Small business deduction webinar
January 17, 2018
Hello and welcome to our questions and answers webinar on the small business deduction (the SBD). My name is Maurice and I am your presenter.
I would like to mention that today's webinar will be recorded and posted on the Canada.ca website at a later date.
We received a lot of questions. However, some questions did not relate to the SBD, so I am not able to answer those questions in this webinar. For any unrelated questions, please contact the CRA at 1-800-959-5525. For help with different aspects of payroll, you can visit the Canada.ca website and search for "Recorded webinars for businesses."
Now let's start answering your SBD questions.
We received questions about the small business job credit (the SBJC) asking if businesses are still able to claim the credit.
The small business job credit is different than the small business deduction. The job credit was a two-year measure for 2015 and 2016 to help small businesses lower their employment insurance (their EI) premiums from the legislated rate during those two years. The small business job credit was not renewed for further years.
So, what is the small business deduction (the SBD)? What are the factors to qualify for the SBD?
The SBD's intent is to allow small businesses to keep and reinvest more of their corporate profits, so they can expand their active businesses and contribute to economic growth and job creation. Canadian-controlled private corporations (CCPCs) can claim a small business deduction on active business income earned in Canada. The deduction effectively reduces the rate of corporate income tax from 15% to 10% effective January 1, 2018, on the first $500,000 of active business income.
The definition of a CCPC states that the corporation must not be controlled, directly or indirectly, in any manner whatever by one or more non-resident persons, one or more public corporations (other than a prescribed venture capital corporation described in regulation 6700 of the Income Tax Regulations), or any combination of non-residents and public corporations.
What does active business income mean?
Generally, for the SBD, active business income is anything other than investment income, rental income, leasing income, and income from a specified investment business or a personal services business.
- A personal services business is a business in which an incorporated individual performs a service for a corporation that an employee for the corporation would typically perform.
Income from a specified investment business or from a personal services business is generally not considered active business income and not eligible for the SBD.
What is a specified investment business?
A specified investment business is a business that mainly gets its income from property, such as interest, dividends, rents, or royalties. It also includes a business that a prescribed labour-sponsored venture capital corporation carries on to get income from property.
Except for a prescribed labour-sponsored venture capital corporation, income from a specified investment business is considered to be active business income. The income is therefore eligible for the SBD if:
- the corporation employs more than five full-time employees in the business throughout the year; or
- an associated corporation provides managerial, financial, administrative, maintenance, or other similar services to the corporation while carrying on an active business. As well, the corporation must employ more than five full-time employees to perform these services if the associated corporation is not providing these services.
Please note that the business a credit union carries on, or the business of leasing property other than real property, is not considered specified investment business.
Would the operation of a small/mini storage facility qualify for the small business deduction? There are no employees, and it's operated by the shareholder. When there is regular turnover, would the operations be active income or passive income?
Generally, the business of a small/mini storage facility involves renting property and providing basic services typical to that type of rental operation. In such a situation, the main purpose of the business would be to earn rental income from real or immovable property (in other words, a specified investment business) so the corporation would not be eligible for the SBD.
However, if the corporation provides significant additional services that are essential to the success of its business operations, the CRA may consider it eligible for the SBD. Generally speaking, the more services the corporation provides and the greater the importance of those services to the corporation's financial success, the greater the chance that the main purpose of the corporation is earning active business income from the services and not earning income from the property. The CRA determines the main purpose of a particular business on a case-by-case basis by closely looking at the specific facts and circumstances of that situation.
How does a sole proprietor or a partnership claim the SBD?
A sole proprietor or a partnership does not qualify for this deduction. As mentioned earlier, the SBD is available only to Canadian-controlled private corporations.
When capital property generating active business income is sold, is the capital gain seen as active income for the small business deduction? What if the property was rented instead of sold?
Generally, taxable capital gains are considered investment income. The definition of active business income excludes both investment income and rental income. However, income from the sale or rental of property may be considered active business income if the property is used or held mainly to gain or produce income from an active business. Therefore, if the property is incidental to or pertains to the corporation's active business, that income would be eligible for the SBD.
When interpreting the meaning of "pertains to" or "incidental to", the courts decided that the property in question has to depend financially on the active business before the property is considered to be incidental to or to pertain to the corporation's active business.
