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: (1) whether the formula in subsection 125(5.1) acts to reduce the business limit of a corporation who has taxable capital in excess of $10 million employed in Canada; (2) whether a CCPC which had taxable income in the preceding year of zero and a business limit of zero is a qualifying corporation for the purposes of refundable ITCs.
Position: (1) yes; (2) no.
Reasons: (1) Subsection 125(5.1) provides a formula which reduces the business limit of a corporation when taxable capital in excess of $10 million is employed in Canada. Paragraph 87 of IT-151R5, and Finance's Technical Notes support this position. (2) When taxable capital is employed in Canada in excess of $15 million the formula in subsection 125(5.1) acts to eliminate the corporation's business limit.
April 28, 2006
SR&ED Directorate HEADQUARTERS
Mr. Kevin Gibson S. Lewis
Technical Guidance Division 941-7239
50 O'Connor Street
2005-016161
XXXXXXXXXX. - Entitlement to Refundable Investment Tax Credits
We are writing in reply to your request dated November 28, 2005, concerning:
(1) the application of subsection 125(5.1) of the Income Tax Act ("Act") in determining a Canadian-controlled private corporation's ("CCPC's") business limit; and
(2) the application of paragraph (b) in the definition of qualifying corporation in subsection 127.1(2) of the Act to a CCPC in a situation in which the total taxable income of the CCPC and its associated corporations was zero and the associated corporations' combined taxable capital employed in Canada was in excess of $15 million.
You describe a situation where XXXXXXXXXX, a CCPC, filed a claim for a refund of $XXXXXXXXXX in respect of investment tax credits ("ITC") earned in its XXXXXXXXXX taxation year on the basis that it was a "qualifying corporation" as defined in subsection 127.1(2) of the Act. XXXXXXXXXX is part of a group of associated corporations that has taxable capital employed in Canada in excess of $15 million. The corporate group filed an agreement (the "Agreement") pursuant to subsection 125(3) of the Act allocating to XXXXXXXXXX a business limit of $XXXXXXXXXX for its XXXXXXXXXX taxation year. The business limit was subject to reduction under subsection 125(5.1). The total tax under Part I.3 of the Act of the group of associated corporations to be used as the value of parameter B in the formula in subsection 125(5.1) was $XXXXXXXXXX. Accordingly, despite the Agreement the formula in subsection 125(5.1) resulted in a computed amount of $XXXXXXXXXX which reduced XXXXXXXXXX business limit of $XXXXXXXXXX to nil. XXXXXXXXXX and its associated corporations incurred losses and had no taxable income in their XXXXXXXXXX taxation years. Your concern is whether XXXXXXXXXX was a "qualifying corporation" as defined in subsection 127.1(2) of the Act for its XXXXXXXXXX taxation year. This is relevant for determining whether XXXXXXXXXX is entitled to the "refundable investment tax credit" as defined in subsection 127.1(2) of the Act. Whether XXXXXXXXXX was a qualifying corporation in XXXXXXXXXX is dependent on whether or not there was a business limit in XXXXXXXXXX for the purposes of paragraph (b) of the definition "qualifying corporation" in subsection 127.1(2).
Hereinafter all references to provisions are in the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended (the "Act"), unless stated otherwise.
Claimant's Opinion
The claimant's representative effectively submits that our interpretation in Interpretation Bulletin IT-151R5 is in error. His submission outlines two arguments. The first argument is a technical analysis of the provision where the taxpayer's representative suggests that the formula in subsection 125(5.1) does not reduce the businesses limit of XXXXXXXXXX. According to the representative, the preamble of subsection 125(5.1) and in particular the wording "...a...corporation's business limit...is the amount, if any," requires that the business limit computed under the subsection must be a positive amount; since XXXXXXXXXX business limit otherwise determined under the Agreement was $XXXXXXXXXX and this amount is less than the reduction amount of $XXXXXXXXXX computed by the formula in subsection 125(5.1), a positive amount of business limit cannot be computed for XXXXXXXXXX under subsection 125(5.1); accordingly, subsection 125(5.1) is inapplicable and, by default, the business limit of XXXXXXXXXX remains at $XXXXXXXXXX.
In the alternative, the taxpayer's representative submits that the calculation of the business limit pursuant to subsection 125(5.1) results in zero not nil. He submits that a business limit of zero does not mean that there is no business limit and as a consequence XXXXXXXXXX should qualify as a qualifying corporation. He suggests that even if the business limit is zero, taxable income of zero does not exceed the business limit of zero and thus, on that basis, XXXXXXXXXX may be a qualifying corporation.
Tax Services Office Position
It is your position that the CRA interpretation outlined in paragraph 87 of IT-151R5 and confirmed in our technical interpretation #2003-0047991I7 is correct. As a result, it is your opinion that the taxpayer's arguments are unfounded and that the TSO has correctly determined that XXXXXXXXXX is not a qualifying corporation and is thus not entitled to a refundable ITC.
It is your understanding that the claimant's representative believes that the CRA has determined that XXXXXXXXXX does not have a business limit because the business limit is eliminated.
We have carefully considered the taxpayer's representative's submission. It is our view that the CRA interpretation set out in paragraph 81 of IT-151R5 that subsection 125(5.1) acts to gradually eliminate the business limit of a CCPC when taxable capital employed in Canada is in excess of $10 million is an appropriate and supportable interpretation of this subsection. The wording "...a... corporation's business limit... is the amount, if any" in the preamble of subsection 125(5.1) requires that a positive amount of business limit be calculated after subtracting the reduction amount computed by the formula in the subsection. This requirement is not met by XXXXXXXXXX because the amount of reduction by the formula in subsection 125(5.1) of $XXXXXXXXXX exceeds its business limit otherwise determined of $XXXXXXXXXX and in such case the corporation would not have a business limit. In our view, it would not be reasonable to interpret subsection 125(5.1) such that, on one hand, if a certain amount of Part I.3 tax reduces the business limit otherwise determined of $XXXXXXXXXX to a positive amount of, say, $0.01, the business limit would be $0.01, and on the other hand, if the amount of Part I.3 tax is much higher than that certain amount, the business limit would remain at $XXXXXXXXXX.
Accordingly, we support our position in paragraph 87 of IT-151R5, which states that:
...corporations (and associated corporations) whose taxable capital employed in Canada in the previous taxation year ... exceeds $15 million will not have a business limit (see paragraph 81) and, therefore will not meet the conditions to be a qualifying corporation. Because they will also have an expenditure limit that is nil (see paragraph 81), they will be prevented from earning refundable ITCs.
XXXXXXXXXX
We would also mention that the CRA position that subsection 125(5.1) acts to reduce and, in appropriate circumstances, phase out the business limit of a corporation is in accordance with tax policy as reflected in the Department of Finance's December 1995 Technical Notes, which stated:
Subsection 125(5.1) restricts larger corporations' access to the small business deduction through the gradual reduction of their annual business limit. This reduction phases out the small business deduction, on a straight-line basis, for corporations having taxable capital employed in Canada in excess of $10 million.
Although the effect of 125(5.1) is to phase out the small business deduction on the basis of a corporation's taxable capital employed in Canada, it uses a corporation's tax payable under Part I.3 of the Act (Tax on Large Corporations) in the computational formula to determine the applicable reduction in the corporation's business limit. The reduction is computed as the proportion of a corporation's business limit that the ratio of its Part I.3 tax liability in the preceding taxation year is to $10,000 (the tax payable under Part I.3, at the current rate of .02%, on taxable capital employed in Canada of $15 million).
S. Parnanzone
Manager
Business Incentives and Capital Transactions Section
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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