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The term “active in the business” is not a defined term. Yet, the July 18 tax proposals make reference to shareholders being active in the business.
We can look at examples of active partners compared to silent partners. A person who is active in the business will be involved in day-to-day operations. This person may also have made an investment in the business. A passive, or silent partner is only involved in the investment and the strategic decision making.
We are silent investors when we buy shares on a stock exchange; we have made an investment and are only asked for our opinion at annual general meetings. We are entitled to receive dividends and it is not called income splitting. This principle is at risk for small businesses.
How will this concept of “active in the business” apply to small business owners? We have been told that shareholders who are not active in the business will not be entitled to dividends. Let’s consider the example of a family business. Imagine a family contracting business where the father (John) does the contracting and both the father and the mother (Susan) are shareholders. If John is the one with the hammer and Susan does the bookkeeping, collections and billing – are they both active in the business?
What if there is a second mortgage on the family home and the money borrowed is invested in the contracting business. This would mean that both parents are bearing the risk and have money invested in the business.
I would suggest that since Susan is sharing in the risk and involved in the billing, collection and bookkeeping that she would be entitled to receive dividends on her shares in the family business. I was also thinking that we are going to have to keep records of the hours Susan works and the input she has on decisions made in the business.
We won’t know how CRA and the courts are going to interpret the proposed rules for some time. While we wait, we should be thinking about how to document the involvement of all shareholders in the business.