Rental income earned by a corporation is considered property income i.e. aggregate investment income.
Active business income of Canadian-controlled private corporations (CCPC) is subject to preferential tax treatment due to the small business deduction. Earning investment income in a CCPC has tax effects since it affects small business deduction. Property income which is an investment income in certain circumstances can be an Active business income.
We are not going to discuss rental income as a business income, however, we are going to focus on rental income from associated corporations.
What is an Associated Corporation?
The question of whether two corporations are associated or not can be answered by looking at the “Control”. If a person, either an individual or a corporation, can exert control either directly or indirectly, there is an association.
Further, control can be either De jure Control or De facto control.
De Jure Control – if control is due to a person owning enough shares to exercise control.
De Facto Control – also called factual control, if any person exercises this influence will result in actual control.
Property income as an Active Business Income
Subsection 129(6)(b)(i) of the Income Tax Act (ITA) allows rental income from an associated corporation engaged in active business to be treated as active business income. Whereas, subsection (129(6)(b)(ii) of ITA allows different expenses to be deducted against this active business income.
How to report rental income from an associated corporation in a Corporate Income Tax Return (T2)?
Rental income from associated corporations is an active business income if the associated corporation is engaged in an active business. As previously mentioned, all the allowable expenses can be deducted. There is no need to complete schedule 7 if there is no other property income for a corporation.
For example, a Holding company can report its rental income from the operating company as an active business income on schedule 125 of T2.
Canadian-controlled private corporations (CCPC) can claim small business deduction on their active business income. Small business deduction (SBD) is used to reduce Part 1 Tax for CCPCs in Canada.
How the property income is reported by a Corporation?
If a corporation has property income that is not an Active Business Income, it needs to complete Schedule 7 to determine aggregate investment income and income eligible for small business
Property income earned in a corporation is subject to income tax in the same way as any other investment income. A CCPC is eligible to get a refund on the refundable portion of part 1 tax paid on investment income when it pays actual dividends to shareholders. The refundable portion is part of the Refundable dividend tax on hand (RDTOH).
Note: For the tax years starting after 2018, a Refundable dividend tax on hand (RDTOH) is replaced by two new accounts; Eligible refundable dividend tax on hand (ERDTOH) and Non-eligible refundable dividend tax on hand (NRDTOH).
Investment income and refundable dividend tax issues are complex topics in Corporate tax. Users are cautioned to consult their professional corporate tax service provider in Canada before making any decision based on the limited information presented above. A brief overview of earning investment income in CCPCs is presented in another post here.
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