Income from business or from property

The taxation of corporate income from the rental of storage facilities appear to be a common business under regular review just like the motel/hotel and rental management business.

Basic tax rate concepts

The Canadian concept of integration is based on the premise that it should cost more to earn income directly or indirectly through a corporation. Unfortunately, nothing is perfect and the differences in provincial tax rates still cause some discrepancies.

The Canadian corporate tax rate on active business income (“ABI”) is lower that the tax rate on investment income. For 2016, the corporate tax rate in the province of Ontario on ABI is 15% whereas on investment income such as interest, dividends, royalties or rent), the rate is 50.2% subject to a refundable tax thereby reducing the effective rate to 19.53 when sufficient taxable dividends are paid.

The 2016 low rate of tax on ABI is on the first $500K of ABI, the ABI rate on any excess is at about 26.5%

The Canadian corporate structure for Canadian controlled private corporations is that one pays corporate tax and then a second level of tax by the individual shareholder when dividends are paid, not unlike utilizing U.S. C corporations. Canada does not have the S Corporation or LLC option.

Essentially being ABI, there is a tax deferral of about 38.53% for one in the top marginal tax bracket earning personally more than $200K. Tax deferral is the difference on tax in earning the income directly or indirectly through the corporation. On ABI over $500K, the deferral is about 27.03%. The absolute tax savings (cost) for 2016 is neutral for ABI up to $500K and an absolute tax cost of about 1.9% on ABI over $500K. Generally speaking, the absolute tax cost or savings is based on distributing all of the corporate income to the individual shareholders.

With regards to 2016 Ontario investment income (other than Canadian portfolio dividends), the tax deferral is about 3.4%, the same as in 2015, but for 2016, with an increase in the absolute tax cost to about 2.4% from 2.27%. For Canadian portfolio dividends, the deferral is about 1% for eligible dividends and about 7% for non-eligible. Eligible dividends comes from the GRIP account, generally dividends from Canadian public corporations. On distribution, there is no savings or absolute tax cost, thereby earning dividend income through a corporation as opposed to earning it personally remains neutral.

Specified investment business

Income from a “specified investment business” (“SIB”) is not considered ABI. By definition, a SIB is a business carried on by a corporation in a taxation year where the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property. Equipment leasing or non-real property rentals is excluded from the otherwise SIB rental. Income is not considered SIB income by statute if the corporation employs more than 5 full-time employees in the taxation year or if an associated corporation provides certain services to the corporation and could reasonably be expected to  require more than 5 full-time employees if those services were  not provided.  Full-time is not one who works part-time hours.

In order to fall outside the ambit of the SIB provisions, more specifically where one cannot meet the foregoing full-time employee test, one would have to argue that the particular income is not income from property but income from a business. There have been  numerous court cases on this subject matter, mostly dealing with rentals, where the taxpayer has to demonstrate based on the facts, that there is a degree of services being provided by the lessor or effort provided to earn the gross rental as opposed to the rent being considered strictly passive in nature. The rental of storage facilities appear to be a common business under regular review just like the motel/hotel and rental management business.

The 2015 Federal Budget announced a review or consultation on active versus investment business. The 2016 Federal Budget announced that the review is compete with nothing being amended.

One would expect better guidance on the subject matter, maybe similar to the U.S. passive activity rules and legislation pertaining to active or material participation.