16 February 2004 Internal T.I. 2003-0051701I7 - Interaction of ss 256(2) and 125(5.1)

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.

Principal Issues: Whether an election under subsection 256(2) of the Act allows an otherwise associated corporation to use the full $10 million capital deduction when calculating its LCT for purposes of the business limit reduction under subsection 125(5.1)?

Position: No.

Reasons: Since an election filed under subsection 256(2) applies for purposes of section 125 only, it is our view that there is no basis for giving effect to an election under this provision when determining a corporation's LCT under section 181.1.

		February 16, 2004

	Hubert Dubois	HEADQUARTERS
	Group Head	Karen Power, CA
	Verification and Enforcement Division	(613) 957-8953
	Montreal, TSO
		2003-005170

Interaction between subsections 125(5.1), 256(2) and Part I.3 of the Income Tax Act

We are writing in reply to your letter of December 3, 2003 regarding the above-noted subject matter. You have asked that we confirm your understanding of our technical interpretation E2000-0036535 dated May 7, 2001.

For simplicity we have restated the facts described in the May 7, 2001 technical interpretation.

1. Aco, Bco and Cco are all Canadian-controlled private corporations ("CCPCs").

2. Aco is associated with Bco.

3. Cco is associated with Bco.

4. Aco would not be associated with Cco except for the provisions of subsection 256(2) of the Income Tax Act (the "Act").

5. Aco, Bco, or Cco is not associated with any other corporation.

6. Bco has always filed an election pursuant to subsection 256(2) not to be associated with Aco or Cco.

7. Aco, Bco and Cco each have taxable capital employed in Canada in the preceding year for the purposes of subsection 181.1(1) of the Act of $7 million.

8. Aco, Bco and Cco are related and associated for purposes of the large corporation tax ("LCT") under Part I.3 of the Act; consequently, the $10 million capital deduction under section 181.5 of the Act is allocated equally resulting in LCT payable for each company in the preceding year of $8,250.

The concern in this situation was how to apply the business limit reduction in subsection 125(5.1) of the Act to Cco.

The proposed amendments to subsection 125(5.1) in the December 20, 2002 draft legislation did not apply to the years at issue in the above situation, nor to the situation you are currently reviewing. Accordingly, we have limited our discussion to the law as currently enacted.

Our Comments

Where two corporations that would otherwise not be associated with each other are deemed, by virtue of subsection 256(2) of the Act, to be associated with one another solely by virtue of the fact that they are both associated with a third corporation and the third corporation elects, pursuant to subsection 256(2) of the Act, not to be associated with either of the other two corporations, then the other two corporations would not be associated with each other only for the purposes of section 125 of the Act. In addition, the third corporation which elects under subsection 256(2) will be deemed to have a business limit of nil for the taxation year for which it files such an election.

A CCPC's access to the small business deduction is restricted by subsection 125(5.1) of the Act through the reduction of its annual business limit. In general terms, subsection 125(5.1) of the Act provides that the business limit of a CCPC will be reduced if tax under Part I.3 of the Act was payable by the corporation for its preceding taxation year. If the corporation is associated with one or more other corporations in the particular year, paragraph (b) of variable 'B' of subsection 125(5.1) of the Act requires the CCPC to take into account the Part I.3 tax payable by it and those other corporations for their last taxation years that ended in the preceding calendar year.

In computing the value for variable 'B' in the formula in subsection 125(5.1) of the Act, paragraph (a) provides that where the corporation is not associated with any other corporation in the particular year, variable 'B' will equal the amount that would, but for subsections 181.1(2) and (4), be the corporation's tax payable under Part I.3 for its preceding taxation year. An election filed under subsection 256(2) of the Act applies for purposes of section 125. In the above situation, as Bco has elected under subsection 256(2) of the Act, Cco is not associated with any other corporation for purposes of section 125, consequently Cco's business limit reduction under subsection 125(5.1) of the Act would be computed pursuant to paragraph (a) of variable 'B' and only Cco's Part I.3 tax for the preceding year would relevant in determining it's business limit reduction. Paragraph (b) of variable 'B' does not apply and consequently Aco's and Bco's Part I.3 tax for the preceding year are not relevant for Cco's business limit reduction.

However, as noted in file E2000-0036535, since an election filed under subsection 256(2) applies for purposes of section 125 only, there is no basis for giving effect to an election under subsection 256(2) when determining a corporation's LCT under section 181.1 of the Act or for recomputing this LCT for purposes of section 125 of the Act. Even though an election has been filed by the third corporation, all three corporations would continue to be associated corporations for the purposes of subsection 181.5(7) of the Act. Consequently in computing Cco's Part I.3 tax for the preceding year, the $10 million capital deduction under section 181.5 of the Act must still be allocated between Aco, Bco and Cco, such that, in the situation described above, Cco would use $8,250 as its variable 'B' in the formula in subsection 125(5.1) of the Act.

We hope are comments are helpful.

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch