3 March 1994 External T.I. 9332935 F - Active Business and Asset Used in an Active Business

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:

1.      Is operating a motel an "active business" if:

a)      rooms rented on a daily basis and services provided?

b)      rooms rented on a monthly basis and no services?

2.      Is a house rented to an employee an asset used in an active business and rental income thereof part of the active business income?

POSITION TAKEN:

1.      a) yes. Services is dominant factor.

b)      yes/no. Winter months it is a specified investment business (125(7)(e) and income excluded 125(7)(c).

2.      Depends on the facts of the case. If necessary for financial survival of the corporation.

REASONS FOR POSITION TAKEN:

5-932891, 5-930553, 7-903654, 5-2741, 5-923567,

5-930199, 5-922056 5-920191

FINANCE OPINION:

none

JURISPRUDENCE:

Atlas Industries Ltd. v. MNR 86 DTC 1756 (TCC) Ensite Limited v The Queen 86 CTC 459 (SCC)

RCT PUBLICATIONS:

IT-73R4 par. 3, 8, 10, 11 and 12. Question 30 Round Table 1981 IT-206R

HAA NUMBER:

4868

XXXXXXXXXX

Attention:  XXXXXXXXXX

Dear Sirs:

Object:  Interpretation of Subsection 248(1)"Small Business Corporation" - Paragraph 125(7)(e)"Specified Investment Business" - Paragraph 125(7)(a)"Active Business"

This is in response to your letter of November 4, 1993, in which you requested our comments on the above as it relates to factual situations.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2. Where the particular transactions are completed, the enquiry should be addressed to the relevant District Office. The following comments are, therefore, of a general nature only, and are not binding on the Department.

Whether an active business is carried on is essentially a question of fact. The Department's position regarding income from an active business and the related issues concerning specified investment business and personal services business is provided in Interpretation Bulletin IT-73R4. The expression "active business" is defined in paragraph 125(7)(a) and in subsection 248(1) of the Act, and includes any business carried on other than a specified investment business or a personal services business.

Pursuant to paragraph 125(7)(e) of the Act, where income is earned by a corporation through the carrying on of a business, "the principal purpose of which is to derive income from property", for instance, rental income, that business will be a specified investment business unless one of the subparagraph 127(7)(e)(i) or (ii) conditions is satisfied. The phrase "principal purpose" is not defined in the Act. It must be given its usual meaning on the basis of all the relevant facts of a particular situation. The Department has stated in paragraph 11 of IT-73R4, that the expression "principal purpose" is considered to be the main or chief objective for which the business is carried on.

In determining whether or not the principal purpose of a particular operation, such as a motel, is to derive income from property, the number and kinds of services it provides is the dominant factor.

Paragraph 12 of IT-73R4 states:

"A corporation which operates a hotel is generally considered to be in the business of providing services and not in the business of renting real property; accordingly, the business is considered to be an active business rather than a specified investment business."

It is our opinion that normally a full-service motel operation would be providing a sufficient level of services such that it would not be considered to constitute a business the "principal purpose of which is to derive income from property".

It is a question of fact whether an asset is used in an active business. The definition of "small business corporation" in subsection 248(1) reads, in part, as follows:

"... all or substantially all of the fair market value of the assets of which at that time was attributable to assets that were

(a)      used principally in an active business..."

The question to be addressed is whether the assets or property are "used" in an active business. The issue of whether property was used or held by a corporation in the course of carrying on a business was considered by the Supreme Court in Ensite Limited v. the Queen, 1986 CTC 459. The court held that the holding or using of property must be linked to some definite obligation or liability of the business. A business purpose test for the use of the property was not enough. The test was whether the property was used to fulfil a requirement which had to be met in order to do business. The threshold of the test was met when the withdrawal of the property would "have a decidedly destabilizing effect on the corporate operations themselves".

In order for the rental income to qualify as part of the active business income, paragraph 125(7)(c) of the Act requires it to be "pertaining to or incidental to that business" other than income that is income from property within the meaning given by subsection 129(4.1) of the Act. This paragraph provides that property income does not include income from any property that is incident to or pertains to an active business carried on by a corporation and income from any property used or held principally for the purpose of gaining or producing income from an active business carried on by the corporation.

There are a number of decisions of the Courts dealing with whether property is "incident to" or "pertains to" an active business carried on by the corporation for purposes of 129(4.1). The approach adopted by the courts is articulated in Atlas Industries Ltd. v MAR, 86 DTC 1756 (TCC) as follows:

"Giving the word "incident to or pertains to an active business" their grammatical and ordinary sense, and bearing in mind their context, there must I think be a financial relationship of dependence of some substance between the property and the active business before the exclusion in paragraph 129(4.1)(b) comes into play. The operations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This is I regard to be the basic approach to paragraph 129(4.1)(b).

Whether income-producing property has crossed the dividing line into the paragraph will depend on the facts of each case. I am satisfied that the facts under consideration do not place the relevant property within it..."

In Atlas Industries, there was no intention to use the term deposits in sustaining the business and therefore, the court concluded that they constituted property that was not incident to or did not pertain to the taxpayer's active businesses.

The Department stated in Question 30 of the 1981 Round Table of the Canadian Tax Foundation Conference that a corporation may carry more than one business, one of which may give rise to income from an active business and another which may give rise to income from a specified investment business. The guidelines used in determining whether a corporation has carried on two or more separate businesses are set forth in IT-206R.

The foregoing comments represent the Department's views in this matter and as such are not to be construed as an advance income tax ruling.

We trust that our comments will be of assistance.

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate