The CRA recently provided a technical interpretation where it discussed the application of the "specified corporate income" rules as proposed in the 2016 federal budget.
The taxpayer in this case had a fairly common corporate setup, see below:
A holding company owned the operating company, OpCo (100%), and the Landco (51%). LandCo would charged Opco for the use of its land and building. Opco operated as an active business from that premises. The question posed to the CRA was whether LandCo could claim the small business deduction on all its income from Opco despite only holding 51% of the shares.
The answer was fairly straight forward – namely, that yes it could claim the small business limit but that since all corporations are control by the same person, HoldCo, they are associated corporations and must share the small business limit of $500,000.
The more interesting part was that the CRA continued by also examining the implications of the proposed "specified corporate income" rules that take effect next year.
The application of the specified corporate income rule was first outlined, as such:
Generally speaking, under the proposed rules, a CCPC's active business income from providing services or property (directly or indirectly, in any manner whatever) in its taxation year to a private corporation will be ineligible for the SBD where, at any time during the year, the CCPC, one of its shareholders or a person who does not deal at arm"s length with such a shareholder has a direct or indirect interest in the private corporation. This type of income is referred to as "specified corporate income" ("SCI") under the proposed definition in subsection 125(7) of the Act. However, a private corporation that is a CCPC will be entitled to assign all or a portion of its unused BL to one or more CCPCs having SCI that would otherwise be ineligible for the SBD under the proposed rules. (my emphasis)
The CRA went on to provide an example:
Assume Landco earns $500,000 of SCI during the year from the provision of property to Opco. Also assume an initial allocation of 50% of the BL under subsection 125(3) is made to Landco and Opco such that the total of the percentages assigned does not exceed 100%. Under the proposed rules, in order to allow Landco to claim the SBD pursuant to subsection 125(1), Opco must assign its $250,000 BL to Landco under subsection 125(3.2). After the assignment, Opco"s BL is reduced to nil under subsection 125(3.1) of the Act with no corresponding increase to Landco"s BL. Accordingly, Landco could only claim the SBD on $250,000 which represents the least of the amount assigned from Opco under subsection 125(3.2) and the BL initially allocated to it pursuant to subsection 125(3). This result appears to be unintended since $250,000 of the BL is lost.
There indeed appears to be an unintended consequences in the new specified corporate income rules where a portion of the small business limit simply disappears, greatly reducing the available limit.
The CRA goes on to state that the matter is being referred back to the Minister of Finance for consideration (i.e., correction):
The Canada Revenue Agency is responsible for administering the tax system and applying current legislation, whereas the Department of Finance is responsible for developing tax policy and legislation. Therefore, we have referred this matter to the Department of Finance for their consideration.
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