Grinding through the small business limit

In 2018, amendments to the Income Tax Act were enacted to limit the $500,000 federal small business limit where a Canadian Controlled Private Corporation (CCPC) earns investment income¹. For every $1 of Adjusted Aggregate Investment Income (AAII) that a CCPC earns in excess of $50,000, its small business limit will be reduced by $5. The full small business limit, where the CCPC earns $150,000 or more of AAII, will be eliminated. AAII effectively includes any investment income that is not incidental or does not pertain to an active asset. Note that in Saskatchewan, the grind will reduce the provincial small business limit by $6 for every $1 of AAII because of the province’s higher provincial small business limit ($600,000).

Ontario and New Brunswick each subsequently announced that they would not parallel the federal government’s legislation, opting instead to preserve the small business limit at the provincial level for CCPCs earning investment income. This decision has created planning opportunities for CCPCs that earn investment income in these provinces.

For example, let’s assume we have a CCPC operating in Ontario and a CCPC operating in New Brunswick. Each CCPC earns $100,000 of active business income. The table below compares the overall tax result at the corporate and personal level using 2019 tax rates where 1) the CCPC is entitled to the small business deduction (SBD) both federally and provincially, and 2) the CCPC is entitled to the SBD only at the provincial level due to the CCPC earning in excess of $150,000 of AAII. We have also assumed that the individual shareholder would be taxed at the top marginal tax rate on the dividends received from the CCPC.

In Scenario 1, the corporation is subject to tax at the low corporate tax rate, both federally and provincially, which provides more after-tax dollars to distribute to the shareholder. However, because the corporate income has been subject to the low corporate tax rate, the dividends distributed are considered ineligible and subject to a higher personal tax rate. In Ontario, ineligible dividends are subject to tax at a top rate of 47.4% and in New Brunswick at a top rate of 47.75%.

On the other hand, in Scenario 2, the corporation is subject to the low corporate tax rate at the provincial level only and will be taxed at the top corporate tax rate federally. As a result, there are fewer after-tax corporate dollars to distribute to the shareholder. However, because the corporation has paid tax at the top federal corporate tax rate, dividends paid out of the corporation can be designated as eligible dividends, resulting in a lower personal tax rate. In Ontario, eligible dividends are subject to tax at a top rate of 39.34% and in New Brunswick at a top rate of 33.51%.

The above example highlights that the loss of the small business limit is not as significant in Ontario and New Brunswick. Although Scenario 2 does not provide the same deferral opportunity as Scenario 1, there is an overall tax savings when funds are distributed to the shareholder.

For shareholders with corporate active business income in New Brunswick or Ontario, losing the SBD federally as a result of excess AAII can actually provide an overall tax savings on fully distributed income. Therefore, shareholders with corporate taxable income in New Brunswick and Ontario need to weigh the loss of tax deferral against the overall tax savings on fully distributed income.