Transcript - Episode 8: Small business deduction – Defining active business
Host: Hello and welcome to the Canada Revenue Agency’s payroll podcast. On today’s episode, we conclude our two-part series on the small business deduction. In part one of my conversation with Lise, a manager with the CRA, she explained that one of the conditions for eligibility is that your corporation, that is a CCPC, must earn income from an active business carried on in Canada, rather than income from a specified investment business. I asked her to define those terms in more detail.
Lise: The term "active business carried on by a corporation" is defined as any business carried on by a corporation other than a specified investment business and a personal services business, which can include an adventure or concern in the nature of trade. For example, a restaurant or a retail store would normally be considered an active business.
Host: Okay, so we really need to be careful of how we interpret the word "active" because one of the things that has come up is many people look at the word and they think "my business is active in the sense that it’s operational, the business is currently open" but what we’re talking about when we use the word "active," is we’re looking at the nature of the income that’s earned by the business, we’re not looking at "active" in the sense of whether or not the business is currently operational. Is that the best way of looking at it?
Lise: That’s exactly it.So, in order to understand the definition of "active business," we first need to define a "specified investment business" and a "personal services business," and then active business income would be anything other than what fits those two other descriptions.
Host: Alright, so it’s really important then for us to clearly define these two terms. If we were to start with specified investment business, what exactly does that mean?
Lise: Generally, a specified investment business is a business where the principal purpose of that business is to derive income from property subject to two exceptions that we already discussed in part one of the series. An example of a specified investment business is an apartment rental.
Host: So that’s a specified investment business. What about a personal services business? Can you help us understand what that is?
Lise: Sure. A personal services business is a business that a corporation carries on to provide services to another entity (such as a person or a partnership) that an officer or an employee of that entity would usually perform. Instead, an individual performs the services on behalf of the corporation. That individual is called an incorporated employee.
Any income the corporation derives from providing the services is considered income from a personal services business, as long as there are some conditions that are met.
Number one, the incorporated employees performing the services, or any person related is a specified shareholder of the corporation.
And number two, the incorporated employee would, if it were not for the existence of the corporation, reasonably be considered an officer or employee of the entity receiving the services.
Host: After the break, I’ll ask Lise how an eligible business can claim the small business deduction. Stay with us.
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Host: Let’s say you’ve reviewed the eligibility criteria and you’ve determined your business is eligible for the small business deduction. How can you claim the deduction?
Lise: That’s a good question because it’s important for those listening to understand. Corporations that are CCPCs throughout the tax year may be able to claim the small business deduction on their T2 corporation income tax return. The small business deduction essentially reduces the corporation’s general income tax rate on the lesser of its income from active business carried on in Canada, or its taxable income, or its business limit of $500,000. The corporation’s business limit may also be reduced by other rules.
Host: If anyone out there wants more clarification on whether or not they would be eligible or if they have any other questions about how to claim it, are there any other resources we provide where they can find more information?
Lise: Aside from the Income Tax Act, we have a number of what we call "interpretation bulletins" available on our website. Basically, these are meant to interpret complex concepts from the Income Tax Act and explain them in a way that’s easier to understand.
Host: Okay. Is there any one of these interpretation bulletins in particular we can point to that would be important for someone to read if they’re unclear about anything we’ve talked about today?
Lise: Probably the most important one is the interpretation bulletin that breaks down the legislation that’s directly related to the small business deduction.
It’s called "Interpretation Bulletin IT-73R6, The Small Business Deduction," but an easy way to find it is just by typing in "small business deduction" in the search field on the CRA website.
This interpretation bulletin covers almost everything that we discussed today.
So everything from income from an active business, the definitions of specified investment business and personal services business. In addition to this IT bulletin, you can also refer to the T2 Guide – T4012. It does a great job explaining the small business deduction in chapter 4.
So, for anyone who’s thinking whether they qualify for the small business deduction or believe that they do qualify, they should probably have a look at these two publications, so the IT-Interpretation Bulletin or the T2 guide just to make sure they meet the necessary criteria in order to qualify for the deduction.
Host: Thank you for listening to the CRA’s payroll podcast. Today’s episode was part two of our two-part series on the small business deduction. If you have any questions about the show, if you’d like to give feedback, or if you’d like to request a topic for a future episode, you can email us at email@example.com. We’d love to hear from you.
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