21 January 2013 External T.I. 2012-0468831E5 - Reduction of a CCPC's Annual Business Limit

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 subsection 125(5.1) is applicable where a CCPC is associated with a corporation that is fully exempt from tax under section 149.

Position: Yes.

Reasons: Wording of the law.

XXXXXXXXXX
2012-046883
Charles Rafuse
613-247-9237

January 21, 2013

Dear XXXXXXXXXX

Re: Business Limit Reduction under Subsection 125(5.1)

This is in response to your email of November 7, 2012, wherein you requested our interpretation regarding the business limit reduction under subsection 125(5.1) of the Income Tax Act (the "Act") in a situation where a Canadian-controlled private corporation is associated with another corporation that is fully exempt from Part 1 tax under section 149 of the Act ("NPO").

Our Comments

Generally, subsection 125(1) of the Act provides a small business deduction ("SBD") from Part 1 tax otherwise payable for a taxation year by a corporation that was, throughout the taxation year, a Canadian controlled private corporation ("CCPC") as that term is defined in subsection 125(7) of the Act. The SBD for a particular taxation year is equal to 17% of the least of three amounts, which in general terms can be described as:

• active business income (paragraph 125(1)(a));
• taxable income (paragraph 125(1)(b)); and
• the business limit (paragraph 125(1)(c)).

A CCPC's access to the SBD may be restricted by subsection 125(5.1) of the Act through the reduction of its annual business limit. Subsection 125(5.1) is proposed to be amended, subject to a transitional provision. The reduction of the business limit under subsection 125(5.1) as currently enacted is calculated by the formula A x (B/$11,250), where A is the CCPC's business limit and B represents the CCPC's Part I.3 tax liability (adjusted if the CCPC is associated with one or more other corporations).

For more information about the application of the current version of subsection 125(5.1) of the Act, see Interpretation Bulletin IT-73R6, The Small Business Deduction.

For taxation years that begin after December 20, 2002, subject to a transitional provision referred to below, a proposed amendment to subsection 125(5.1) of the Act would compute the amount for parameter B by way of a formula, whereby the taxable capital employed in Canada (within the meaning assigned by subsection 181.2(1) or 181.3(1) or section 181.4, as the case may be) (adjusted if the CCPC is associated with one or more corporations), in excess of $10 million, is multiplied by 0.225%.

The transitional provision mentioned above applies to a corporation described in subsection 181.1(3) of the Act (i.e. that is not subject to tax under Part 1.3 of the Act) for taxation years that begin before the proposed amendment to subsection 125(5.1) of the Act referred to above receives Royal Assent. The transitional provision stipulates a special way for computing the amount for parameter B in the formula under subsection 125(5.1). Under the transitional provision, in computing the business limit reduction under subsection 125(5.1) for a particular year, the value for parameter B is computed with reference to the Part I.3 tax liability if the CCPC is not associated with another corporation in the particular year. However, under the transitional provision, if the CCPC is associated with one or more corporations in the particular year, the value of parameter B is computed by way of a formula that takes into account the taxable capital employed in Canada (within the meaning assigned by subsection 181.2(1) or 181.3(1) or section 181.4, as the case may be), not unlike the manner in which the value of B is computed under the proposed amendment to subsection 125(5.1) discussed above.

The transitional provision contemplates that a CCPC that is associated with one or more particular corporations may suffer a reduction of its business limit under subsection 125(5.1). As explained above, the value of parameter B is computed by way of a formula that takes into account the taxable capital employed in Canada of the associated corporations.

Accordingly, in a situation such as you have described, a CCPC would have to take into consideration the taxable capital of a corporation that is an NPO in determining its reduction of the business limit under subsection 125(5.1) of the Act. We would also mention that the CRA responded to a similar question (Q36) at the 2008 APFF Conference (see 2008-0285371C6 (F)).

We trust that these comments will be of assistance.

Yours truly

Michael Cooke, C.P.A., C.A.
Manager
Business and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch