30 August 1989 Internal T.I. 73959 F - Active Business Income vs. Property Income

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.

Subject: 24(1) Active Business Income vs. Property Income

We are writing in reply to your memorandum of May 25, 1989, wherein you requested our comments related to the treatment of interest income, from investments held by 24(1).  The facts related to your request were as follows:

24(1)

Auditor's Position

The auditor's opinion is that the interest earned from investments constitutes income from property within the meaning of subsection 129(4.1) of the Income Tax Act (the "Act") on the basis that the investment activities of the corporation constitute a "specified investment business" as defined in paragraph 125(7)(e) of the Act. In the auditor's view the investment activities are a separate and distinct business unrelated to the manufacturing business.

This position is based on the following:

1)     

2)     24(1)

3)     

Taxpayer's position

The taxpayer is of the opinion that income earned from investments should be reported as active business income for the following reasons:

1)     24(1) the company.

2)     

3)     24(1)

4)     

5)     

Our Comments

Based on the information received we offer the following comments:

1)     The taxpayer has made representation that the income from the investments would not be income from property as paragraph 129(4.1)(c) of the Act states that income from property does not include income from any property held principally for the purpose of gaining or producing income from an active business carried on by it.  In our opinion, the available information indicates that paragraph 129(4.1)(c) of the Act would not apply as the investments are not held principally to earn income from the active manufacturing business.

2)     It is a question of fact whether the investments represent temporary surplus of the business which may be considered to be pertaining to or incidental to the manufacturing business as stated in paragraph 129(4.1)(b) of the Act or are in reality funds held in excess of the requirements of the business and are set aside for investment or non-qualified uses (i.e. uses other than in an active business).  However,it would appear that a significant portion of the investments owned by 24(1) represent amounts in excess of that required for 'use' in its business and are being retained in the corporation on a permanent basis. This is indicated by the following:

a)      24(1)

b)

c)      There is no evidence that the funds have been required to meet current liabilities of the active business in the years reviewed.

d)      In order to maintain a total debt to equity ratio equal to the industry average in 1985 of 1.65 the taxpayer would-have needed to maintain equity of only 24(1) as other businesses in the same industry did not require such large reserve investments to operate, it would be difficult for the taxpayer to show that the amounts pertained to the manufacturing business.

     In our opinion, a significant portion of the investments are in excess of that required for use in the taxpayer's active business and, the income on the excess investments should be considered to be income from property as defined in subsection 129(4.1) of the Act and thus not eligible for the small business deduction.

3)     It is also a question of fact whether a taxpayer's activities are such that in deriving income from property they operate a "specified investment business".  If evidence indicates that considerable time and effort is being expended by company personnel in the day to day management of the investments, similar to that which would occur in a business operation, a separate "specified investment business" would exist.

     If it is determined that a "specified investment business" does exist, paragraph 125(7)(a) of the Act indicates that the "specified investment business" is not an "active business" and precludes entitlement to the small business deduction.

We trust that our comments will be of assistance to you.

Acting Chief Merchandising, Manufacturing andConstruction Section Small Business and General Division Specialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch