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 employees.

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
Jeanne.Cheng@mnp.ca
Tom.Qubti@mnp.ca


Canadian Tax Focus
Volume 8, Number 2, May 2018
©2018, Canadian Tax Foundation