13 August 1990 Income Tax Severed Letter AC74820 - Small Business Deduction - Amount of 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.

Scientific Research Audit              Head Office
          Applications Section                Rulings Directorate
       C.  Lamarche                           C.R. Bowen
       A/  Chief                              957-2096

       Jim Millen
                                              7-4820 (900096)

SUBJECT:
OBJET:    Subsection 125(2) of the Income
          Tax Act (the "Act") -Amount
          of Business Limit

We are writing in reply to your memorandum of March 16, 1990, wherein you requested our comments on whether for the purposes of subsection 125(2) of the Act, the business limit is applicable to all corporations or only to a Canadian-controlled private corporation ("CCPC") (as defined in paragraph 125(7)(b)) of the Act. The term "business limit" is referred to in subsection 127(10.1) of the Act and affects the eligibility of a corporation to claim an investment tax credit ("ITC") rate of 35% rather than 20% on its qualified expenditures. We apologize for the delay in responding to your letter.

Factual Situation The particular fact situation which brought this issue to your attention occurred as a result of an audit of a taxpayer's claim for ITC and is summarized below:

                       24(1)

Taxpayer's Opinion

                               24(1)

Your Opinion

It is your opinion that only a CCPC can have a business limit. Consequently, a corporation must be a CCPC for at least two consecutive taxation years before its qualified expenditures will be eligible for the 35% ITC rate referred to in subsection 127(10.1) of the Act.

                      21(1)(a)

Our Comments

A) Business Limit

In the Supplementary Information and Notice of Ways and Means issued by the Department of finance on November 8, 1984, it was stated that by removing the cumulative business limit of $1,000,000, "the low small business tax rate will be available on up to $200,000 of active business income a year earned by any CCPC". Therefore, the purpose of paragraph 125(1)(c) of the Act and the definition of the business limit is to restrict the amount of the small business deduction which can be claimed by a CCPC to a maximum amount that has been legislated as being the amount of income that a small business would earn.

It is our opinion that the wording of the preamble of subsection 125(l) of the Act "there may be deducted by a corporation that was a CCPC the least of" serves to narrow the scope of the benefit and hence the applicability of the amounts determined in paragraphs (a) to (c) therein only to a CCPC. In reviewing the intent of section 125 of the Act in the court case Holiday Luggage Mfg. Co. Inc. v. The Queen, 86 DTC 6601, the court indicated on page 6609 that:

         "The terms of section 125 are no longer of the
         brush-stroke variety bringing to the canvas all
         corporations ... the section now limits its
         special tax break to a special group, namely
         CCPCs, as that expression is defined in the
         Act".

The opening words in subsection 125(2) of the Act "for the purposes of this section", also serve to limit the definition of the business limit to only those corporations to which the deduction available in section 125 of the Act applies, i.e. CCPCs. It is our opinion that the words "with one or more other CCPCs" infer that the first corporation in question must also be a CCPC. If there is another associated CCPC, the business limit must be shared in accordance with subsection 125(3) of the Act. The creation of a business limit for a non-CCPC would serve no purpose under the Act as the tax benefits do not apply to that group of taxpayers. In the court case Stubart Investments Limited v. The Queen, 84 DTC 6305 (S.C.C.), the court recognized that in the construction of taxation statutes the law is not confined to a literal and virtually meaningless interpretation of the Act where the words will support on a broader construction a conclusion which is workable and in harmony with the evident purposes of the Act in question. The absence in subsection 125(5) of the Act to the application of the special rules to non-CCPCs further supports the concept that the business limit applies only to CCPCs, as equitable treatment for all corporations would require that all corporations which have a business limit must also be subject to those rules.

The court case The Queen v. B & J Music Limited, 83 DTC 5074 (F.C.A.), (that was heard prior to Stubart) considered whether the taxpayer had to bring into account in computing its "cumulative deduction account", as defined in former paragraph 125(6)(b) of the Act, income for taxation years in which it was not a CCPC. While the court accepted that section 125 affords a CCPC special tax treatment, in a split decision it held that the reference to the words "the corporation's taxable income for taxation years commencing before 1971", included taxation years in which the taxpayer was not a CCPC. In order to exclude that income, the words would have to be amended to clearly reflect the intent of the legislation. It is interesting to note that the dissenting judge stated that "the word `corporation' must be determined by the context of the whole section in which it was used, and in my opinion .... the opening words of the subsection can only mean a CCPC" and therefore `the corporation' referred to is a CCPC. However, due to the fact that the words being interpreted by the court, i.e. the corporation, are different from those currently under consideration, the outcome of this case is not considered as a precedent in interpreting these words.

In summary, it is our opinion that the reference in subsection 125(2) of the Act to "a corporation's `business limit'" is to a corporation to which section 125 of the Act applies, which must by definition be a CCPC, and is not to all corporations.

B) 35% ITC Rate

In the Supplementary Information issued by the Department of Finance on November 8, 1984, page 10 thereof states that "..the draft legislation published in August proposed a test to determine whether a CCPC qualifies for the three measures directed at small business: the 35% rate of ITC,.. This test was based on the aggregate incomes for the year of the corporation and all other corporations with which it was associated in the year. In order to facilitate compliance with this test and the administration of the affected provisions, the test will be changed so that it will be based on the aggregate incomes for the immediately preceding taxation year of such corporations." Therefore, it is our opinion that the reference in subsection 127(10.1) of the Act to the taxable income of a prior taxation year of a corporation that is a CCPC throughout the current taxation year is for the purposes of the test and not a requirement that the corporation be a CCPC in the prior taxation year. However, a corporation that was not a CCPC in its prior taxation year would not have a business limit for that prior year. It is our opinion that the words in that subsection "the taxable incomes of corporations with which it is associated" refer to all associated corporations of the CCPC regardless of whether or not they are CCPCs. Therefore, where a corporation that is a CCPC throughout its current taxation year is associated with other corporations in that current year, the aggregate of the prior year's taxable incomes of that CCPC and those associated corporations must be less than the aggregate of the business limits allocated among all those corporations in that prior year in order for the 35% ITC rate to be available to the CCPC.

C) Fact Situation

Where a new corporation is formed by amalgamation, its taxable income and business limit for the preceding taxation year will be the aggregate of those amounts of the predecessor corporations for their taxation years ending immediately before the amalgamation (per paragraph 87(2) (00) of the Act). In the fact situation outlined,

                   24(1)

We trust these comments will be of assistance.

Ray Thompson Chief Merchandising Manufacturing and Construction Section Rulings Directorate Legislative and intergovernmental Affairs Branch