The Small Business Deduction & Private Campgrounds Tax Audits – A Canadian Tax Lawyer Analysis
Small Business Deduction
The small business deduction is set out in section125 of the Canadian Income Tax Act. Corporations that qualify for the small business deduction pay reduced rates of both federal and provincial tax. Qualifying corporations have a federal tax rate of 11% compared to the 15% general corporate tax rate. The small business deduction rates and general corporate rates differ province by province, but for example, the general rate in Ontario is 11.5% while the small business rate is 4.5%. Clearly this deduction greatly benefits Canadian small businesses. However, in order to qualify, there are a number of requirements.
Eligibility for Small Business Deduction
First, the corporation must qualify as a Canadian controlled private corporation (CCPC). As the name suggests, the corporation must be resident in Canada and it must be de facto controlled by a Canadian resident. The corporation must also be a private corporation, meaning that it does not have any shares or stocks traded on a designated stock exchange. Additionally, the small business deduction only applies to the active business income of a corporation – meaning income from the corporation’s regular active business operations but not passive sources of income such as investment income or rent or royalties. Furthermore, a qualifying corporation can only claim the small business deduction on a maximum of $500,000 of income. Anything the corporation earns above that amount is taxed at the general tax rate. Our top Canadian tax law firm can advise your SME about all of the tax deductions available.
Specified Investment Business – Aggregate Investment Income
A specified investment business is a special classification of corporation where the principal purpose of the business is to derive income from property. Essentially, this applies to corporations whose main purpose is to earn investment income, including rental income, interest, royalties, and dividends. However, where a corporation hires more than 5 full time employees, it will not be characterized as a specified investment business. Most notably, specified investment businesses earn what is called aggregate investment income, which is taxed at much higher rate than other corporations. While it varies from province to province, aggregate investment income is taxed at a combined federal and provincial tax rate between 49% and 55%. The policy behind this high rate is to discourage individuals from benefitting from a tax deferral by putting their personal investment portfolios into corporations; as such, the aggregate investment income rate is designed to approximate the top marginal personal tax rate. Talk to one of our experienced Canadian tax lawyers to make sure your corporation is not going to be taxed in way that will hurt you.
Private Campgrounds – Small Business Deduction and Audits
A private campground is a privately owned recreational facility that offers temporary access to individual campsites to the public for set rates. These campgrounds may offer a variety of services or facilities to their guests such as laundry facilities, swimming pools or showers, though some may also offer no additional services or facilities. In the past, private campgrounds were seen as service-based small businesses and usually claimed the small business deduction and thus paid a low rate of corporate tax. However the Canada Revenue Agency (CRA) has recently begun auditing these private campgrounds and reassessing them as specified investment businesses with a corresponding increase of their tax rate from being 15.5% to 50% in Ontario and similar increases in other Canadian provinces. The reason for these tax reassessments is that the CRA does not consider the business that private campgrounds carry out – renting campsites to the public – to be active business. The CRA argues that corporations that simply rent out space to others are actually specified investment businesses and thus should pay tax at aggregate investment income rates unless they employ more than 5 full time employees. However, this characterization does not seem to be identical across the board. The CRA has indicated that some private campgrounds do qualify, particularly the ones that provide additional services and facilities such as pools, laundry facilities, playgrounds and shops. Generally, the more services the campground provides and the more important the additional services are to the campground’s success, the more likely the business would be characterized as active business and thus qualify for the small business deduction and consequently escape characterization as a specified investment business. Our team of motivated and professional Canadian tax lawyers can deal with tax audits and tax auditors on your behalf and help your business come out unscathed.
Next Steps for Private Campgrounds
Private campground owners going forward should be cognizant of the CRA’s campground auditing and plan accordingly. The CRA has indicated that private campgrounds which offer few additional amenities and facilities are most at risk to be audited and reassessed as specified investment businesses. On the other hand, private campgrounds with significant additional facilities which are key to their success are likely to still be able to access the small business deduction. Looking forward, the addition of a few more facilities may be the difference between a 15.5% tax rate and a 50% rate – see our expert Canadian tax lawyers and make sure your corporation meets the tax requirements. On the other hand, qualifying in the future does not mean the CRA will not audit campgrounds’ past returns. If the CRA has not contacted you about your private campground business, there may be an opportunity to use the voluntary disclosure program (VDP or Tax Amnesty) that is offered by the CRA. If accepted, a disclosure under this program will require that a taxpayer pays the taxes that they owe. In exchange, the CRA will waive all penalties and may reduce the interest that would have accrued on the outstanding tax debt.