7 June 1991 Income Tax Severed Letter - 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.

Dear Sirs:

Re: Subsection 125(1) of the Income Tax Act (the "Act")

This is in reply to your letter of March 9, 1991, concerning the interpretation of subsection 125(1) of the Act in the following particular situation. The relevant given facts are as follows:

• 1. XXX
• 2. XXX
• 3. XXX
• 4. XXX
• 5. XXX
• 6. XXX

With regard to the XXX you request our views as to whether the income will be income of the corporation from an active business for the purposes of paragraph 125(7)(c) of the Act and whether or not that business is carried on in Canada for purposes of subsection 125(1) of the Act.

Although you have asked for a technical interpretation, it would appear that a proposed transaction by a particular taxpayer is involved. Thus this matter would be more appropriately the subject of an Advance Income tax Ruling except that the conclusions are so heavily dependent on the facts of the matter which could be difficult to establish at the time of the request for a ruling and which might in any case vary from year to year: see paragraph 14(j) of Information Circular 70-6R2. We are, however, prepared to provide you some general comments.

Our Comments

Pursuant to paragraph 125(7)(e) of the Act where royalty income is earned by a corporation through the carrying on of a business, "the principal purpose of which is to derive income from property", that business will be a specified investment business unless one of the subparagraph 125(7)(e)(i) or (ii) conditions is satisfied. The phrase "principal purpose" is not defined in the Act and therefore must be given its usual meaning with the result that this determination can only be made on the basis of all the relevant facts of a particular situation. As noted in paragraph 2 of Interpretation Bulletin IT-290 the word "principal" is considered synonymous with the words "chief" and "main", however for the purposes of paragraph 125(7)(e) it is the principal purpose of the business which must be considered rather than the "principal business" as discussed in the above-mentioned Interpretation Bulletin. In our opinion since it is a "purpose" test which is involved in this provision all the relevant factors concerning the income earning process of a particular situation would have to be considered to determine whether or not the income derived constitutes income from property i.e. the source of the revenue would not necessarily be the only relevant factor in determining whether or not the revenue would constitute income from property. Where the royalty income is related to an active business carried on by the recipient corporation, or that corporation is in the business of dealing in or originating the property from which the royalties are received, such income will not be considered as income from property. However, this conclusion would have to be considered annually: see paragraph 13 of IT-73R4.

A determination of the place where a particular business (or a part thereof) is carried on necessarily depends upon consideration of all of the relevant facts, but has been stated in general terms to be the place where the operations in substance take place. In determining where a particular type of business is carried on, the Department generally follows the guidelines set out in paragraph 26 of IT 270R2 [IT- 270R2].

XXX. However, a determination of whether the royalty income is necessarily from an active business carried on in Canada is a question of fact that can only be determined with any certainty after reviewing the licensing agreements and the resulting activities of XXX for that year.

The above comments are only expressions of opinion on the application of the Income Tax Act to the hypothetical example given and as such should not be construed as advance income tax rulings, nor are they binding on the Department.

We trust this information is of assistance.