The Small Business Deduction ("SBD") is a mainstay in the Canadian taxation of small-to-medium sized Canadian-controlled private corporations' ("CCPC") business profits. The SBD reduces a CCPC's tax rate on its first $500,000 of business profits to a rate of between 10.5% to 15% depending on the province or territory (Quebec being the outlier at 18.5%). This lower tax rate enables small businesses to reinvest more profits. It also provides an opportunity to split income with family members by paying dividends from after-tax profits to individuals that otherwise have low income, which results in them paying minimal personal tax.
These benefits make accessing multiple SBDs an attractive business goal. The Income Tax Act contains rules that prevent SBD multiplication by restricting each "associated" group of corporations to one shared $500,000 Small Business Limit ("SBL"). A corporation's association status is determined by a number of rules that look at family ownership.
Not directly restricted under the existing rules is the payment of fees between non-associated corporations. The 2016 Federal Budget proposed a new set of rules intended to restrict perceived abuses of the ability to multiply the SBD. The new rules apply for corporate taxation years starting on or after March 22, 2016.
How will the new rules impact non-associated corporations?
The changes also impact partnerships with corporate partners but the following comments focus on the payment of fees between two non-associated corporations.
The new rules will impact any situation where fees are paid from one private corporation to another when there is even a minimally direct or indirect ownership connection between the two corporations. "Direct or indirect interest" is not defined but it is a very broad term that may not only refer to share ownership. These rules go far beyond the reach of the current association rules. For example, take the following scenario.
Aco and Bco are not associated. Therefore they each are entitled to a $500,000 SBL under the existing rules. However, under the new rules, if Aco pays fees to Bco, Bco is not able to claim a SBD with respect to that income.
Are there any relieving provisions?
The restriction on claiming the SBD does not apply if at least 90% of recipient corporation's income is derived from unrelated parties. So, in our example, if Bco generates 90% of its income from unrelated parties and 10% from Aco, the restriction will not apply and Bco will not be restricted from claiming the SBD on all of its income, including the income generated from Aco.
But what if we are not trying to multiply the SBD?
The new rules will apply regardless of whether or not the intent is to multiply the SBD. If we assume, in our example, that Aco has $500,000 of active business income prior to paying a $100,000 fee to Bco (Bco's only income), Bco will not be entitled to claim the SBD on the $100,000 income.
In this situation, relief can be found when the payor corporation assigns some of its SBL to the recipient corporation. In our example, Aco could assign $100,000 of its SBL to Bco reducing Aco's SBL to $400,000 and allowing Bco to use the $100,000 against its income derived from Aco.
The ability to assign the SBL is subject to a number of restrictions and both corporations must report the amount assigned on a form included with their tax returns.
In summary, the new rules could represent a significant change for some corporate structures.
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.
