The Canada Revenue Agency (CRA) offers many benefits to small business owners, including Small Business Deduction (SBD). Although the name is small business deduction, even mid-sized corporations can avail themselves of this benefit if they qualify. SBD allows qualifying businesses to pay a reduced federal tax rate of 9% instead of 28% after federal tax abatement. Even provinces allow a lower tax rate of 0-3%, depending on the province, instead of a tax rate as high as 15%. This preferential tax rate applies to the first $500,000 active business income.

The significant tax benefit from the SBD encourages businesses to incorporate as Canadian-controlled private corporations (CCPC) despite several rules and compliances.

Before taking the big step of incorporation, small business owners must understand the Small Business Deduction to maximize this benefit.

What is Your Business Limit for Small Business Deduction?

The CRA has assigned a $500,000 business limit in a taxation year for the Small Business Deduction. However, this limit is reduced under the following circumstances:

1. There are less than 51 weeks in the tax year as the business was incorporated mid-year. In such a scenario, the business limit will be prorated for the number of days in the year.
2. The business has multiple CCPCs. As per the associated corporation rule, all CCPCs owned by the same person or group of persons will be allocated a combined business limit of $500,000. The business limit for Corporation A will be reduced by the limit assigned to other associated corporations.
3. The CCPC and associated corporations have more than $10 million in taxable capital in Canada. In this scenario, the business limit will be reduced by the surplus capital employed (above $10 million) and become nil when the capital employed reaches $15 million.
4. The CCPC and associated corporations have a passive income of over $50,000. In such a scenario, the CCPC’s business limit will fall by $5 for every $1 of passive income above $50,000. The business limit will become nil when the passive income reaches $150,000.

Suppose the third and fourth scenarios apply to your business. In that case, the business limit for a taxation year will be greater than its taxable capital business limit reduction and its passive income business limit reduction.

Before incorporating your business, you might want to adjust the passive income and capital employed to maximize the SBD.

Does Your Business Qualify for Small Business Deduction

Once you are sure that SBD can bring significant tax benefits to your business, it is time to see if your business qualifies. To be eligible for the SBD, your business:

• Must be a Canadian-controlled private corporation (CCPC)
• Must be earning active business income

These two criteria have several elements.

What is a Canadian-Controlled Private Corporation?

A Canadian-controlled private corporation is

• Canadian – resident and incorporated in Canada.
• Controlled by a Canadian, and not a non-resident person, a public corporation, or any combination thereof.
• a Private corporation whose shares cannot be listed on a designated stock exchange.

The Income Tax Act defines “control” as owning more than 50% stake in the company.

Note that the Income Tax Act has additional rules for private Canadian corporations with complex ownership structures. A tax consultant can guide you on whether your corporation qualifies as CCPC.

Active Business Income

The second qualification for the small business deduction (SBD) is for the CCPC to earn active business income, which includes:

• income from the corporation’s active business
• income from an adventure or concern in the nature of trade
• income from any business other than a specified investment business or a personal service business 

Note that the specified investment business (SIB) or a personal service business is not eligible for SBD.

Specified investment business derives its income from property. Its income sources include interest, dividends, rent, or royalties. However, a business is not SIB if:

• It is carried on by a credit union,
• It leases property other than real or immovable property. It includes leasing cars, equipment, and furniture.
• It employs more than five full-time employees throughout the year or hires an associated corporation to do the work of five full-time employees.

A personal service business is also called an incorporated employee, as the individual is the employee and the corporation’s “specified shareholder.” The CRA excludes personal service businesses from the SBD benefit to demarcate between independent contractors and employees.

We have just touched upon the basics of the Small Business Deduction to give you an idea of this tax benefit. It will help you understand whether to consider incorporation to avail yourself of this deduction. The benefit has various rules and criteria; a tax consultant can help you analyze your business case.

Contact Glenn Graydon Wright LLP in Oakville to Make Your Business Tax-Efficient  

Talk to a professional tax consultant to understand the Small Business Deduction benefit and any other benefit that applies to your business. At Glenn Graydon Wright LLP, our tax experts can help you make informed business decisions to qualify for tax benefits. To learn more about how Glenn Graydon Wright LLP can provide you with the best tax planning expertise, call us today at 905-845-6633 or connect with us online to schedule an initial consultation.