29 July 2011 External T.I. 2011-0401731E5 - 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 to a farm mutual insurance corporation.

Position: While it is a question of fact which depends on the circumstances, where an insurer described in paragraph 149(1)(t) is only eligible for a partial exemption from Part I tax under subsection 149(4.1), the insurer is not considered exempt on all of its taxable income and is therefore subject to Part 1.3 in that particular year (or would be subject to Part 1.3 tax if the Part 1.3 tax had not been eliminated).

Reasons: Both the current and proposed subsection 125(5.1) may apply if the corporation has taxable capital employed in Canada in excess of $10,000,000.

XXXXXXXXXX 							2011-040173
								Kathryn McCarthy, CA
								(613) 828-9377
July 29, 2011

Dear XXXXXXXXXX :

Re: Reduction of a CCPC's Annual Business Limit

This is in response to your e-mail of April 1, 2011, concerning the above-noted subject.

You described a farm mutual insurance corporation ("Corporation") which has no tax payable on a portion of its taxable income pursuant to paragraph 149(1)(t) and subsection 149(4.1) of the Income Tax Act ("Act"). The Corporation is incorporated without share capital and, in your opinion, is a "Canadian-controlled private corporation" ("CCPC") because all or substantially all of the members are Canadian.

You asked three questions, the first of which is whether subsection 125(5.1) of the Act is applicable to the Corporation to reduce the business limit for purposes of the small business deduction ("SBD"). Your other two questions will be answered by the Financial Sector and Exempt Entities Division of the Income Tax Rulings Directorate under separate cover.

Our Comments

The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular IC 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This IC and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at www.cra-arc.gc.ca. Should the situation involve a specific taxpayer and a transaction that has already been completed, you may wish to submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. However, we are prepared to provide the following general comments, which may be of assistance.

Generally, subsection 125(1) of the Act provides a SBD from Part I tax otherwise payable for a taxation year by a corporation that was, throughout the taxation year, a CCPC as defined in subsection 125(7) of the Act. For more information about the meaning of CCPC, see Interpretation Bulletin IT-458R2, Canadian-Controlled Private Corporation. An entity described in paragraph 149(1)(t) may qualify as a CCPC and you have advised that the Corporation you are considering does qualify as a CCPC.

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)).

It is noted that the amount of taxable income is adjusted to remove foreign income (i.e., the income that supported a foreign tax credit) and income that is statutorily exempt from tax under Part 1 of the Act such as income exempt from tax under section 149 of the Act.

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 not otherwise subject to tax under Part I.3 because the CCPC is a corporation described in subsection 181.1(3) may still suffer a reduction of its business limit under subsection 125(5.1). For instance, while subsection 181.1(3) provides that corporations listed therein are not subject to Part I.3 tax, subsection 181.1(3) does not stipulate that such corporations do not have taxable capital employed in Canada.

For the purposes of Part 1.3 of the Act, including the definition of "taxable capital employed in Canada of a financial institution" in subsection 181.3(1), the definition of "financial institution" in subsection 181(1) (as proposed to be amended) includes an insurance corporation that carries on business in Canada.

According to paragraph 181.1(3)(c) of the Act, Part 1.3 tax is not payable for a taxation year by "a corporation ...that was throughout the year exempt from Part I tax under section 149 on all of its taxable income". Where an insurer described in paragraph 149(1)(t) of the Act is only eligible for a partial exemption from Part I tax for a taxation year under subsection 149(4.1), the insurer is not exempt from tax under Part I.3 by virtue of the exception in paragraph 181.1(3)(c) because it is not exempt from tax under section 149 on all of its taxable income.

In conclusion, the answer to your question is that subsection 125(5.1) of the Act may be applicable to the Corporation to reduce its business limit for purposes of the SBD.

We trust the foregoing comments are of assistance.

Yours truly,

S. Parnanzone
Manager
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch