If you have married clients who each legally own separate small businesses, but one of them takes care of operations for both, watch out.
The Finance Department, in the federal budget released Wednesday, says it wants to “ensure taxpayers do not inappropriately access certain tax preferences” related to owning multiple corporations.
Canadians can have legal (de jure) or factual (de facto) control of a corporation under the Income Tax Act. Factual control can be proven where a person has direct or indirect influence on the corporation, and can be used by tax authorities to pursue people who are involved in multiple corporations but make it seem like they aren’t.
For instance, a factual control test is used to determine whether two or more Canadian-controlled private corporations are “associated corporations.” If they are, they must be lumped together for determining tax thresholds such as the $500,000 limit for the small business deduction.
But the 2017 federal budget indicates the Finance Department is changing the rules so that factual control can be proven where appropriate, after case law had established a narrower interpretation of the rules.
“What the government has done here is opened it back up again,” says Doug Carroll, vice-president of tax and estate planning for Invesco. The new rules mean the government can more easily treat corporations as being associated. “Effectively, the government can look at that, treat those corporations as being associated and having to share the tax benefit.”
Kevyn Nightingale, spokesperson for Chartered Professional Accountants Canada, says there are situations where spouses each legally own a separate small business, yet one of them is in fact running both corporations.
“In a real operating sense, they may be controlled by just one of the spouses, and if they’re owned separately, they get two small business deductions,” Nightingale says.
The budget notes that case law established a set of factors to look at when determining whether there is factual control of a corporation, and those factors were limited in a 2016 court decision, McGillivray Restaurant Ltd. v. Canada.
The court decision said factual control must look at factors that include “a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability,” the federal budget says, citing the decision.
That limitation was not a policy intent of the government, the budget plan says: “It is not intended from a policy perspective that the factual control test be dependent on the existence of such a legally enforceable right, or that factors that do not include such a right ought to be disregarded.”
The government says it will amend the Income Tax Act to clarify that, “in determining whether factual control of a corporation exists, factors may be considered that are not limited to the requirement” set out in the 2016 court decision.
The new measure will apply in taxation years beginning on or after March 22, 2017, the budget says.