Professional Corporations

May no longer benefit from lowest tax rate

Professional Corporations

Taxation of Professional Corporations
The Income Tax Act (Canada) (“Act”) provides a small business deduction (“SBD”) that reduces the combined federal and provincial corporate tax rate on the first $500,000 of active business income earned by a “Canadian-controlled private corporation” (“CCPC”), as defined in the Act. In British Columbia, the combined tax rate on such income is currently reduced from 26% to 13%. The provincial component was further reduced by 0.5% in the 2017 BC Budget, making the combined rate 12.5%, effective April 1, 2017.

A CCPC is generally a private Canadian corporation, which is not controlled by non-residents of Canada or public companies. Where a CCPC is a partner of a partnership, the existing “specified partnership income” (“SPI”) rules generally provide that a single $500,000 limit applies to the partnership’s business. The partner CCPC is only entitled to claim its pro-rata share of the SBD in respect of the portion of the partnership’s active business income that it is allocated. 

Historically, various structures have been implemented to avoid the application of the SPI rules and allow CCPCs to claim a full SBD. For example, a common structure is as follows:

  • CCPC 1 (“Partnerco”) is the partner in the partnership and is allocated partnership income; and 
  • CCPC 2 (“Holdco”) provides services to Partnerco and is paid a service fee by Partnerco. 

Prior to the Act being amended, the SPI rules did not apply in the above situation because Holdco was not a partner in the partnership. Holdco could claim the full SBD on the service fee received from Partnerco, up to $500,000. 

New SPI Rules 
For taxation years that begin after March 21, 2016, the SPI rules have been amended to address structures that effectively allow partner corporations in partnerships to multiply the SBD. Consequently, professional corporations that earn income from partnerships, regardless of their tax structure, may no longer be able to claim the full SBD and should review the amended SPI rules in light of their particular circumstances. 

The new SPI rules now generally deem a CCPC that is not a partner of the partnership to be a partner where the CCPC provides services, directly or indirectly, to the partnership and one of its shareholders holds a direct or indirect interest in the partnership. As a result, the SBD of the CCPC is limited to its pro-rata share of the partnership’s $500,000 limit, which must be shared with other partners and deemed partners.

Applying the new SPI rules to the example above, Holdco is deemed to be a partner of the partnership because it provides services indirectly (i.e. through Partnerco) to the partnership and its shareholder (the professional) holds an indirect interest (i.e. through Partnerco) in the partnership. Consequently, Holdco’s SBD is limited to its pro-rata share of the partnership’s $500,000 limit.

Notwithstanding the new SPI rules, professional corporations can still benefit from a 26% combined federal and provincial tax rate in British Columbia and tax deferral is also still achieved if any income allocated from the partnership is left in the CCPC. 

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