Clients should stay away from wielding influence over businesses they don’t want associated with their own corporations for tax reasons.
That’s the conclusion of tax advisors after reviewing Ottawa’s latest rules on factual control of private corporations, released in the federal budget on Wednesday.
“They’re going after schemes that really should be confined to one small business deduction but are taking advantage of the law,” says Paul Schnier, lawyer with Blaney McMurtry in Toronto.
The government’s 2017 budget says it is broadening the definition of factual (de facto) control of a private corporation after case law had narrowed it. The new rules, to be made effective immediately, will allow tax authorities to show factual control where a person has direct or indirect influence on a corporation other than their own. Where there’s factual control, the two corporations would be “associated,” and must be lumped together for determining tax thresholds like the $500,000 limit for the small business deduction.
The 2017 budget responded to McGillivray Restaurant Ltd. v Canada, a 2016 court decision, which narrowed the definition of factual control to legal control rights such as changing the board of directors or its powers.
The government has now re-broadened the definition. Before the McGillivray decision, CRA could challenge cases based on whether there was influence, and that could be interpreted broadly.
For instance, perhaps someone held a significant amount of debt in another corporation. “The corporation owes you a lot of money and you said, ‘OK, unless you do what I want, I’m going to call on this debt,’” Schnier says.
Or perhaps someone is a large customer of another corporation, accounting for roughly half of its sales, and tries to influence its decisions. That person could also be exercising factual control of the corporation, Schnier says. It comes down to day-to-day influence over the company.
“If it’s an arm’s-length creditor, debtor relationship, or an arm’s-length supplier or customer relationship, I don’t think CRA’s going to be concerned,” Schnier says.
Tax authorities are more concerned about family business structures, with different family members owning corporations to reap the tax benefits, tax advisors say.
Perhaps a family furniture company is structured such that one family member owns the business that manufactures desks, while another family member owns the one manufacturing chairs. That would be concerning to CRA.
Kevin Stienstra, senior manager of tax services for Grant Thornton in St. Catharines, Ont., says CRA is more interested in people who intentionally set up corporations to skirt the rules. A client who is simply a major customer or supplier for another corporation, and not exercising any influence, should not be a concern in terms of having factual control, Stienstra says.
“It’s quite the leap to say they have de facto control over that business—typically they wouldn’t deem them to be associated,” Stienstra says. “It’s more the related party context that they’re looking at.”
While family businesses may be more a focus for CRA, the lines are back to being blurred.
The Federal Court of Appeal decision had made the interpretation of factual control a little too clear for the government’s liking, Schnier says. CRA and the government prefer that tax advisors have some doubt about where the line is—so that they stay further away from it.
“Now, CRA says, ‘We want to put some doubt in tax advisors’ minds, so you don’t really know what we’re going to challenge, or not,’” Schnier says. “They’re happy about it going back to being a grey area.”
Wilmot George, vice-president of tax, retirement and estate planning for CI Investments in Toronto, says the rule changes highlight the complexity of the law and the pitfalls of tax planning without an advisor.
“The small business deduction is a significant deduction for business owners,” George says. “You’ve got to be very careful with de facto control and de jure [legal] control when you’re looking at access to the small business deduction.”
The federal budget also announced a tax review of strategies for the use of private corporations and other advantages for “high-income individuals”—so tax advisors may want to brace for further changes.
That would be keeping with the approach of the Justin Trudeau government.
Stienstra says the clarification of the factual control rules follows several similar changes made in the 2016 budget, such as those for the specified corporation and partnership income rules.
Before those 2016 changes came into force, for instance, a partner could create a private corporation with the partnership paying the company as an independent contractor for services. The private corporation would not be part of the partnership and could claim the full small business deduction.
“It’s kind of a continuation of the 2016 budget,” Stienstra says. “There was a whole bunch of rules […] aimed at stopping taxpayers from multiplying the small business deduction limit.”
He adds: “The government is looking at tax fairness, and I guess they see that these tax strategies are available primarily to more wealthy business owners as opposed to the middle class.”