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Help from a CPA Tax Consultant – How is Active Business Income Defined?

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Only the income earned from an active business by a Small Business Corporation qualifies for the lower small business tax rate [thanks to the small business deduction (SBD)], up to the corporation’s annual business limit.

What is Active Business Income?

Under the Income Tax Act, “active business income” generally refers to income from a business carried on by a Canadian resident corporation, with two main exceptions:

Specified Investment Business

This is a business whose main purpose is to earn income from property, such as rent, interest, dividends, or royalties. Income from these activities usually does not qualify for the small business deduction unless the business employs more than five full-time employees throughout the year.

Personal Services Business

This is a business where an individual provides services through a corporation, but would otherwise be considered an employee if not for the corporation. Income from a personal services business also does not qualify for the small business deduction.

While the full legal definitions are more detailed, these simplified explanations cover most situations.

Anti-Avoidance Measures and Assignment of Business Limits

Canada’s Income Tax Act contains specific anti-avoidance rules designed to preserve the integrity of the small business deduction and restrict inappropriate access to the business limit for active business income. These rules are especially relevant when dealing with corporate groups, associated corporations, or structures where ownership and control are not fully independent.

The business limit, which sets the threshold for income eligible for the small business deduction, is generally $500,000 per associated group of corporations. When two or more corporations are associated within the meaning of section 256, they are not each entitled to their own separate $500,000 limit. Instead, they must allocate that amount among themselves using a prescribed form, typically Schedule 23 of the T2 return.

Anti-Avoidance Provisions for Artificial Structures

To prevent the multiplication of the small business limit through artificial separation of ownership or income-splitting strategies, the Act includes targeted anti-avoidance provisions. One such measure is in subsection 125(5.1), which addresses situations where corporations that are not legally associated may nonetheless be considered “associated” for the purpose of limiting access to the small business deduction. This rule applies when two corporations are effectively under common control or when the arrangement appears designed to sidestep the association rules.

Furthermore, subsection 256(2.1) allows the Canada Revenue Agency to deem corporations to be associated if their separate existence primarily serves to reduce tax. This discretionary power can apply even in the absence of a formal association, where the operations, finances, or management of two corporations are significantly integrated.

Specified Corporate Income and Restrictions on Internal Billing

Assignment of the business limit among related corporations must be done deliberately and documented properly. Corporations are required to agree on how the $500,000 limit is divided, and failure to file the appropriate election can result in the entire deduction being denied. Inaccurate or inconsistent allocations between corporations may also prompt a review by the CRA.

Finally, rules under section 125(7) and the associated definition of “specified corporate income” are intended to prevent planning strategies where one corporation earns active business income from another related corporation, recycling income through multiple entities to extend access to the small business deduction. Income that falls within this definition is generally excluded from the small business deduction unless the payer and recipient jointly elect to treat it as eligible, and the recipient corporation can demonstrate it has a substantial economic contribution to the arrangement.

Together, these anti-avoidance measures ensure that the small business deduction supports genuinely independent small businesses operating within an applicable income threshold.

Specified Partnership and Farming or Fishing Income

The Income Tax Act also contains detailed rules that determine whether income earned through partnerships or from farming and fishing operations qualifies as active business income. These rules are especially relevant for private corporations seeking to benefit from the small business deduction (SBD), which applies only to qualifying active business income (ABI).

Income from Partnerships

When a corporation is a member of a partnership, its share of income from that partnership may qualify as active business income depending on the nature of the partnership’s business and the corporation’s role. If the partnership is carrying on an active business and the corporation is meaningfully engaged in that business, the corporate partner’s share of income is generally considered active business income.

However, the Act introduces the concept of a “specified partnership income” (SPI) to address potential abuses. SPI applies when a corporation earns income from a partnership in which it is not an actual partner but provides services or property to the partnership and is considered to be related to a partner in the partnership. In these cases, the income is deemed to be SPI and is subject to the business limit rules that restrict the availability of the Small Business Deduction (SBD).

