This is article is part of a series dealing with draft legislation released for comment by the Department of Finance on July 29th. Read the complete series:
- The evolving taxation of derivatives
- Sales of linked notes
- Taxation of switch fund shares
- Changes coming to country-by-country transfer pricing documentation requirements
- Proposed replacement of eligible capital property rules by new depreciable property class
- Alternative arguments in support of tax assessments
- Foreign exchange gains on debt-parking
- Cross-border surplus stripping
- New limits on the small business deduction
The section 125 small business deduction (SBD) is a tax policy tool that the Canadian government uses to encourage private businesses in Canada. However, the SBD applies to only the first $500,000 of income of an eligible CCPC. This $500,000 income cap is the “business limit” of the corporation, and it is shared between associated CCPCs. To prevent the SBD from being multiplied through the splitting of income into two or more associated CCPCs each having income under the business limit, the ITA has various rules that force associated CCPCs to share one business limit and to reduce the shared business limit based on the taxable capital limit of the CCPC and associated CCPCs.
The 2016 Legislative Proposals include amendments designed to supplement these rules while attempting to “[strike] a balance between allowing different family members to carry on businesses through CCPC’s […] and addressing tax planning arrangements used by a single economic group as an attempt to multiply the small business deduction”. Section 125 will be amended, as explained in our article Multiplication of the Small Business Deduction. This article addresses the proposed changes to subsection 256(2), which deems unassociated CCPCs to be associated in certain circumstances.
Currently, subsection 256(2) deems two corporations that would otherwise not be associated with each other to be associated if each corporation is associated with the same third corporation. Pursuant to subsection 256(2), all three corporations are deemed to be associated and, therefore, share a single business limit and taxable capital limit. However, if the third corporation is not a CCPC or if the third corporation is a CCPC and elects in the prescribed form, then the third corporation is deemed not to be associated with either of the two corporations and its own business limit is deemed to be nil.
The first amendment to subsection 256(2) is structural – a division of the subsection into paragraphs (a) and (b). Proposed paragraph (a) applies for the purposes of the entire ITA and contains the same deeming rule as the current subsection 256(2): two corporations are deemed to be associated with each other if they would not otherwise be associated with each other but are each associated with the same third corporation.
Paragraph (b) applies only for the purposes of section 125 and contains the exceptions to the deeming rule in paragraph (a). The amendment limits the disassociating power of subsection 256(2). As with the current rules, if the third corporation is not a CCPC, the other two corporations are deemed not to be associated with each other. However, under the proposed amendments, each of the two corporations remains associated with the third corporation. Similarly, if the third corporation is a CCPC and elects for its own business limit to be nil, each of the two corporations remain associated with the third corporation.
The most important result of this change is that the taxable capital of the third corporation will now be included in calculations under subsection 125(5.1), which reduces the business limit based on the taxable capital of the corporation and associated corporations.
A related amendment is proposed to subsection 125(1) related to income from property of a CCPC that is deemed to be active business income where one of the exceptions of 256(2) applies.