Eligibility For Small Business Tax Rate
Access to the small business rate has been effectively removed for small businesses working solely for large private corporations. In B.C. this would mean a doubling of the tax rate from 13% to 26%. This greatly reduces the tax incentive for small businesses to operate in Canada. Loss of small business in Canada is detrimental to the entire economy.
Legislation was introduced in the March 21, 2016 budget and was intended to apply to years beginning on or after the budget date, meaning it will apply to years ending March 20, 2017 or later. These rules affect corporate groups by removing access to the small business limit.
If you have two private companies and one company gets 10% or more of its taxable income from the other private company and there is a non-arm’s length shareholder, then the income between the two companies is deemed to be “specified corporate income”, (herein referred to as “SCI”). SCI is still considered active business income, but is no longer eligible for the small business deduction (i.e. gets the 26% general corporate rate rather than the 13% small business rate). There is no specified amount of ownership the non-arm’s length shareholder needs to own for these rules to apply as it’s written. The company paying the other company is able to elect to share their small business limit with the other company to then have it taxed at 13%.
- Company A – Owned by Mr. A, say their taxable income is $500,000;
- Company B – Large private corporation in which Mr. A’s cousin (not “related” for tax purposes, but “non-arm’s length”) owns 1 common share out of 100,000,000 common shares;
- Company A gets 15% of its taxable income from Company B;
- Since it’s more than 10% and the other company has a non-arm’s length shareholder, this income is considered SCI;
- This means the $75,000 ($500,000 x 15%) of income Company A receives from Company B is no longer eligible to get the small business rate of 13%, but gets bumped to 26%; and
- Company B can elect to give Company A some of its small business limit up to $75,000, but Company B is very unlikely to do so since Mr. A’s cousin only owns a single share in a large corporation.
The intent of these rules was to catch corporate structures that circumvent the existing association rules to share the small business limit among many otherwise non-associated corporations. Unfortunately, the legislators used wording that was too broad and currently there is no % of ownership the non-arm’s length shareholder needs to own for these rules to kick in and as a result they cast a much bigger net than it appears they were intending.
A simple solution is to have the share ownership for the non-arm’s length party defined as a percentage so it will not affect most small businesses working for large private corporations.
THE CHAMBER RECOMMENDS
That the Federal Government defines a share ownership percentage of 10% or higher for the non-arm’s length party with respect to specified corporate income.