New legislative amendments have enabled the Quebec government to overhaul the existing small business deduction (“SBD”) eligibility requirements through the introduction of new stringent rules which may impede a corporation’s right to access the SBD tax rate.
The new rules may affect a vast number of small business owners by disqualifying their corporations’ access to the reduced SBD tax rates.
The old SBD rules mirrored the federal rules, where a corporation was eligible to claim the SBD provided they carried on an active business. The new rules were originally drafted to require that a corporation employ a minimum number of full time employees. The minimum number of employees’ criterion was subsequently amended by requiring that a corporation’s employees work a minimum number of hours throughout a taxation year.
The new rules come into effect for taxation years beginning after December 31, 2016. A corporation will now qualify for the full SBD rate, provided the following criteria is met:
- during the taxation year, its employees worked at least 5,500 hours; or
- during the previous taxation year, the number of hours worked by its employees and the employees of the corporations with which it is associated total at least 5,500 hours.
A corporation needs to employ slightly less than three full time employees throughout a year to meet the 5,500 hours threshold. The following rules, inter alia, apply in meeting the 5,500 hours criterion:
- a maximum of 40 hours per week per worker will be considered;
- the hours worked must be paid at the time the SBD is claimed;
- the hours worked by a person who holds shares of a corporation, directly or indirectly, will also be counted without regard to whether they are remunerated;
The SBD will be reduced linearly between 5,500 and 5,000 hours, and will be nil when 5,000 hours or less are worked.
Additional care will need to be exercised to ascertain whether a corporation qualifies for the SBD tax rate. A corporation will have to document the hours worked by a person, especially in situations where a corporation is at the cusp of the 5,000 and 5,500-hour thresholds.
The new rules are akin to the “personal service business” rules contained in the federal Income Tax Act, which notably targets and deters incorporated employees from incorporating. The new rules spell trouble not only for professional corporations held by sole practitioner doctors, lawyers, and accountants, but may affect many small businesses with minimal staff, or operating a seasonal business. Ascertaining whether a corporation is a personal service business requires a factual determination and hence allows for a greater degree of flexibility to enable a corporation to be eligible for the SBD tax rate, whereas the new Quebec rules apply a rigid 5,500 hours bright line test.
In re-focusing the SBD, the Quebec government has provided corporations operating in the primary (i.e. agricultural, fishing, forestry) or manufacturing sectors favorable incentives by according a further enhanced SBD rate. Furthermore, the foregoing criteria is not as rigid for corporations in the primary or manufacturing sector, as they may access the SBD rates granted their activities are attributable to manufacturing and processing and the primary industry exceeds certain thresholds.