Last week, the Tax Court of Canada ruled that Rocco Gagliese Productions, a small business created by award-winning composer Rocco Gagliese, was entitled to the SBD rate on the royalty income he received from the music he composed.
This is seen as a huge victory to Canadian music composers. As reported by the Financial Post, Canadian composers are often members of the Society of Composers, Authors and Music Publishers of Canada (SOCAN), and receive their income from SOCAN, rather than their direct clients. SOCAN, when making payments to composers, characterizes those earnings as royalties, and a large segment of SOCAN members incorporate companies for their composing business. The issue then becomes how royalty income from music is characterized under the Act, as well as the nature of the businesses themselves.
Rocco Gagliese has composed music for a wide variety of television shows, including Peep and the Big World, Curious George, Wonder Why?, and Fetch!. He has also written music for a variety of CBC programs, including The National, The Passionate Eye, and The Lang and O’Leary Exchange.
In 2011, 2012, and 2013, the Canada Revenue Agency (CRA) had consistently denied his corporation’s right to claim the small business deduction (SBD) on the royalty income he received from his music, arguing that it fell within an exemption under the Income Tax Act (the Act).
Under the Act, Canadian controlled private corporations (CCPCs) are able to claim the SBD tax rate on the initial $500,000 of annual active business income and defer paying personal tax on that income until those funds are withdrawn from the corporation. For business owners who can afford to leave some of their income in their corporation for investment purposes, this becomes a significant tax advantage.
In order for a CCPC to be entitled to the SBD tax rate, however, the CCPC must carry on an active business and not a ‘specified investment business’ or a ‘personal service business.’
The CRA insisted that Rocco Gagliese Productions was a specified investment business and thus not entitled to the SBD tax rate. And so, the issue before the Court was whether Rocco Gagliese Productions was a specified investment business or not.
Under the Income Tax Act (“the Act”), a CCPC is entitled to claim the SBD if the CCPC carries on an active business, which is defined as, “any business carried on by a corporation other than a ‘specified investment business or a personal services business.’”
The Act also defines, “specified investment business,” as a business that has the principal purpose of earning income from property, which includes interest, dividends, rents, and royalties, and which has less than six full-time employees.
In other words, any business carried on by a corporation will be an active business, unless the business is not a specified investment business or a personal services business.
Mr. Gagliese argued that his business was an active business. More specifically, he was in the business of creating, writing, and composing music that is used for television shows. It was his position that his company was incorporated for the purpose of writing music and earning income from music writing itself.
He also argued that should his business fall within the definition of a “specified investment business,” the income he earned was from property that was related to an active business and not directly from property.
The CRA, however, argued a conservative interpretation of the law. It was CRA’s position that Rocco Gagliese Productions was a “specified investment business” based on the royalty income it earned from SOCAN.
The Court ultimately agreed with Mr. Gagliese and held:
It was not the principal purpose of the Appellant’s business to earn income from property. The principal purpose of the Appellant’s business was to earn income from Mr. Gagliese’s daily activities of originating and recording music tracks for individual television episodes. As Mr. Gagliese testified, if you take away his daily writing activities, [he] earned little or no income.
The Court further noted,
Prior to SOCAN coming into existence, a music composer’s client paid the composer directly for the services rendered in writing and recording tracks/cues for television episodes. It appears to me that in such a situation, the income realized from the business of composing and recording that music would clearly be income from an active business.
The Court concluded,
Once SOCAN came into existence, the client no longer paid the music composer directly for the services. Instead, the payments were made through SOCAN. However, they were being made for the same services. The unique method used in the Appellant’s industry to pay for the services provided does not change the principal purpose of the Appellant’s business.
Mark Feigenbaum is highly experienced in both entertainment law as well as related areas of law including family law, wills and estates, cross-border tax, and a wide range of litigation. He can provide exceptional multi-disciplinary legal guidance and help anticipate and proactively address potential legal and financial risks.
In addition to having both U.S. and Canadian accounting designations, Mark holds a Masters of Law (L.L.M) degree in Entertainment, Media and Sports Law, and a Doctorate in Law (J.S.D) focusing on the taxation of sports and entertainment professionals.
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