Holding Passive Investments Inside a Private Corporation

Active business income earned by a Canadian controlled private corporation (CCPC) is generally eligible for the small business deduction. This means that the first $500,000 of income is subject to reduced tax rates – these rates are significantly lower than the top personal rates in all jurisdictions.

If funds are not reinvested into your business and are instead invested passively (e.g. stock portfolios, bonds, real estate, etc.), owners of CCPCs will have significantly more after-tax cash to invest than an individual who earned their income personally and paid high personal rates of tax. The federal government sees this as an unfair advantage and has introduced rules to curtail some of the tax savings that are available.

Business Limit Reduction

The first measure proposes to reduce the small business deduction limit for any associated group of companies that has annual investment income in excess of $50,000. Under this measure, the business limit will be reduced by $5 for every $1 of investment income in excess of $50,000. The result is that the small business deduction will no longer be available once investment income for the associated group exceeds $150,000 per year.

The following table from the 2018 budget shows how your access to the small business deduction will be affected depending on your level of passive income, and the amount of active business income earned each year:

It is also important to note that lost access to the small business deduction reduces a corporation's ability to defer income tax as more corporate income tax is paid up front. However, income that is subject to the higher general corporate tax rate can be distributed as "eligible" dividends, which attract a lower level of personal tax.

Refundability of Taxes on Investment Income

Under the previous tax regime, passive investment income earned by a CCPC was subject to tax at approximately the top personal marginal tax rate. A portion of this tax was added to the CCPC's refundable dividend tax on hand (RDTOH) account and was refundable at a rate of $38.33 for every $100 of taxable dividends paid to shareholders.

Dividends paid by corporations are classified as either "eligible," or "non-eligible." Income that is taxed at the higher general corporate tax rate and eligible dividends received by a CCPC are added to the corporation's general rate income pool (GRIP) and can be paid out as eligible dividends, which are subject to a lower personal tax rate. All other sources of income, including business income eligible for the small business deduction, and passive income (interest, rent, capital gains, etc.) needs to be distributed as non-eligible dividends, which attract a higher personal tax rate.

Changes to Dividend Refund

Currently, a CCPC will receive a refund of its RDTOH regardless of what type of dividend is declared. Legislation has been introduced to change this and proposes that a dividend refund will only be available where non-eligible dividends are paid. This is intended to better align the taxes paid on passive income with the payment of dividends that were sourced from passive income. One exception will be provided in respect of RDTOH that arises from the receipt of eligible dividends by a CCPC, in which case the corporation will still be able to obtain a refund of that RDTOH upon the payment of eligible dividends.

The result of this rule change is that it is more important than ever to revisit your remuneration plan. Corporations are still valuable with the new tax regime. Proper planning will ensure that you maximize your dividend refund in a given year, and therefore minimize your tax obligation.

For more information on how MNP can help you plan your tax strategy, contact Nick Korhonen, CPA, CA at 613-691-4245 or [email protected]