Corporations earning SPI are only allowed to allocate a portion of the partnership’s business limit in order to qualify for the SBD on that income. This prevents multiple corporations from claiming the full business limit on essentially the same partnership income.

Farming and Fishing Income

Income from farming or fishing activities can also qualify as active business income, provided the activities are commercial in nature and conducted with a reasonable expectation of profit. Small family-owned farming and fishing corporations are eligible to claim the SBD on qualifying ABI from these sources, subject to the usual business limit.

Corporations involved in partnerships or cooperative structures must accurately assess whether their income qualifies as active business income and whether the business limit must be shared, allocated, or reduced under the specified partnership or specified cooperative income rules. Proper documentation, tax planning, and professional tax advice are critical to ensure compliance and optimize the tax benefits of this income.

 

As experienced and licensed CPA tax consultants, we help our clients handle all tax and accounting issues. Give us a call today at 1 844 340 5771 to schedule an assessment.

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Case Study

A new client faced a challenging CRA audit, which resulted in the disallowance of an HST refund valued at nearly $1 million. The audit revealed that his previous accountant had made significant errors, which led to the denial.

Our team conducted an in-depth review of the proposal letter from the CRA, in conjunction with the Income Tax Act. We were convinced that the case would be won if the records were corrected and a new argument was submitted as a response to the CRA’s proposal letter.

The CRA auditor denied the response. Our firm filed a Notice of Objection with the CRA.

The Objection was successful, and our client was able to recover not only the original refund but also additional amounts that the previous accountant had missed, which were also awarded to our client.

Testimonial

Sam Faris reduced the significant unreported income based on net worth audit to be nil. Sam’s approach in fighting these types of complex audits is unique and sophisticated. He found countless mistakes made by the auditor which were rectified when Sam appealed the audit decision. Instead of owing significant amount of taxes, Sam reduced it to zero. I highly recommend to hire Sam for this type of audits and any CRA problem.”

E.M., Ottawa
pro-tip

Pro Tip

ACCESSING THE SMALL BUSINESS DEDUCTION IN YOUR BUSINESS

The Small Business Deduction gives businesses a tax deduction on the first $500,000 of income. This saves an eligible corporation around up to $50,000 in income taxes. There are a number of conditions that have to be met to be eligible for this deduction.

Faris CPA absolutely fantastic tax consultant firm. Sam and his team help me with an extremely difficult tax audit by CRA. They have done an amazing job. You guys are amazing and well deserve five star.
Response from the owner:Dear Eliyas Thank you for the positive Google review and the kind words. We heave dealt with many CRA audit cases. We have delivered the best services to our clients as we are confident with our work and its quality. Please feel free to reach out us if you require our services in the future. Sam Faris
Sam Faris is number one tax advisor and consultant. I contacted a few professionals but he was the only one who was able to help me with my dispute with the CRA. Many thanks to him.
Response from the owner:Said Thank you for the kind words and the 5 stars Google review. CRA issues may get very complicated. I am glad that everything worked out perfectly with you. Feel free to reach out to us any time you require our services. Sam Faris
If you are looking for a tax consultant to help you with the CRA tax audit, Sam is the man. I appreciate Sam for helping me during the tax audit. He is the best professional and number one tax consultant out there. I will recommend him to anyone who has issues with the CRA.
Response from the owner:Thank you Omar for your positive feedback and the five stars Google review. We have more than a decade of experience in dealing with the CRA audits and helping our clients and providing all the required support. As you noticed, we provide a high quality of work to support our calculations and to save our clients from an unfair assessments by the CRA. Thank you again and will remain at your disposal if you require our services in the future.
I had Sam to help me filling my outstanding personal and corporate tax returns under the voluntary disclosure program. He did a very good job and filled them within 4 days and had me protected under the program. As a result of his work efficiency, I saved interest and penalties and now I am up to date with filling all tax returns.
Response from the owner:Anjan Your positive feedback is much appreciated. Providing a high quality services and submit the packages on timely basis is essential especially once it comes to cases which involves voluntary disclosures program. We prioritize these cases and we do our best to file the packages asap and before CRA contacts our clients. Thanks again and let us know if you have any question in the future. Sam Faris
Sam and his team are expert and awesome tax consultants. They were incredibly professional, respectful and informative in dealing with us. What stood out the most was the team’s attention to details to finding all possible deductions to minimize my tax liability.

