Small business deduction rules

The following questions and answers are intended to provide a general overview of the changes to the small business deduction (SBD) rules proposed in Budget 2018. They are not a substitute for the law.



1. What is the SBD?

The SBD reduces the corporate income tax that a corporation would otherwise have to pay in a taxation year throughout which it was a Canadian-controlled private corporation (CCPC). A corporation’s SBD for a taxation year is generally calculated by multiplying its SBD rate by the lesser of its: 

  • income for the year from an active business carried on in Canada, excluding certain income and exceeding certain losses;
  • taxable income for the year; and
  • business limit for the year. 
2. How is the business limit determined?

A CCPC’s business limit for a taxation year is $500,000, prorated for the number of days in the year if there are less than 51 weeks in the year. The business limit must be allocated amongst corporations that are associated in a taxation year, and is reduced by any portion that the CCPC assigns to another corporation. The CCPC’s remaining business limit is then further reduced on a straight-line basis if the combined taxable capital employed in Canada of the CCPC and any associated corporations is between $10 million and $15 million (the taxable capital business limit reduction).

3. What is the proposed change to the SBD rules?

The budget proposes to phase-out a CCPC’s business limit, on a straight-line basis, if the total of the adjusted aggregate investment income of the CCPC and any other corporation with which it is associated is between $50,000 and $150,000 (the passive income business limit reduction).

The reduction in a CCPC’s business limit for a taxation year will be the greater of its taxable capital business limit reduction and its passive income business limit reduction for the year.

4. How will a CCPC's passive income business limit reduction be calculated?

A CCPC’s passive income business limit reduction for a particular taxation year will be the amount determined by the formula:

BL/$500,000 x 5 (AAII - $50,000)

where

BL is the CCPC’s business limit otherwise determined for the particular year (i.e., its business limit as described above); and

AAII is the total of all amounts each of which is the adjusted aggregate investment income of the CCPC, or of any corporations with which it is associated at any time in the particular year, for each of their taxation years that ended in the preceding calendar year. 

Example 1

ABC Company is a CCPC having a December 31, 2020, taxation year end, and is not associated with any other corporations in the year. ABC Company’s adjusted aggregate investment income for its December 31, 2019, taxation year was $75,000.

ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:

= $500,000/$500,000 x 5($75,000 - $50,000)

= 1 x 5($25,000)

=$125,000

Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $375,000 (i.e., $500,000 - $125,000).

Example 2

Same facts as Example 1 above, except that ABC Company is associated with XYZ Company, which had $55,000 of adjusted aggregate investment income in its December 31, 2019, taxation year. The entire business limit for the 2020 taxation year was allocated to ABC Company.

ABC Company’s passive income business limit reduction for its 2020 taxation year is determined as follows:

= $500,000/$500,000 x 5(($75,000+$55,000) - $50,000)

= 1 x 5($80,000)

=$400,000

Consequently, ABC Company’s business limit for its December 31, 2020, taxation year will be reduced from $500,000 to $100,000 (i.e., $500,000 - $400,000).

5. What is a corporation's adjusted aggregate investment income for a taxation year?

Adjusted aggregate investment income of a private corporation for a taxation year is calculated as follows:

Add

  • the eligible portion of the corporation’s taxable capital gains for the year that is more than its eligible allowable capital losses for the year (other than capital gains and losses from the disposition of property that is, at the time of disposition, an active asset of the corporation);
  • the corporation’s total income for the year from property* (including income from a specified investment business carried on by it) from which the following amounts have been deducted:
    • exempt income,
    • AgriInvest receipts,
    • dividends from connected corporations,
    • business income from an interest in a trust that is considered property income under paragraph 108(5)(a) of the Income Tax Act;
  • the amount of any foreign accrual tax that the corporation deducted in computing its income for the year under subsection 91(4) of the Income Tax Act; and
  • amounts in respect of a life insurance policy that are included in computing the corporation’s income for the year, if those amounts were not already included in the above amounts;

Deduct

  • the corporation’s total losses for the year from property* (including losses from a specified investment business carried on by it). 

