The 2022 Federal Budget proposed a favourable tax change for Canadian-Controlled Private Corporations (CCPCs) that have been restricted from claiming the small business deduction because they were too large.
Legislation to enact this change received royal assent on Dec. 15, 2022, and it is now law for taxation years that started after April 6, 2022.
What is the small business deduction?
Available exclusively to CCPCs, the small business deduction (SBD) provides corporations with a reduced tax rate on up to $500,000 of active business profits. Profits qualifying for the SBD are taxed at a federal tax rate of 9%, compared to the general rate on business profits from active businesses of 15%. This difference in tax rates can save a corporation a maximum of $30,000 in federal taxes per year, provided the profits are retained in the corporation.
Provinces and territories also provide a small business deduction, which results in additional corporate tax savings.
Profits eligible for the SBD are subject to a higher rate of personal tax when paid out as dividends to shareholders than profits that are subject to the general business tax rate. Consequently, the tax savings of the small business deduction only represent a deferral of tax rather than permanent tax savings.
The $500,000 annual limit can be claimed in a single corporation or shared amongst other CCPCs that are associated for income tax purposes. In general, associated corporations share some degree of common control within a related group of shareholders.
The rules contain a restriction in claiming the small business deduction based on size, which is triggered when the taxable capital of a CCPC, together with the taxable capital of associated corporations, exceeds $10 million at the end of the taxation year. The SBD is reduced when taxable capital employed in Canada within the associated group exceeds $10 million and, before this new change, was eliminated when taxable capital reaches $15 million.
Changes to the small business deduction
This recent change raises the upper limit of taxable capital from $15 million to $50 million, phasing out the small business deduction at $50 million in taxable capital and increasing the number of CCPCs eligible for the deduction.
The increase is effective for tax years that start on or after April 7, 2022, which means that for companies with a calendar year end, this change will be effective with their taxation year starting on Jan. 1, 2023. For CCPCs with non-calendar taxation years that started on or after April 7, 2022—and that may now be approaching the end of their taxation year—this change is now effective and may allow them to start benefitting from the SBD, whereas they might not have before.
The table below illustrates the anticipated annual tax savings of the increased small business deduction at levels of taxable capital between $10 million and $50 million. The tax savings are the most significant at levels of taxable capital near the previous limit of $15 million and gradually decrease as taxable capital increases.
| Before 2022 budget change | Anticipated results under new law | Additional tax savings with 2022 budget change | |||
|---|---|---|---|---|---|
| Taxable capital ($) | SBD ($) | Taxes payable ($) | SBD ($) | Taxes payable ($) | |
| 10 million | 500,000 | 45,000 | 500,000 | 45,000 | 0 |
| 11 million | 400,000 | 51,000 | 487,500 | 45,750 | 5,250 |
| 12 million | 300,000 | 57,000 | 475,000 | 46,500 | 10,500 |
| 13 million | 200,000 | 63,000 | 462,500 | 47,250 | 15,750 |
| 14 million | 100,000 | 69,000 | 450,000 | 48,000 | 21,000 |
| 15 million | - | 75,000 | 437,500 | 48,750 | 26,250 |
| 20 million | - | 75,000 | 375,000 | 52,500 | 22,500 |
| 25 million | - | 75,000 | 312,500 | 56,250 | 18,750 |
| 30 million | - | 75,000 | 250,000 | 60,000 | 15,000 |
| 35 million | - | 75,000 | 187,500 | 63,750 | 11,250 |
| 40 million | - | 75,000 | 125,000 | 67,500 | 7,500 |
| 45 million | - | 75,000 | 62,500 | 71,250 | 3,750 |
| 50 million | - | 75,000 | - | 75,000 | 0 |
* Assume $500,000 of taxable income
Taxable capital is defined according to legislation. In general, it is the sum of the carrying values of shareholders' equity, surpluses, debt, and reserves, reduced by investments in shares and debt held in other companies.
Small business deduction in provinces and territories
All provinces and territories have a preferential tax rate on profits that qualify for the federal small business deduction or are similarly determined. Except for Ontario and Québec, all provinces and territories automatically follow the federal rules with respect to the interaction of taxable capital and the small business deduction. Québec and Ontario have announced they will harmonize their rules with this federal change.
Québec imposes additional criteria on the business profits that qualify for the Québec small business deduction.
Other restrictions to claiming the small business deduction
Having taxable capital that exceeds $10 million is not the only restriction to an otherwise eligible corporation claiming the small business deduction.
In 2018, another restriction was added to limit the SBD where certain investment income within an associated group of corporations exceeds $50,000 in the preceding taxation year. Under this provision, the small business deduction is eliminated when investment income exceeds $150,000 in the preceding taxation year.
No changes have been proposed to this investment income reduction of the SBD. As a result, not all taxpayers will be able to take advantage of the increased limit to phase out the small business deduction based on taxable capital.
How BDO can help
Our BDO tax professionals can help you assess how this change will affect your business and whether you are eligible to access these additional savings.
For assistance, please contact:
Rachel Gervais, Managing Partner, Tax
Greg London, Partner, Domestic Tax Consulting Leader
The information in this publication is current as of February 27, 2023.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.
