The current Canadian government’s proposed C-29 will surprise a lot of small businesses. There will be big changes to what income is eligible for the Small Business Deduction. To be fair, some taxpayers were pushing the limits of the law. That being said, the government’s solution puts so much of a burden on small business that it threatens use of the Small Business Deduction. Over four blogs, I will explain what the Small Business Deduction is, who is eligible for the Deduction, describe the changes and why they are being made, and the outcome for small business.
The Small Business Deduction substantially lowers the corporate tax rate. As of 2016, the federal corporate tax rate is 38% in Canada. After the 10% federal tax abatement (to offset provincial taxes), that falls to 28%. Furthermore, the Small Business Deduction deducts 17% more, meaning the effective federal corporate tax rate for Small Business is 11%.
The type of income eligible for the Small Business Deduction is active income. Active income is basically any business, with two exceptions. The first exception is personal services business, where one is paid as a business but is essentially an employee. The second is a specified investment business, so one cannot save 17% by incorporating with the intention of investing in the stock market. The basic principle behind the Small Business Deduction is that you have to be building an active business.
Of course, there is a limit. When the company gains millions in assets, the Deduction is phased out. Also, only the first $500,000 of income is eligible for the Small Business Deduction. It is not surprising that successful businesses try to split income between two businesses for the Small Business Deduction. The Association rules block doubling the $500,000 limit, or even more. Associated companies with 25% or more cross-ownership have to share the $500,000 limit.
In the next blog, I will discuss what companies are eligible for the Small Business Deduction.