towards the more inclusive interpretation. Although there is a dearth of CRA views on other sections of the ITA which incorporate the phrase "direct or indirect interest", commentary on the interpretation of "direct interest" in paragraph 55(3)(a) and "direct or indirect interest" in subparagraph 88(1)(c.2)(iii) similarly supports a broader interpretation. See, for instance, the report of the CBA/CICA Joint Committee on Taxation in response to the December 21, 2012 technical amendments of subparagraph 88(1)(c.2)(iii).

Substantially all (i.e., 90%) Arm's Length Test

As an example of the broad potential application of the new SBD rules, consider a situation in which a corporation owned by a sister (SisterCo) provides services to a small number of clients, one of which is a company owned by her brother (BrotherCo). The income earned by SisterCo from providing services to BrotherCo constitutes only 11% of the "income from an active business of the corporation for the year" for the purpose of subparagraph (a)(i) of the definition "specified corporate income" in subsection 125(7).

Because the owners of SisterCo and BrotherCo do not deal at arm's length and SisterCo provides services to BrotherCo, the arrangement will be caught by new clause (a)(i)(B) of the definition "specified corporate income". As a result, SisterCo will be precluded from claiming the SBD on income earned from BrotherCo, except to the extent that BrotherCo assigns a portion of its business limit to SisterCo under subsection 125(3.2). We suspect that the tax consequences of this scenario were not intended by the Department of Finance.

This example also raises another issue, namely how is the income from an active business of the corporation determined for this purpose?  In light of the definition "income of the corporation for the year from an active business" in subsection 125(7) and the definition of income from business in subsection 9(1), "income" in this context could be interpreted as referring to "net income" or "profit".  However, this is not clear and may be the subject of some debate in applying the new rules.


The 2016 Legislative Proposals have taken aim at preventing taxpayer's from multiplying the SBD for multiple CCPCs or partnerships that provide services or property to associated parties. Structures that previously gave rise to the SBD – and which had been approved in rulings issued by the CRA – will need to be rethought and retooled. Finally and most importantly, the new rules are very broad, include significant elements of uncertainty and discretion, and could apply to a myriad of business arrangements that were contemplated neither by the Department of Finance or taxpayers. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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.

Events from this Firm
8 Nov 2016, Seminar, Ottawa, Canada

The prospect of an internal investigation raises many thorny issues. This presentation will canvass some of the potential triggering events, and discuss how to structure an investigation, retain forensic assistance and manage the inevitable ethical issues that will arise.

22 Nov 2016, Seminar, Ottawa, Canada

From the boardroom to the shop floor, effective organizations recognize the value of having a diverse workplace. This presentation will explore effective strategies to promote diversity, defeat bias and encourage a broader community outlook.

7 Dec 2016, Seminar, Ottawa, Canada

Staying local but going global presents its challenges. Gowling WLG lawyers offer an international roundtable on doing business in the U.K., France, Germany, China and Russia. This three-hour session will videoconference in lawyers from around the world to discuss business and intellectual property hurdles.

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.