How do I ensure my rental income is active business income? Why would this be a good idea?

Facts:

Rental income falls under the definition of aggregate investment income in the Canada Income Tax Act. That means that it is not classified as active business income and does not qualify for the small business tax rate, resulting in higher tax rates on most rental income.Active business income of a Canadian Controlled Private Corporation (CCPC) in BC is taxed at a combined rate of 13.5% (reducing to 13% in 2016). Aggregate investment income of a CCPC in BC is taxed at a higher rate, usually 30% or more.

Discussion:

Rental income can be considered active business income if it is from an associated company that is in an active business.

In this case, the corporation’s rental income does qualify for the small business credit, but the small business credit is shared between the associated corporations. Rent should be charged to the associated company at the market rate. If some of the building is rented to a third party that is not an associated company, all of the rental income can qualify as active business income if the portion that is not associated is incidental.

An example would be if “A” Corporation owns a building and rents 90% of the building to an associated company, “B” Corporation. The other 10% of the building is rented to a third party that is not associated to the group. All of A’s rental income can qualify as active income.