The small business deduction is a key tax incentive for entrepreneurs of small businesses.  If the corporation qualifies as a Canadian controlled private corporation (commonly referred to as CCPC), the net federal tax rate for active business income is 9% on the first $500,000.

The Income Tax Act (the “Act“) also has association rules to prevent business owners from multiplying the small business deduction among their businesses.  When two or more CCPCs are associated for tax purposes, the small business deduction limit of $500,000 must be shared annually among the associated corporations.  If a corporation sees its small business deduction reduced, it intrinsically results in a higher tax rate on its active business income.

The association rules are complex.  Essentially, two or more corporations will be associated if they are controlled by the same person or group of persons that are related.  Control can be exercised “directly or indirectly in any manner whatever” and can be control in law (referred as de jure control) or control in fact (referred to as de facto control).

One can inadvertently trigger the association rules especially in an estate planning context.

Choosing Your Attorney under Power of Attorney for Property Wisely

It is not uncommon for business entrepreneurs to appoint a family member or a close friend, who is also a business owner, to be their attorney for property.  The thinking is their attorney’s business experience will be a benefit in administering the Grantor’s business.

If the Attorney has the power and authority over voting shares of the Grantor, the Attorney controls the Grantor’s business, therefore the association rules are triggered. As such, the Grantor’s corporation and the Attorney’s corporation will have to unexpectedly share their small business deduction and potentially pay a higher corporate tax rate.

What’s worse, subsection 256(1.4) of the Act will trigger the association rules if a person (i.e. the Attorney) has a right at any time under a contract, in equity or otherwise, either immediately or in the future and either absolutely or contingently, to control the voting rights.  The Canada Revenue Agency (the “CRA“) has issued a view that since the Attorney has a contingent right to act on behalf of the Grantor, the association rules are triggered even if the Grantor has not yet invoked his or her Power of Attorney for Property.

The sole exception to this rule is if the right to act [as Attorney] is contingent on the permanent disability of the Grantor.

Options to Consider?

The Grantor should always appoint the most suitable person to be their Attorney for property.  However, if accessing the small business deduction is important to the business, the Power of Attorney should include a clause stating that an alternate person is to be appointed if the small business deduction is jeopardized.

Alternatively, one may consider appointing one Attorney for administering all personal affairs and another Attorney solely for business purposes.  Obviously, the appointed Attorney under the “Business Power of Attorney” would be a non-business person or someone with business knowledge that would avoid triggering of the association rules.  It may be advisable to insert a clause so the Attorney can retain the services of a business advisor to assist with the decision-making.

We can agree that tax should not be the decisive factor in choosing your Attorney for property.  However, when the Grantor is a business owner, estate advisors may want to enquire whether the person to be appointed Attorney is also a business owner as a matter of diligence and so the Grantor can make an informed decision.  After all, it’s their decision.