Power of Attorney (POA): Caution about inadvertently restricting your access to the low small business tax rate

If the person you appoint as your Attorney (your representative) under a Power of Attorney (POA) has a corporation of their own, their status as your Attorney can cause their corporation to be “associated” with your corporation, whether or not your Attorney has begun to act under the POA. The result may be that both corporations will have reduced access to the low tax rate that applies to business income under the $500,000 “small business limit”.

Sean Rheubottom, B.A., LL.B., TEP

Having an Enduring Power of Attorney (“POA”) is a critical part of any estate plan. Under an Enduring POA you would appoint someone to handle your property and financial affairs (for example, the ability to withdraw money from bank accounts, pay bills and sell or purchase property), and/or someone to handle your personal affairs (for example, deciding where you should live and what kind of help you need around the home, but not health care decisions), or someone to take care of both property and personal affairs.

“Enduring” means the Power of Attorney is effective even after you have lost the capacity to give instructions or handle your affairs. For estate planning purposes, a POA should normally be “enduring”.

If you appoint someone under an Enduring POA, unless you state otherwise, their powers will include both personal and property matters.

Associated corporations

The $500,000 “small business limit” is the maximum amount of business income of a private corporation, per year, that can be taxed at the low (currently 9%) “small business deduction” rate in a given year. (For Saskatchewan provincial tax purposes, the limit is $600,000.)

Where two or more corporations are “associated” for tax purposes, they must allocate a single $500,000 “small business limit” between themselves each year, rather than each enjoying the full $500,000 small business limit. The result is higher tax. The “associated corporations” rules under the Income Tax Act (Canada) are very complex. Basically, the rules seek to “associate” two or more corporations where the corporations are controlled by the same person or by related groups of persons.

Association because of a POA – the “right to control” rule

There is a rule in the Income Tax Act that can cause two or more corporations to be associated because of a POA. This rule is relevant in situations where someone you may want to appoint as Attorney has their own corporation and may want to preserve access to a full small business limit. This often needs to be considered in family business succession planning, where a son or daughter has a corporation that needs to access the small business deduction.

The “right to control” rule provides that for the purposes of the associated corporations rules, if a person has a right either immediately or in the future, and either absolutely or contingently, to control voting rights, that person is in the same position as if he or she owns the shares. The CRA has repeatedly confirmed that this rule can result in the association of your Attorney’s corporation with your corporation, because the attorney has the right to control voting rights, absolutely or contingently.

Furthermore, CRA has confirmed that this rule applies whether or not the Attorney has begun to act under the POA.

However, an express exception within this tax rule states that the rule does not apply where the right is not exercisable at the time because the exercise thereof is contingent on the death, bankruptcy, or permanent disability of an individual.

There is a technical interpretation from CRA in which CRA confirms that where the POA provides that it is to take effect only on the “permanent disability” of the individual who gave the power, then the rule does not apply until the POA becomes effective because of permanent disability. However, this is not helpful as a planning option because there is little point in making a POA that only becomes effective on “permanent disability”. The POA is meant to assist as the person begins to lose capacity, among other circumstances. There may be periods of incapacity and periods of full lucidity. Further, it may be difficult to ever be certain whether there is “permanent disability”.

Possible solutions

Possible planning solutions need to be carefully considered and planned for your specific circumstances.

One less than ideal solution is to accept as unavoidable the association of the relevant corporations. The thought process may be something like this: The person acting as your Attorney will be in control of your corporations and will continue to be in control after your death since they are the beneficiary of your estate and succession plan. Therefore association of the corporations is an expected eventuality.

Where association must be avoided, a simple solution is to appoint as your Attorney someone other than a person with a corporation that could become associated with yours. It’s possible to appoint such a person with a limited power to handle only your corporation’s affairs.

In certain situations, appointing two or more persons with a requirement that they act together unanimously can be solution. CRA statements have indicated that in this case, the “right to control” rule should not apply. This solution must be carefully considered to ensure that it works in your specific situation and all contingencies are considered. For example, what if one of the appointed Attorneys is incapacitated or unable to act? Naming an alternate to take that person’s place is another possible solution.

Estate planning - consider tax as well as legal aspects

Where private corporations are involved, some of the normally routine aspects of estate planning, such as making a POA, can become more complex because of the tax rules that may apply. It’s important to work with professional advisors who are considering both the tax aspects and the legal aspects of your planning.

© Heritage Private Wealth Law

General information only; not intended as legal or tax advice. Readers are encouraged to obtain legal and tax advice before acting in their specific circumstances.