S. 125(5.1)(b) passive income grind can be avoided by winding-up subs

The passive income grind to the small business deduction under s. 125(5.1)(b) potentially can be avoided by promptly winding-up an associated corporation that has realized a passive gain. For example , if Holdco holds Opco and Realtyco, and Realtyco realized a capital gain from selling its land in Year 1, and Realtyco is wound-up before the end of Year 1, then that passive gain will neither affect Opco’s ability to claim the SBD in Year 1 (because s. 125(5.1)(b) operates on a lagged basis) nor in Year 2 (because in Year 2, Realtyco no longer is associated with Opco).

If the passive asset with the accrued gain instead is held by Holdco, Holdco could drop-down that asset to a Newco sub under s. 85(1), with Newco then selling the asset and being promptly wound-up. However, in “this situation…GAAR must be considered” (see e.g., Iberville re using s. 85 to avoid rather than defer tax).

Neal Armstrong. Summary of Martin Lee and Thanusan Raveendran, “Possible Anomaly in the Passive Income SBD Grind?,” Canadian Tax Focus, Vol. 9, No. 4, November 2019, p.1 under s. 125(5.1)(b).