 

*Note that this amount does not include income or loss from property that is incident to or pertains to, or used or held principally for the purpose of gaining income from, an active business carried on by the corporation. The meaning of “incident to or pertains to” the active business of the corporation is discussed in paragraph 5 of IT Bulletin IT-73R6 Small Business Deduction.

6. What is an active asset of a corporation?

An active asset of a particular corporation, at any time, means:

  • a property that is used at that time principally in an active business carried on primarily in Canada by the particular corporation or by a related CCPC;
  • a share of another corporation if, at that time, the other corporation is connected with the particular corporation and the share would be considered a qualified small business corporation share, as defined in the Income Tax Act, if the references to an individual in the definition were replaced by references to the particular corporation; or
  • an interest in a partnership if, throughout the 24-month period ending before that time, more than 50% of the fair market value of the property of the partnership was attributable to property described in this bullet or the first two bullets above and, at that time,
    • the particular corporation holds 10% or more of the total fair market value of all interests in the partnership; and
    • all or substantially all (90% or more) of the fair market value of the property of the partnership was attributable to another partnership interest described in this bullet, or to property described in the first two bullets.
7. How can I demonstrate to the CRA that a property was an active asset when I disposed of it?

Generally, an asset is considered to be used principally (i.e., more than 50%) in an active business if its primary or main use is in that business. Whether a particular asset is used principally in an active business is a question of fact, which must be determined with reference to the circumstances of the case under review. The relevant circumstances include the actual use to which the asset is put in the course of the business, the nature of the business and the practice in the particular industry.

8. Can a CCPC lower its passive income business limit reduction by transferring passive investments to a related coporation that is not associated with it?

Under a proposed anti-avoidance rule, a CCPC will not be able to avoid or lower its passive income business limit reduction. Specifically, for the passive income business limit reduction, a particular corporation will be deemed to be associated with a related corporation, that is not otherwise associated with it, if 

  • it lends or transfers property at any time, either directly or indirectly, to the related corporation, and
  • it may reasonably be considered that one of the reasons the loan or transfer was made was to reduce the amount of its adjusted aggregate investment income for a taxation year, and thus its passive income business limit reduction in future. 
9. How can a CCPC demonstrate to the CRA that a passive investment was not loaned or transferred to a related corporation that is not associated with it in order to reduce its passive income business limit reduction?

In general, transactions that were contemplated or initiated prior to the budget announcement will be considered not to have been undertaken for this purpose. Taxpayers and their representatives should maintain documentation that sets out the purpose of any transaction of this nature. In particular, information should be maintained regarding the business purpose of the transaction, the relationship of the transaction to other transactions undertaken as part of the same series, and information regarding the recipient corporation and its purpose for acquiring or borrowing the property.

10. When are the changes to the SBD rules effective?

The budget proposes that changes to the SBD rules will apply for taxation years that begin after 2018. However, the rules will also apply to a taxation year of a corporation that begins in 2018 and ends in 2019 if 

  • the preceding taxation year was, because of a transaction or event or a series of transactions or events, shorter than it otherwise would have been, and
  • one of the reasons for the transaction, event or series was to defer the application of the changes to the SBD rules, or the changes to the dividend refund rules, to the corporation. 
11. How can a corporation demonstrate to the CRA that none of the reasons for a short taxation year was to defer the application of any of the new rules?

Where a short taxation year arises in the context of a transaction or event or a series of transactions or events that was contemplated or initiated prior to the budget announcement, the resulting short taxation year will not generally be considered to have arisen for the purpose of deferring application of these rules. Taxpayers and their representatives should maintain documentation regarding the timing and purpose of any such transactions or events. As a reminder, corporations must receive approval from the CRA to change their tax year end. To change a fiscal year end, write a letter to your tax services office asking for approval and include details explaining the reasons for the change.

12. Where can I get more information on the proposed changes?

The CRA provides the latest information on the proposed changes on Canada.ca. Taxpayers should check online regularly for updated forms, policies, guidelines, questions and answers, and guidance.

In the meantime, please consult the Department of Finance Canada’s Budget 2018 documents for details.

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