One of the most important reasons to differentiate business and property income from capital gains is that 100% of business and property income (and losses) are taxable whereas only 50% of capital gains are taxable. This has a big tax impact (which often ends up in court) and therefore it is important for us to understand how to differentiate business and property income from capital gains.
Business Income vs. Capital Gain.
There is limited specific guideline in the ITA on whether economic activity represents business income. If you look up ‘business’ in ITA 248(1) it basically says a business is “…an adventure or concern in the nature of trade but does not include an office or employment.” This is not particularly helpful guidance as it basically says ‘well we don’t really know what a business is, but we know it is not office or employment’.
The CRA has filled this void by publishing IT-459 “Adventure or Concern in the Nature of Trade”. This Interpretation Bulletin provides guidance to determine whether amounts represent business income or capital gains. In determining whether something is an ‘Adventure or Concern in the Nature of Trade’ (i.e. business income) the CRA primarily looks at “Taxpayer Conduct”, the “Nature of the Property” and the “Taxpayer’s Intention”
Taxpayer’s Conduct: One of the major considerations is whether the taxpayer is acting in a manner that is consistent with the way other taxpayers would typically act with the same property, goods or services. So, per IT-459, you would compare the activity to what “dealers would do with the same kind of property and what the taxpayer did when he purchased the property, when he sold it and during the time when it was in his possession.” If the taxpayer’s activity is consistent with what a dealer in the property would typically do, then this would be an indication of business income.
Other elements of the taxpayer’s conduct that might indicate business income include the following:
- Evidence that the taxpayer attempted to find a purchaser for the property shortly after the initial purchase
- Evidence that the taxpayer improved the property to increase potential re-sale value.
- The purchaser has a commercial background dealing with similar property.
Nature of the Property: When property is of such a nature that it couldn’t create income on its own (for example a building might be able to create rental property income on its own) or be enjoyed by the taxpayer on its own, then it likely would be considered business income. Effectively this criteria is looking at the goods or services themselves and saying ‘look, you did a wholesale purchase of 15,000 rolls of toilet paper, the only reason to have this would be for resale and therefore this will create business income.’
Taxpayer’s Intention: IT-459 states that “A taxpayer’s intention to sell at a profit is not sufficient, by itself, to establish that he was involved in an adventure or concern in the nature of trade. That intention is almost invariably present even when a true investment has been acquired, if circumstances should arise that would make it financially more beneficial to sell the investment than to continue to hold it.” So, intention to sell at a profit does not, on its own, indicate business income. If however intention to sell is linked to the other criteria (Taxpayer Conduct, Nature of the Property) then this would provide further support that this is business income.
The CRA will look at both the taxpayer’s primary intention and their secondary intention when considering whether activity creates business income or capital gains.
Business Income vs Property Income
The difference between business income and property income is usually based on the amount of activity needed to generate the income. If it is an active source of income it is typically considered business income whereas a passive source of income would be considered property income.
Interactive content (Author: Gurmehar S. Grewal, March 2019)
Interactive content (Author: Simran Gill, June 2019)
References and Resources:
- IT-459 “Adventure or Concern in the Nature of Trade”
- Competency map: 6.3.2