by Millie Bojic
Last year, Canada’s Department of Finance passed new legislation that affects small businesses and incorporated professionals across the nation. This year, the most significant new change concerns the potential loss of the small business deduction (“SBD”) for Canadian-controlled private corporations (“CCPC”) with more than $50,000 of passive investment income in the previous year.
For definition’s sake, know this: a CCPC is a private corporation which is not controlled by one, or any combination of, non-resident persons or public corporations. Being a CCPC in Canada enables the corporation to obtain the SBD, which provides a low rate of corporate tax on the first $500,000 (i.e. the “SDB Limit”) of annual active business income. Active business income means exactly what is sounds like – “income earned from a business source, including any income incidental to the business,” with the exception of personal service businesses specified investment businesses.
If you own a small business or are an incorporated professional, and do not need to pay yourself out of your business’ annual earnings, then a significant tax deferral advantage (roughly 41% at best) is available to you by leaving the earnings in the business and investing them.
The tax deferral advantage described is so significant, that the Department of Finance decided it was too good a deal for the average middle-class businessowner – and proceeded to undercut it. As of 2019, the SBD Limit is lowered based on what is termed “adjusted aggregate investment income” (“AAII”) which the CCPC earned in the previous year. AAII, in a nutshell, is passive investment income — i.e. dividends, capital gains, interest on loans. Under the new rule, the SBD Limit is reduced by $5 for each $1 of AAII that exceeds $50,000. Effectively, this means the SBD Limit reaches nil once $150,000 of AAII is achieved in the year in question. Practically, then, if a CCPC has at least $50,000 of AAII in its previous year, then a portion of or the full amount of the income that previously would have obtained the favourable SBD tax rates (in Ontario: 12.5% for 2019) is now slated for taxation at the general corporate tax rate (in Ontario: 26.5%).
So, how big of a problem does this really pose for small businesses in Canada? The short – and typical – lawyer’s answer as always, is, it depends.
If, as previously mentioned, the after-tax business income is taken out of the business in the same year as it is earned, then you as a business owner or incorporated professional are not enjoying any tax deferral advantage. As such, the SBD has little impact on your tax planning. If, however, you retain said earnings in the business for investment before paying out the earnings in a future year in the form of dividends, then the SBD tax deferral advantage is significantly compromised for you going forward.