Small Business Deduction
Contact Neufeld Legal PC for your incorporation legal work at 403-400-4092 or Chris@NeufeldLegal.com
The Small Business Deduction (SBD) is a key tax benefit for eligible Canadian businesses. It allows qualifying corporations to pay a significantly reduced corporate income tax rate on their first $500,000 of active business income. (1) This is a federal tax incentive, but each province and territory also has its own parallel small business deduction, which further lowers the overall tax rate. (2)
How the SBD Works
The SBD works as a tax credit that reduces a corporation's tax rate on its active business income. A corporation’s SBD for a taxation year is generally calculated by multiplying its SBD rate by the lesser of its:
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income for the year from an active business carried on in Canada, excluding certain income and exceeding certain losses;
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taxable income for the year; and
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business limit for the year.
From an analytical perspective, the federal general corporate tax rate is 15%, but with the SBD, this rate is effectively reduced to just 9% on the first $500,000 of income, and in Alberta, there would be additional 2% provincial corporate tax rate under the SBD, for a combined rate of 11%. For comparison, the general corporate tax rates for income not eligible for the small business deduction would be as follows: federal corporate tax rate of 15%, Alberta general corporate tax rate of 8%, resulting in a combined rate of 23%.
SBD Eligibility Requirements
To be eligible for the SBD, a corporation must be a Canadian-controlled private corporation (CCPC) throughout the tax year. A CCPC is a private corporation that is:
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A resident of Canada;
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Not controlled by non-residents of Canada or public corporations; and
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Its shares are not listed on a designated stock exchange.
Additionally, the income must be from an active business carried on in Canada. This generally includes income from the corporation's primary business operations, but it does not apply to:
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Specified investment businesses: These are businesses that primarily earn income from property, such as interest, dividends, rent, or royalties. However, there are exceptions if the business employs more than five full-time employees.
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Personal service businesses: This is a business where a person, who is a "specified shareholder," would reasonably be considered an employee of the client if not for the corporation's existence.
SBD Limit and Reductions
The annual business limit for the SBD is $500,000. However, this limit can be reduced under certain circumstances:
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Associated Corporations: If you own or control multiple CCPCs, they are considered "associated." The combined group of associated corporations must share a single $500,000 business limit.
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Taxable Capital: The SBD is gradually phased out if the combined taxable capital of the corporation and any associated corporations is between $10 million and $50 million. The deduction is completely eliminated once taxable capital reaches $50 million.
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Passive Income: The SBD is also phased out if the corporation's (and any associated corporations') adjusted aggregate investment income (passive income) in the preceding tax year exceeds $50,000. The deduction is completely eliminated once this passive income reaches $150,000. The reduction is the greater of the taxable capital reduction and the passive income reduction.
Key Considerations
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Tax Deferral: The SBD offers a significant tax deferral opportunity. The lower corporate tax rate allows a business to retain more after-tax earnings for reinvestment in the business. However, when these profits are eventually paid out to shareholders as dividends, the personal tax rate on those dividends is higher than on dividends from a corporation taxed at the general rate.
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Tax Planning: The rules surrounding the SBD can be complex, especially with associated corporations and passive income. It is highly recommended to consult a tax professional to ensure you are meeting all eligibility criteria and maximizing the benefits for your business.
When your corporate buisness is looking to take advantage of the Small Business Deduction, and other tax-driven mechanims and strategies, contact our law firm at 403-400-4092 or via email at Chris@NeufeldLegal.com to schedule a confidential initial consultation.
(1) A CCPC’s business limit for a taxation year is $500,000, prorated for the number of days in the year if there are less than 51 weeks in the year. The business limit must be allocated amongst corporations that are associated in a taxation year, and is reduced by any portion that the CCPC assigns to another corporation. The CCPC’s remaining business limit is then further reduced on a straight-line basis if the combined taxable capital employed in Canada of the CCPC and any associated corporations is between $10 million and $15 million (the taxable capital business limit reduction)
(2) The legislative underpinnings of the Small Business Deduction are set out at section 125 of the Income Tax Act (Canada), which sets out key aspects of the SBD in detailed particularity.
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