10 October 2000 External T.I. 2000-0038685 - Reserves

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether initiatives promised under the 2000 Ontario Budget regarding providing professionals with the ability to carry on their activities through a corporation would change the position in our Document No. 9530795 to permit the individual to claim the 34.2(4) reserve, since there will be some mitigating differences such as no limitation of liability, etc.

Position:

No.

Reasons:

Position is based primarily on subparagraph 34.2(6)(c)(i) which deals strictly with a taxpayer that is an individual where in order to claim the reserve in a taxation year, the business must be carried on at the beginning of the year by the individual.

An individual who incorporates his business becomes a "person" separate from the corporation.

The definition of the term "corporation" in the Act as well as in the Ontario Business Corporations Act.

XXXXXXXXXX 							F.B. Fontaine, FCCA
								2000-003868
Attention:  XXXXXXXXXX 

October 10, 2000

Dear Sirs:

Re: Deduction of Reserve under Subsection 34.2(4) of the Income Tax Act
Incorporation of Sole Proprietorship into Professional Corporation

This is in reply to your letter dated July 18, 2000 concerning our document, number 9530795 dated March 7, 1996 (the "Document"), in which we indicated that an individual who incorporated his sole proprietorship in 1995 would not be allowed, by virtue of subsection 34.2(6) of the Income Tax Act (the "Act"), to deduct a reserve under subsection 34.2(4) of the Act for the 1996 and subsequent taxation years.

You stated that the Ontario Budget of May 2, 2000 promised to provide regulated professionals in Ontario with the ability to operate their professional activities through a corporate entity. Accordingly, you asked whether the above position would apply to deny the deduction of the reserve upon incorporation, given that:

(a) the limitation of liability that typically accompanies incorporation will not be avoided, and

(b) share ownership of the corporate entity will be held solely by accredited professional individuals.

Our comments:

1. The position described in the Document was predicated primarily on the requirements of subparagraph 34.2(6)(c)(i) of the Act which provides that no reserve may be deducted in computing a taxpayer's income for a taxation year from a business "where the taxpayer is an individual, and at the beginning of the year, the business is not carried on principally by the individual nor by members of a partnership of which the individual is a member". Since paragraph 34.2(6)(c) refers only to individuals (whereas paragraph 34.2(6)(b) of the Act deals strictly with corporations), essentially these requirements would appear to recognize that for the purposes of the Act, the individual would not be the same "person" that carried on the business following the incorporation of the individual's sole proprietorship. This is supported by the definitions of the terms "corporation", "individual" and "person" under subsection 248(1) of the Act.

2. Under the Act, a "corporation" is defined to include an incorporated company while the Ontario Business Corporations Act defines the term as a body corporate with share capital and defines "body corporate" as any body corporate with or without share capital.

3. Accordingly, an individual who incorporates his sole proprietorship would, for tax purposes, not only be a person separate from the corporate entity created but also would normally be a shareholder and/or employee of that corporate entity. In such a situation, the individual who holds a position in either capacity would no longer be considered to continue carrying on the previous business, or to be carrying on the incorporated business. Whether, as a result of the Ontario Budget proposals, an individual who incorporates his/her business in a particular taxation year would be entitled to claim a reserve under subsection 34.2(4) of the Act in a subsequent year, would depend on the enactment into law of the particular Budget proposals and any consequential changes, as they relate to subsection 34.2(6) of the Act and, among other things, to the definition of the term "corporation" in the Act and the Ontario Business Corporations Act.

4. Subject to the enactment and appropriate amendments to the law referred to above, it is our view that subparagraph 34.2(6)(c)(i) of the Act would apply to the situation described in your letter to deny a reserve upon the incorporation of a sole proprietorship.

We trust that the comments above which represent an expression of opinion will be of assistance. As stated in paragraph 22 of Information Circular 70-6R3, written opinions are not advance income tax rulings and, accordingly, are not binding on the Canada Customs and Revenue Agency.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch