Canada: The Small Business Deduction

The small business deduction has been the focus of much attention recently, with perceived abuse of the available deferral provided to corporations. Of particular concern are corporate and partnership structures that work around the existing partnership and association rules to multiply their small business deductions. In response, the 2016 Federal Budget has taken steps to close these gaps in the legislation and limit the use of the small business deduction to its original intention.   

What's new?

Effective for taxation years beginning after March 22, 2016, legislative changes limit access to the small business deduction for certain partnership and corporation structures. In particular, those structures in which a corporation provides property or services to a partnership or another corporation with common ownership will be affected.  

Background

The small business deduction (SBD) is a tax deferral available for Canadian Controlled Private Corporations (CCPCs) amounting to a maximum tax credit of 17.5 per cent on a CCPC's first $500,000 of active business income. Each associated group of CCPCs is entitled to one $500,000 business limit, which may be allocated among the group. Similarly, a CCPC that is a member of a partnership may claim an SBD equal to the lesser of its active business income earned from the partnership and its proportionate share of the partnership's notional $500,000 business limit.  

The Changes

Overview

The 2016 Federal Budget introduced the concepts of "designated member," "specified corporate income" and the exclusion of certain types of property income earned from associated corporations for the purposes of claiming the SBD. These changes have closed previous gaps in the legislation that allowed for the unintended multiplication of SBDs.

Designated member and specified corporate income

If you are a member of a partnership and property or services are provided (directly or indirectly) to that partnership through a non-member CCPC of which you are a shareholder (or are related to a shareholder), that CCPC may be considered a designated member of the partnership. A designated member will no longer be entitled to its own SBD. The CCPC will only have access to the SBD to the extent that its related partner assigns that partner's portion of the partnership's $500,000 business limit to it.  

Similarly, if you are a shareholder of a CCPC that provides property or services (directly or indirectly) to another (recipient) CCPC in which you own an interest, the first CCPC may be deemed to earn specified corporate income. A CCPC earning specified corporate income is no longer entitled to its own SBD. The CCPC may only claim an SBD to the extent that the recipient CCPC allocates a portion of its $500,000 business limit to it.     

Income from property earned from associated corporations

The SBD is intended for active business income (ABI) and not income from property (i.e. rent, royalties, interest). The Income Tax Act (Canada) (the Act), however, does provide an exception for income from property earned from an associated corporation if that corporation earns ABI. Consider, for example, the corporate structure in the image below. Interest, management fees or rental income earned from A Co. and C Co. are income from property but are deemed to be ABI, assuming B Co. is earning ABI. This re-characterization allows A Co. and C Co. to claim the SBD. The issue arises when the group also makes an election under s. 256(2) of the Act – the so-called "third corporation election"– to disassociate two corporations that are only associated through a third corporation. This election will now break the re-characterization of income from property, and CCPCs likeA Co. and C Co. will no longer be entitled to the SBD.

So, what do we do now? 
If any of the above structures sound familiar and you think your days of paying low corporate rates are over, we may be able to provide some comfort. 

Don’t worry about it! 

Your corporate structure will continue to provide the benefit of low corporate tax rates of between 25 per cent and 30 per cent, depending on your province. With top marginal rates paid personally of 50 per cent or more, there is still a significant deferral available by earning income through a corporation.

In addition, the SBD is, in fact, a deferral of tax and not a true tax savings due to the concept of integration, which provides a correlation between corporate, dividend and personal tax rates. Integration ensures the government eventually receives its approximately 50 cents on every dollar earned, whether it is earned through a corporation first and then paid out to the shareholders, or earned by the shareholders directly. For income earned through a corporation, the tax rate paid by the shareholder on dividend income is adjusted to account for the tax rate paid by the corporation. Thus, income that is taxed at the higher, non-small business rate in a corporation can be paid to its shareholders as eligible dividends, which are taxed favorably at the personal level. On the other hand, income taxed at the small business rate in a corporation must be paid to the shareholders as ordinary dividends, which are taxed at a higher rate than eligible dividends. 

If your corporation is not taking advantage of the deferral by reinvesting its after-tax earnings into its operations and instead paying the majority of it out to its shareholders each year, these changes will not significantly affect your overall tax bill, as illustrated herei:

Consider other arrangements 

If the deferral provided by the SBD is vital to your business, consider the following strategies.

Separate your businesses

If you can reasonably separate your business into smaller business units that can then be spun off to separate corporations, you may be able to increase your access to the SBD. For example, if you operate two franchise locations within one corporation, you may want to separate each location into its own corporation. This spin-off can generally be done on a tax-deferred basis and, if the ownership is structured properly, may allow for multiple SBDs. There are, of course, non-tax issues to consider, such as franchise, employment, banking and supplier agreements. A recent decision by the Federal Court of Appealii suggests that actual control of each corporation is a relevant consideration, looking at factors other than mere share ownership.   

Joint ventures and cost-sharing arrangements

A group of individuals in the same line of business may enter an agreement to share costs without the formality of a partnership or central billing corporation. The individuals run their businesses through their existing corporations, maintaining their own customers and the ability to claim the small business deduction. However, the benefits of sharing costs (such as overhead, administrative costs and staffing costs) that a partnership affords remain available through the joint venture or cost-sharing agreement. Again, there are non-tax considerations that may make these arrangements impractical for certain businesses. For example, joint ventures do not limit the legal liability of their venturers.  

Contact your Collins Barrow advisor to discuss further how these changes may affect your business.   

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 Mondaq.com.

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

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (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 www.mondaq.com

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 Mondaq.com’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.

Disclaimer

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.

Registration

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 unsubscribe@mondaq.com 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.

Cookies

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.

Links

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.

Mail-A-Friend

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.

Security

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 webmaster@mondaq.com.

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 EditorialAdvisor@mondaq.com.

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 enquiries@mondaq.com.

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