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Response from the owner:Sangeet Thank you for the five stars review. Filling multiple years of personal and corporate tax returns is one of our specialties. We have been helping clients catching up with their taxes for more than 15 years now. While we are doing the work, we perform tax planning to minimize taxes owing and at the same time we prepare a high quality package to protect our clients and protect our work in case CRA decides to perform tax audit. Thank you again and feel free to contact us in the future if you have any question regarding our work. Sam Faris
We spoke to a few CPAs before hiring Sam of Faris CPA. Immediately Sam was able to pin point the problem and provided a solution to my problems with the CRA tax audit. We had a very pressing deadline to make a submission to the CRA and missing the deadline will involve significant amount of penalties that we will have to pay. Not only that Sam worked none stop to meet the deadline, he was able to save us thousands of dollars. We are also now in full compliant with the taxes and in a good standing. If you are looking for a tax consultant or you are having a CRA tax audit, don’t waste your time and money. Hire Sam Faris and you will not be disappointed.

Many thanks to Sam and well deserved 10 stars.
Response from the owner:Anish Thank you for your positive feedback. When it comes to CRA issues, meeting deadlines is extremely important and at the same time providing a top quality package is as important. This will avoid escalation with the CRA and as you realized, will save money to our clients. As in all cases, we took your case seriously and we aggressively worked on it to meet the deadline at the same time we did not compromise our work quality. I am glad that you are satisfied with the results. Posting the Google review is rewarding to our hard work too. Please feel free to contact us in the future if you have any questions. Sam Faris
Faris CPA filed my multiples years of unfilled tax returns for both my corporate and my personal. He saved me taxes and was able to waive the penalties for me. Great job team and I will recommend Faris CPA to everyone who has CRA problems.
Response from the owner:Ahmad Your five stars Google review and your positive feedback is much appreciated. All the cases that we take are time sensitive and we take them extremely seriously to avoid complications with the CRA. Meeting deadlines is essential in any case we work on. This is why we were able to save you penalties and interest as we filed all returns before CRA makes a contact with you. We will remain at your disposal anytime you need our services in the future. Sam Faris
CRA performed net worth audit to my company and my personal taxes for three years. I hired another professional at the beginning and paid him 25k. This professional did not deliver what he promised and was unable to reduce taxes as per the CRA proposal letter. I was referred to Sam by a tax lawyer who highly recommended him for any CRA audit. I consulted Sam and I googled him as well. I was impressed with his knowledge, confidence and excellent reputation and decided to hire him. Sam results at the end were way less from CRA proposal. He backed up all his numbers in a way that CRA had to accept his approach and his final numbers. I was very happy with the final tax bill after the audit was completed. I have so much respect to Sam and his work ethics. I was also happy with his fee and I think his fee is reasonable too. Thank you Sam for all your help. You saved mine and my family lives.
Response from the owner:Thank you for the positive five stars review and your kind words. Net worth audit is the most complicated audit that CRA performs where CRA has doubts that taxpayers under reported the income. This kind of audit is one of our specialties. Over the years, we have developed a unique and sophisticated strategy to defend our clients from the CRA excessive numbers. In many cases, CRA auditors acknowledged and complemented our work and our approach. We will remain at your disposal if you need our services in the future. Sam Faris
Dealing with CRA is stressful. Sam took care of me from day one and accommodated my unique needs without hesitation. 5 stars for being professional and a good human.
Response from the owner:Thank you Don for the five stars Google review. We are glad that we met your expectations and your case is closed now. Happy to answer any questions in the future and we will address all queries CRA may have regarding our work. Sam Faris