Basic Rules: Business Income vs Property Income

Question 1

Describe the types of transactions that arise from holding or disposal of property.

Answer 1

1. Income or loss produced during ownership of property:
   
   • income or loss from a business; or
   • income or loss from property
2. Income or loss produced from the disposition of property
   
   • a capital gain or loss; or
   • income or loss from a business; or
   • income or loss from a property

Question 2

How do you apply the active vs passive test to determine the type of income produced - business or property?

Answer 2

Passive (inactive) income (income from property):

• requires little or no activity by the taxpayer (or his or her employees) (dividends, bank savings interest, bonds, royalties, rental income).
• if the purpose of a corporation with not more than five employees is to earn income from property (interest, dividends, rents, and royalties, but excluding leasing income from other than real property)
• investment income earned by a corporation unless it is from an active business
• short-term corporations that become more or less permanent (never depleted in the course of carrying on the business
• income of a limited partner not actively engaged in the partnership business on a regular, continuous, or substantial basis.

Active income (income from a business):

• if the purpose of a corporation with more than five employees is to earn income from property (interest, dividends, rents, and royalties)
• Investment income earned by a corporation that is considered active income:
  
  • charged on accounts receivable;
  • interest on monies held in short-term investments;
  • rents on (otherwise) unused portion of a manufacturer’s premises

Question 3

Definition of “Property”

Answer 3

To determine whether the source of income is from property or a busines it is necessary to establish whether the taxpayer has purchased property or inventory. Property is defined as property of any kind whatever, whether real or personal or corporeal or incorporeal and specifically includes:

• a right of any kind, a share or a chose in action (chose: a thing or piece of personal property)
• money (includes gold, silver, copper, nickel, coins, and any paper notes, such as bank notes and cheques, and extends to property, possessions, and wealth)
• a timber resource property; and
• work in progress of a business that is a profession

Question 4

Why is the distinction between business income and other income important?

Answer 4

• It affects the rate of tax used.
• RRSP earned income for calculating the contribution limit:
  
  • For an individual, it includes property income (except for rental income)
  • For self-employed, it includes business income.
• Child care expenses: For earned income eligible for a deduction for child care expense:
  
  • inlcudes business income
  • excludes income from property
• Property income from rental properties is subject to separate rules. For example, capital cost allowance may not create or increase a loss from rental properties.
• Business income by corporations has special rules. For example:
  
  • small business deduction for active business income
  • manufacturing and processing deductions for profits derived from manufacturing
  • property and investments are taxed at a much higher rate.
• Income attribution rules generally apply only to the non-arm’s length transfer of property income and not to transfer of business income;
• Non-resident taxpayers are taxed on income from a business carried on in Canada; Income from property is subject to withholding tax under a different part of the Act.