Does the small business deduction carry over when I buy a company?

The small business deduction reduces the federal tax a corporation pays on its active business income, so it belongs to a corporation’s own tax year, not to the business you are buying.

Who can claim it

Section 125 of the Income Tax Act allows the deduction to a corporation that was a Canadian-controlled private corporation throughout the taxation year, on income from an active business carried on in Canada, capped by, among other things, the corporation’s business limit. The Act’s definition leaves out, among others, a corporation controlled, directly or indirectly, by non-residents or by public corporations (other than a prescribed venture capital corporation). If the buyer is a non-resident or a public company, the acquired company may stop qualifying.

Buying shares: the limit is shared

Under section 256, two corporations are associated if one controls the other or the same person or group of persons controls both, and further cases involve related persons. If your corporation buys control of the company, the two become associated. A Canadian-controlled private corporation associated with other such corporations has a nil business limit except as the section otherwise provides: the group can file an agreement assigning percentages of one limit among them, and the Minister allocates it after notice if they do not. The limit is divided, not doubled, and subsection 125(5.1) can reduce it for large taxable capital employed in Canada or for adjusted aggregate investment income, counted across the group.

Buying assets: the seller’s deduction stays behind

In an asset purchase the seller’s corporation keeps its own tax history, including whatever deduction it claimed. Your corporation claims the deduction, if it qualifies, on its own active business income, including income from the business you bought, within its own business limit. A buyer who operates personally has no corporation to claim it, because section 125 speaks of a corporation. See also why buyers prefer asset purchases for tax reasons.

What to settle before closing

Ask your accountant to map who will control which corporations before and after closing, and how the limit will be split. Afterwards, tell the Canada Revenue Agency about changes of owners, officers or administrators, and keep filing the T2 return that resident corporations, with a few exceptions, file each year. The Act sets the business limit and the rate, and the rate has varied by year, so take current figures from the CRA or your accountant.