Blog: Restricting access to the Federal Small Business DeductionJuly 8th, 2016
The 2016 federal budget introduced several legislative changes to limit access to the federal small business deduction (SBD) among partnership and corporate groups. They are to apply to taxation years beginning after March 21, 2016. The SBD provides small business with a low rate (10.5%) of federal corporate tax on the first $500,000 of its active business income.
Election by a third corporation not to be associated
Currently, where two corporations are associated solely because they are each associated with a common third corporation, an election is available for the third corporation to opt not to be associated. This allows each of the first two corporation’s full access to its own SBD limit while the third corporation’s limit is Nil.
As proposed, the election will continue to associate the third corporation for all other purposes of the Income Tax Act. For example, the $15 million taxable capital limit will apply to the group and could potentially reduce the SBD limit of the other two corporations.
Further, when the election applies, investment income received from the associated third corporation’s active business (e.g. rent) will continue to be deemed active business income, however, it will no longer be eligible for the SBD.
In the past, partnerships have been structured to avoid the specified partnership income (SPI) rules that require corporate partners to share the SBD. Common strategies by doctors, lawyers and other professionals included incorporating professional corporations (PC) that were not partners of the professional partnership. The PCs charged a fee for services to the partnership. As the PCs were independent of the partnership, the income was not considered SPI and therefore each partner’s PC was entitled to a full SBD. In the past, this strategy was supported by a number of rulings issued by CRA. This allowed access to multiple SBD limits among large professional practices.
The budget introduces a new concept: designated member of a partnership to limit the benefit of these structures. This applies to a corporation where more than 90% of its active business income is earned by providing services to persons or partnerships with which the corporation does not deal at arm’s length. This could apply where the individual shareholder is a partner or where a partner’s spouse owns a corporation that provides services to the partnership.
The result, should a corporation be deemed a designated member of a partnership, is that its income will be treated as SPI and a single SBD limit must be shared among actual and designated corporate partners.
Similarly, the budget introduces a term – specified corporate income to restrict multiple access to the SBD among certain corporate groups. Specified corporate income is income from the provision of services or property to a private corporation, if the corporation, one of its shareholders, or a person not dealing at arm’s length with one of them, holds a direct or indirect interest in the private corporation receiving the services, and if greater than 9.9% of the corporation’s income from an active business is from providing services to those with which the corporation does not deal at arm’s length. The result is that income that is found to be SCI of the corporation will be denied the SBD. Companies could be caught under the new rules even if the two companies themselves are not associated.
The budget provides for a payor corporation to assign a portion of its SBD to a recipient company within the corporate group, up to the level of the recipient’s SCI. The assignment provision is beneficial where income from the active business is less than $500,000.
How significant are these restrictions to access to the small business deduction?
At the corporate level, the restrictions are significant as the differential between the general corporate tax rate and the small business tax rate on active business income is 11.5% in Ontario and 8.4% in Quebec.
It is important to assess the impact of these proposals on the availability of the SBD within your corporate or partnership group. Planning or restructuring may be warranted to minimize the negative tax consequences.
Please contact the Crowe BGK tax group for more information.
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