For example, if withdrawing the property will have a definite destabilizing effect on the business's operations, the property will generally be considered to be used in the course of carrying on the corporation's active business.
Here are some questions we got about associated corporations and the new rules for Budget 2016.
- Are you going to review the new rules recently introduced limiting the SBD to associated groups of companies and individuals related to the business owner?
- Can you clearly define "related" as it pertains to sharing the SBD (in other words, how can I determine if two entities are to share the SBD)?
- How do these new rules affect related corporations that do not sell or purchase goods and/or services from one another?
- I realize it is complicated, but could you detail the situations where the SBD must be allocated (for example, between husband and wife companies that have cross shareholdings)?
When one CCPC is associated with other CCPCs, these corporations must share the $500,000 SBD limit. Associated corporations are based on control and is defined in section 256 of the Income Tax Act. Generally, associated corporations include:
- a corporation and another corporation that controls it
- two or more corporations controlled by the same person or group of persons
- two corporations if one is controlled by one person and the other is controlled by person related to the first person and either person owns at least 25% of the shares of any class of each corporation
- two corporations if each is controlled by a related group of persons and each of the persons in one related group is related to all the persons in the other group and a person in either group owns at least 25% of the shares of any class in each corporation
- two corporations that are not associated with each other but both are associated with another third corporation.
Let's elaborate further.
Here is an example to illustrate the situations in which the SBD must be allocated between husband and wife companies when there are cross shareholdings.
Mark and Liz are married. Liz owns 75% of the shares of Corporation B. Mark owns 100% of the shares of Corporation A and 25% of the shares of Corporation B. Corporation A is considered to be associated with Corporation B because Mark is related to Liz and holds at least 25% of the shares of each corporation.
Therefore, Corporation A and Corporation B must share the $500,000 SBD limit.
New rules were introduced in Budget 2016 that prevent individuals from creating corporate structures to multiply their access to the SBD. These rules apply to all tax years beginning on or after March 22, 2016. These rules apply to:
CCPCs that provide services or property to a partnership and that (or one of its shareholders) do not deal at arm's length with the partnership (or one of its members) will be considered a designated member of the partnership. Therefore, the active business income the CCPC received from the partnership is considered to be the partnership's active business income. The CCPC will have access to the SBD only when the member of the partnership who does not deal at arm's length with the CCPC assigns a portion of their specified partnership income limit to the CCPC.
A CCPC that provides services or property to another CCPC (a recipient or one of its shareholders) has an interest in the recipient CCPC, will be deemed to earn specified corporate income. A CCPC earning specified corporate income is no longer entitled to its own SBD. The CCPC can claim the SBD only if the recipient CCPC allocates a portion of its $500,000 business limit to it.
The concept of arm's length is defined in section 251 of the Income Tax Act. In the situation described on the previous slide, corporations can be excluded if 90% of their income comes from sources other than the non-arm's length corporations and partnerships.
How does the manufacturing and processing come into play with the SBD?
Under subsection 125.1(1) of the Income Tax Act, a credit is available CCPCs that derive at least 10% of their gross revenue for the year from the manufacturing or processing goods in Canada for sale or lease. The credit is calculated on the associated business income that is not eligible for the SBD at a rate of 13% (For example, if a corporation involved in manufacturing and processing already claimed a SBD on their initial $500,000 of active business income, they can claim a manufacturing and processing deduction on the rest of their active business income.)
We received questions asking if there is a form to fill out to claim the SBD.
To claim the SBD, you have to consult Chapter 4 of Guide T4012, T2 Corporation Income Tax Guide. It explains what you can claim and how to claim it. You would then fill out Schedule 7 of the T2 return and claim the credit. The link to the form is found in the guide.
If you are looking for more information about the SBD, you can visit canada.ca where you can find the following publications:
The archived IT73R6 explains what the small business deduction is.
Chapter 4 of the Guide T4012 also explains what the small business deduction is and how to claim it.
The archived IT458R2 explains what a Canadian-controlled private corporation is.
We also have a webpage titled "Eligibility requirements for campgrounds in order to claim the small business deduction" on Canada.ca.
We have reached the end of our webinar. Thank you for joining me today. I hope that the questions and answers we reviewed during this webinar will help you meet your obligations.
Thank you for watching.
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