Rental Income and ABI: Structuring Around the Five-Employee Test
For CCPCs, there is a large differential between the tax rates on
investment income and on active business income (ABI), particularly when
the ABI qualifies for the SBD. For rental income, the key to avoiding
the higher investment income rate is to ensure that the rental business
is not considered a specified investment business (SIB). One way to
achieve this objective is to have more than five full-time employees
employed by the corporation throughout the year in the rental business.
Although one corporation by itself might not have enough such employees,
this employment level can be achieved by combining efforts with other
investors—for example, by creating a pooled ownership of multiple
properties, or multiple interests in one large property.
Consider using a partnership structure to hold the properties. Although
the definition of a SIB does not contemplate a business that is carried
on by a partnership, the CRA's view is that "[a] business carried on by a
corporation as a member of a partnership is not a [SIB] if the
partnership employs more than five full-time employees" (Interpretation Bulletin
IT-73R6, "The Small Business Deduction," at paragraph 20). This view
was also expressed in CRA document nos. 2009-0335731E5 (June 16, 2010)
and 2008-0284681E5 (January 20, 2009). Thus, if two CCPCs each own
properties requiring three full-time employees, a partnership structure
in which the two CCPCs are members of the partnership can be used to own
and manage both properties, thereby causing the rental income to
qualify as ABI.
However, ownership of properties through a joint venture/co-tenancy
arrangement may not result in ABI in the same manner as ownership
through a partnership. According to paragraph 16 of the IT, individuals
employed by a joint venture cannot be counted as full-time employees of a
corporation participating in the joint venture, either in whole or in
proportion to its interest in the joint venture. The CRA's view is that
only those persons (if any) who are employed full-time in the business
directly and solely by the corporation can be counted as its full-time
employees in the definition of a SIB.
This position follows Lerric Investments Corp. v. Canada (2001 FCA 14).
In that case, the appellant had used fractions of an employee from each
investment in a joint venture to arrive at a total of more than five
full-time employees in the business. The court determined that the
taxpayer could not aggregate its own employees with its share of the
joint venture's employees to meet the requirement that the corporation
had employed more than five full-time employees in its rental business.
The court found that the words of the provision of the Act that were
determinative were "the corporation employs."
Thus, for a CCPC that uses this structure to carry on a rental business
to avoid being considered a SIB, prudent tax planning may involve
structuring direct employment relationships between the employees of the
business and one or more of the corporate members of the joint venture.
But this structure will not be as effective as the partnership
structure, because each corporation with an interest in the joint
venture will have to separately employ more than five full-time
An alternative structure to avoid the SIB problem was considered in "SIB and Partnership," Canadian Tax Highlights, April 2006.
Jeanne Cheng and Tom Qubti
MNP LLP, Markham, ON