26 April 2010 External T.I. 2010-0359481E5 - Small Business Deduction

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 the small business deduction may be multiplied where a corporate partnership is introduced to operate a new business using two pre-existing holdcos, as corporate partners, in order to generate active business income in the hands of the holdcos. The holdcos were 50/50 shareholders of an Opco, which already enjoys the benefits of the SBD.

Position: General comments provided.

Reasons: Whether the SBD must be shared amongst the corporations involved rests upon a determination whether or not they are "associated". The association test relies on control that is exercised "directly or indirectly in any manner whatever," which is an expression that encompasses de jure or de facto control. Whether de facto control exists would ultimately have to be decided by the local TSO.

2010-035948
XXXXXXXXXX James Atkinson CGA
(519) 457-4832
April 26, 2010

Dear XXXXXXXXXX :

Re: Small Business Deduction

This is in response to your fax of March 5, 2010, concerning the small business deduction ("SBD") under subsection 125(1) of the Income Tax Act ("Act").

The SBD, which may be deducted by a Canadian-controlled private corporation from tax otherwise payable, is equal to 17% of the least of three amounts, one of which is the "business limit". However, the business limit must be shared among members of a group of associated corporations pursuant to subsections 125(2) and (3) of the Act. Your inquiry concerns whether or not the business limit must be shared amongst three corporations in the situation described below.

In your correspondence, you describe two unrelated individuals, A and B, each of whom is the 100% shareholder of a private corporation, Aco and Bco, respectively. Aco and Bco do not carry on any active business and act as holding companies in respect of the common shares of an operating company, Cco. Aco and Bco each have a 50% interest (i.e., 50/50 common shareholders) in Cco. You indicate that Cco carries on an active business in Canada and that Aco, Bco and Cco are Canadian-controlled private corporations.

You explained that A and B intend to commence a new business venture, unrelated to the business carried on by Cco. A and B have decided that the new business will be operated by a newly created partnership, the partners of which will be Aco and Bco, each having a 50% interest. The choice of the partnership structure to operate the new business, as opposed to commencing the new business within Cco, is intended to allow active business income from the new business to be earned by Aco and Bco. Providing that Aco, Bco and Cco are not associated, you believe that the partnership structure may permit Aco and Bco to claim the SBD on their respective share of the income earned by the new active business.

You asked our opinion as to whether, in the circumstances described above, Aco, Bco and Cco would be entitled to claim the SBD without sharing the business limit on the basis that they are not associated corporations. If the answer to the above is positive, you also asked whether our opinion would change if the only reason to carry on the new business via the corporate partnership structure was to increase the total aggregate active business income eligible for the SBD.

In your opinion, none of Aco, Bco and Cco is associated with other. Therefore, there would be no requirement to file an agreement to allocate a percentage of the business limit to each corporation for the purpose of the claim of the SBD, as would otherwise be required by subsections 125(2) and (3) if the corporations were associated.

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 advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should 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. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

As regards the claim of the SBD under subsection 125(1) by any particular corporation, there are a number of conditions that must be satisfied. For example, the SBD may only be claimed by a "Canadian-controlled private corporation" in respect of "income of the corporation for the year from an active business" carried on by it in Canada. For the purposes of section 125, the expressions "Canadian-controlled private corporation," "income of the corporation for the year from an active business" and "active business carried on by a corporation" are defined in subsections 125(7) of the Act. Whether or not the conditions for claiming the SBD are met is a question of fact. Useful comments regarding the SBD can be found in Interpretation Bulletin IT-73R6 - The Small Business Deduction, which is available from the CRA website at www.cra-arc.gc.ca.

You have concluded that Aco, Bco and Cco are not associated. However, in our view, the determination of whether or not such corporations are associated is a question of law and fact. The CRA provides guidance in making such a determination in Interpretation Bulletin IT-64R4 (Consolidated) - Corporations: Association and Control, also available from the CRA website.

Whether or not two or more corporations are associated must be determined with reference to section 256 of the Act. For instance, under paragraph 256(1)(a), two corporations are associated with each other if one of them is "controlled, directly or indirectly in any manner whatever," by the other and under paragraph 256(1)(b), two corporations are associated with each other if they are both "controlled, directly or indirectly in any manner whatever," by the same person or group of persons.

The essential test in determining whether a corporation is associated with another relies on the control of the corporation that is exercised "directly or indirectly in any manner whatever." This expression encompasses de jure control (i.e., control in law), the meaning of which has been determined by case law; and de facto control (i.e., control in fact), as determined under subsection 256(5.1).

The general test for de jure control was first articulated in Buckerfield's Ltd. et al., 64 DTC 5301 (Ex. Ct.), as "the right of control that rests in ownership of such a number of shares as carries with it the right to a majority of the votes in the election of the Board of Directors." This test has been repeatedly accepted and confirmed by the Supreme Court of Canada (See for example, Duha Printers (Western) Ltd., 98 DTC 6334 (SCC)).

De facto control goes beyond de jure control and includes the ability to control "in fact" by any direct or indirect influence and may exist even without the ownership of any shares. It can take many forms, e.g., the ability of a person to change the board of directors or reverse its decisions, to make alternative decisions concerning the actions of the corporation in the short, medium or long term, to directly or indirectly terminate the corporation or its business, or to appropriate its profits and property. The existence of any such influence, even if it is not actually exercised, would be sufficient to result in de facto control.

A recent example of a tax case in which it was held that de facto control existed, even where the appellant corporation was co-owned 50% by two unrelated individuals and a unanimous shareholder agreement "as drafted respected the equal division of the appellant's share capital and did not benefit one shareholder to the detriment of the other," can be found in the Federal Court of Appeal decision in Plomberie J.C. Langlois, 2006 FCA 113 (FCA).

Thus, it is our opinion that whether a corporation is associated with another in a situation, such as the one you have described, is to be resolved based on the facts and circumstances of the case. This determination of fact, as it may relate to any specific case, is generally made by the local TSO.

If, as you suggest, Aco, Bco and Cco are not associated and all other conditions for claiming the SBD under subsection 125(1) are met, the SBD may be available to each corporation, without having to allocate the business limit amongst the three corporations. As regards your second question, the carrying on of the new business via a corporate partnership involving Aco and Bco, would not, in and of itself, cause the denial of the claim for the SBD by the corporate partners.

We trust that these comments will be of assistance.

Yours truly,

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