Published: March 18, 2020
Last Updated: October 25, 2021
Introduction: How Tax Planning Can Help Raise Funds for Your Business
Starting a new business requires a lot of good planning. Not the least of which is good tax planning. But good tax planning is not simply about minimizing your tax related costs. Good tax planning incorporates the complexity of the tax system into the decision making process of the broader start up and management of the business. For instance, good tax planning can help to open up new capital markets for a business.
Not every small business corporations’ shares will qualify as an eligible investments to be held within RRSPs (or RESPs, TSFAs, etc). A business that is ineligible to raise capital from these sources may be cutting off a major source of start-up funding. A business that is eligible, on the other hand, will have the ability to raise start up funding from registered investment plans.
Qualified Investment: How to Know If Your Business is Eligible
To be eligible to be characterized as a prescribed qualified investment, a small business must satisfy the requirements of subsection 4901(2) of the Income Tax Regulations. Specifically, the shares held in the registered plan must be of a business that is considered a “specified small business corporation”.
For a business to be a “specified small business corporation” it must be a Canadian controlled corporation where all or substantially all of the fair market value of its assets are used in active business which is carried out primarily in Canada. Determining whether certain assets are “used in active business” is often cut and dry, for example a restaurant that has assets such as ovens and dishwashers is obviously using them in active business. But sometimes that judgement is more subjective. Take for example, the asset that almost every successful business has: cash. A new business often has raised a surplus of cash which is sitting on its balance sheet to cover future operating expenses should it have to endure an initial period of negative cash flow. But this surplus cash is still an asset that needs to be assessed, along with the other assets of the business, as to its use. But how does one “actively use” cash?
How to Know If Your Business Assets Are “Active”: Interpreting Income Tax Regulations 4900(14)(a) and 4901(2)
A recent publication by Canada Revenue Agency has provided guidance for businesses that are concerned about this very issue.
Generally speaking, the following rules can be a guideline for common start up and post start up situations:
- Cash or near cash property is considered to be used principally in the business if it will destabilize the business to withdraw it from the corporation.
- Cash that is temporarily surplus to the actual needs of the business and is invested in short-term income producing investments may be considered to be used in business
- Cash balances that fluctuate in accordance with a seasonal pattern throughout the calendar year will generally be considered to be used in active business. However, a permanent balance in excess of the company’s reasonable working capital needs will generally not be considered used actively.
- The retention of a cash balance to fulfill an obligation required in order to do business will be considered as being used in the business. For example, it is often the case that creditors require a minimum level of liquidity on hand or a minimum current ratio (the ratio of current assets to current liabilities). Under such a situation, the cash and near cash assets held to offset current liabilities will generally be considered to be used in the business. The surplus balance (in excess of current liabilities) held for the purpose of repaying non-current liabilities or in anticipation of capital acquisitions or replacements will not, of itself, evidence use in active business.
Assessing whether any particular balance sheet or asset class passes the ‘active use’ test is a question of fact to be determined on a case by case basis. The actual use of the asset, as well as the circumstances of the business and the progression through the start-up phase all contribute to making the assessment.
Making this type of assessment is important to the broader planning process of every small business. By being cognizant of the tax consequences to your investors, the management of a business can broaden their available options for fund raising; a critical part of any business plan.
Tax Tips: Incorporate Tax Planning into Management
The proper decision making approach to taxation is not to place tax planning in isolation but rather to include, in a formal way, taxation as a major variable to be considered in decisions made regarding all your businesses financial matters. This kind of broad, pre-emptive planning doesn’t necessarily require the managers of a business to have extensive knowledge of the intricacies of the tax system. A simple consultation with an experienced Canadian tax lawyercan help to identify the issues that may arise in a particular business plan.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."