Donna Mazerolle & Associates Newsletter
LOSING THE SMALL BUSINESS DEDUCTION (SBD): Intercompany Payments
The 2016 Federal Budget proposed a number of measures to prevent the ability to multiply access to the $500,000 SBD limit, addressing several strategies which the Government perceived as inappropriate. Broad restrictions in eligibility for the SBD on payments between private corporations in general have been introduced. The restrictions as proposed are so broad that they will affect many corporations and structures where multiplication of the SBD was not a goal or even a consideration.
The measures will apply to taxation years that begin on or after March 22, 2016. For example, a corporation with a December 31 fiscal year-end will first be subject to these restrictions in the year ending December 31, 2017. A corporation with a March 31 fiscal year-end will first be affected in the year ending March 31, 2017.
In general, these new Specified Corporate Income (SCI) rules will restrict access to the SBD on any active business income (ABI) earned from providing services or property to another private corporation (PayerCo) where there is common ownership. Such income will not be eligible for the SBD.
Consider the situation where ServiceCo provides services to PayerCo, and PayerCo pays a fee back to ServiceCo.
Payments will be restricted by the SCI rules where an interest in PayerCo is held by any of:
* ServiceCo (the corporation providing the service and receiving the fees);
* any shareholder of ServiceCo; or,
* any person who does not deal at arm’s length with any shareholder of ServiceCo.
There is no de minimis ownership interest threshold – based on the draft legislative proposals of July 29, 2016, even one share of thousands will cause these restrictions to apply. In addition, even indirect interest can trigger the SCI rules. For example, if you own 10% of ServiceCo, and your brother-in-law owns one share of thousands issued by PayerCo, these rules could apply.
An exception: if all or substantially all of ServiceCo’s active business income (which CRA generally considers to be 90%) is earned from providing services to arm’s length persons other than PayerCo, ServiceCo will not be subject to the SCI rules.
The Budget also proposed that PayerCo may be permitted to assign a portion of its own unused SBD limit to ServiceCo to make the payments SCI (a special form must be filed to make the assignment).
Examples of Corporations Potentially Affected
Consider a corporation, OpCo, held by four unrelated shareholders which pays management fees (or some other type of active income) to four HoldCos each owned by one of the four shareholders (whether in whole or in part).
Under the proposals, the management fees earned by the four HoldCos would not generally be eligible for the SBD, unless OpCo allocated a portion of its own $500,000 limit amongst the HoldCos. In other words, OpCo and the four HoldCos must now share access to a single business limit, assuming the HoldCos do not have ABI from other sources. Historically, each of the five corporations (OpCo and the four HoldCos) may each have had full access to the $500,000 SBD depending on their ownership and business structure.
As a second example, consider Dr. A, whose professional corporation (PC) carries on a dental practice. Dr. A’s spouse owns a second corporation (HyCo), which carries on the hygiene practice at the PC’s dental clinic. PC and HyCo are not associated, either by share structure or by de facto control. Currently PC and HyCo each have full access to the SBD. Under the proposals, if HyCo provides its services to the PC, HyCo’s income would be ineligible for the SBD, unless one of the exceptions noted above applies.
The proposals are quite broad and there are many existing corporate structures which are, or could be, exposed to these provisions. While the proposals may change during the process of becoming law, it is clear that many existing structures will be affected.
Action Item: Review your current corporate structures to determine if the small business rates will remain applicable, and whether any change in historical planning is appropriate.
LOSING THE SMALL BUSINESS DEDUCTION (SBD): Partnerships
Similar to limitations on accessing the SBD on payments amongst certain corporations, the 2016 Federal Budget also proposed changes when payments are made from a partnership. The measures will apply to taxation years that begin on or after March 22, 2016.
Currently, a corporation which is a member of a partnership may claim the SBD on active business income it receives from the partnership up to its pro-rata share of a notional $500,000 business limit determined at the partnership level (its specified partnership income limit, or “SPI”). For example, if $500,000 or more of ABI is earned by a partnership with 10 equal partners, the SPI of each partner would be $50,000.
A corporation’s SPI is added to its active business income from other sources, if any, and the corporation can claim the SBD on the total (subject to its annual business limit).
Some business structures circumvent the application of the SPI rules. In one structure, a shareholder of a corporation is a partner and the partnership pays the corporation as an independent contractor under a contract for services separate from the Partnership Agreement. As a result, the corporation claims a full SBD in respect of its active business income earned in respect of the partnership because the corporation itself is not a partner. A number of professional services firms, such as those of lawyers and medical professionals, use a structure like this.
To address this, and other similar strategies, the 2016 Federal Budget proposed to extend the SPI rules. Basically, the amount paid to a corporation available for the SBD will be restricted if the corporation has a shareholder who is a partner, or, if it does not deal at arm’s length with a partner.
Action Item: Consider whether your current partnership structure achieves your goals. Be prepared to pay a higher corporate tax rate if affected by these changes.
DIRECTOR LIABILITY: Reliance on the Active Shareholder
In a May 5, 2016 Tax Court of Canada case, at issue was whether the taxpayer (a director and 50% shareholder of the Corporation) was liable for the Corporation’s unremitted payroll deductions and tax. A director would not be held liable if he/she had exercised the degree of care, diligence and skill of a reasonably prudent person in comparable circumstances in order to prevent the corporation’s failure to remit.
In this case, the taxpayer was informed by the other 50% shareholder, who was involved in the day-to-day operations, that the business was doing well. In reality, the Corporation was in financial difficulty and remittances were not being made.
On receiving correspondence from CRA regarding arrears with its GST and payroll deduction remittances, the taxpayer turned his attention to the corporation’s failures. He spoke to the other 50% shareholder about the need to be diligent, as well as stopping by the business every two or three weeks to check on matters. However, he continued to rely on assurances provided by the other 50% shareholder, even after receiving additional correspondence regarding outstanding source deductions.
Director loses – personally liable for corporate remittances The Court found that reliance on the other shareholder’s word was not acting diligently given the taxpayer’s knowledge of the Corporation’s financial state. The Court suggested a reasonable person would independently verify that remittance payments were being made, whether by direct contact with CRA, review of the Corporation’s bank account, or other approaches. As a result, the Director was personally liable for the unremitted corporate GST/HST and source deductions.
Action Item: Especially in times of corporate financial difficulty, review source documents to ensure that payments to CRA are being made appropriately.