Readers may recall that the 2018 Federal Budget restricted the tax advantages for a Canadian-controlled private corporation (“CCPC”) when it generates investment income. This is aimed at CCPCs investing their after-tax business income that was subject to the small business corporate tax rate.
Basically, the new rules provide that where a CCPC (along with any associated corporation) earns more than $50,000 of investment income in a year, its small business limit, which is normally $500,000, is ground down for the next year. The small business limit is the maximum amount of CCPC active business income that is subject to the small business corporate tax rate, which varies from about 9% to 13% depending on the province. Business income above the small business limit is subject to the general corporate tax rate, which ranges from about 26% to 31% depending on the province.
The reason the government introduced the new rule is that CCPC owners had a significant advantage in earning investment income inside the CCPC relative to non-CCPC owners. For example, if an individual in a 52% tax bracket had a CCPC earning business income subject to a 12% tax rate, the CCPC would retain 88% of its income after-tax, which could be invested. Another individual in the same 52% tax bracket earning business income (or other income) personally would only have 48% of income after-tax to invest. Although the CCPC in the first case would be subject to a refundable tax on the investment income as it was earned, there would be an overall tax savings owing to the deferral of tax payable on the original business income.
The new rules provide a $5 grind-down in the CCPC small business limit in a particular year for every $1 that the total of the “adjusted aggregate investment income” of the CCPC (and any associated corporation) for its taxation year ending in the preceding calendar year exceeds $50,000. For example, if the CCPC’s adjusted aggregate investment income is $80,000 in one taxation year, its small business limit will be reduced from $500,000 to $350,000 in the following taxation year (i.e. it is reduced by 5 x ($80,000 − $50,000)). As a result, once the adjusted aggregate income hits $150,000 or more in a year, the small business limit will be zero for the next year and the CCPC will pay the high rate of tax (about 26-31%) on all of its business income.
In general terms, “aggregate investment income” of a CCPC includes net taxable capital gains (i.e., half of capital gains, net of allowable capital losses), most forms of income from property like interest and rent, and portfolio dividends (dividends received from “non-connected” corporations). However, net taxable capital gains from the disposition of “active assets” are excluded from the definition. Active assets are generally properties used principally in an active business by the CCPC or a related CCPC, and certain shares in other CCPCs that carry on an active business in Canada. The exception is meant to allow CCPCs to invest in small start-up businesses and certain other corporations in Canada without being subject to the small business limit grind-down.
The new rules apply to taxation years that begin after 2018.
As noted, if the aggregate investment income grinds down the CCPC’s small business limit, any business income above the limit will be subject to the general corporate tax rate of about 26% to 31%, depending on the province. Therefore, if you are in a high personal tax bracket, there can still be a tax advantage to earning investment income in the CCPC even if it is subject to the general corporate tax rate. For example, if you are in a 52% tax bracket and the general corporate tax rate is 26%, you would have 48% of income after-tax to invest personally, while the CCPC would have 74% of income after-tax to invest at the corporate level. So a tax deferral can still be available and advantageous.