Income Tax Act (tax considerations) · Active business & the small business deduction
The restriction on business authorises real estate investment inside the operating corporation
What the check looks for
Rental and investment income is generally income from property, not active business income: it does not earn the small business deduction, and appreciating investment assets held inside the operating company put the qualified small business corporation tests at risk.
Authority: ITA s. 125(7) ("specified investment business"); s. 110.6 (QSBC)
The Income Tax Act sets no requirements for the articles; this is a tax consideration that can follow from how they are drafted.
What goes wrong
The business restriction expressly authorises real estate investment inside the same corporation that earns the commission income. Investment income is generally income from property and does not earn the small business deduction; unless it employs more than five full-time employees, it is generally a specified investment business. More seriously for a later sale of the shares, they qualify for the lifetime capital gains exemption only as qualified small business corporation shares: all or substantially all (the CRA reads this as 90% or more) of the assets used in an active business at the time of sale, more than 50% throughout the preceding twenty-four months, and the shares held by you or a related person throughout those twenty-four months. Investment property and other passive assets building up inside the corporation are a common way those asset tests are failed, and so a common way the exemption is lost.
What good looks like
The articles do not authorise an investment business inside the operating corporation.
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