After a lot of public debate in the tax and small business community around the way in which passive investment income is taxed in Canadian controlled private corporations, the changes that were announced in the 2018 Federal Budget are now law. These changes will limit the amount of the small business deduction for many corporations.

 What are the Changes?

The federal small business deduction limit is $500,000.  For taxation years ending after December 31, 2018, the small business deduction will be reduced by $5 for every $1 of passive income a corporation (and associated corporations) earns over $50,000 and is completely eliminated if the corporation earns over $150,000 of passive income. It is important to note that it is the passive income of the prior year that is used to calculate the reduction.

What do These Changes Mean?

For example, a small business owner in British Columbia earns $500,000 in active business income and $80,000 in passive income*. Under the new rules, since the passive income is $30,000 over the $50,000 passive income threshold, the corporation’s small business deduction is reduced to $350,000 which results in an increase of tax of $24,000.

Planning can be completed to maximize the small business deduction by reducing the corporation’s passive investments. This can be accomplished by investing in assets that generate capital gains rather than dividends and interest, repaying shareholder loans, distributing assets to shareholders by way of capital or taxable dividends, or by purchasing life insurance.

Want to Learn More?

There are many complexities to these rules, and every situation is unique. Your best option is to speak with your professional advisor to help determine the best solution for you and your corporation.

For more information on the passive investment income changes and how it will affect small businesses, feel free to look at our Passive Investment Income Calculator.

*Using the 2019 federal small business tax rates and provincial tax rates.