Small Business Owners
The provided list of terms forms the foundation of the tax system for Canadian-controlled private corporations (CCPCs). These rules are designed to achieve several key objectives: encouraging small business growth, preventing tax avoidance, and creating a complex but logical system for integrating taxes between corporations and their shareholders.
The terms can be broadly grouped into several key themes:
Supporting Small Business & Active Operations
The system strongly favors Active Business Income (ABI)—money earned from core business operations—over passive investment income.
The Core Incentive: The Small Business Deduction (SBD) is the centerpiece, offering a significantly reduced tax rate on the first $500,000 of ABI each year.
The Key Limitation: The concept of Associated Corporations prevents business owners from multiplying this valuable deduction by splitting one business into multiple corporations. Associated corporations must share the single $500,000 SBD limit.
The Goal for Growth: Income that does not qualify for the SBD is taxed at the higher general rate and is tracked in the General Rate Income Pool (GRIP). This pool is important because it can later be paid out to shareholders as Eligible Dividends, which are taxed at a lower personal rate.
Managing Investments and Passive Income.
The rules for passive income are stricter, designed to discourage corporations from being used as pure investment shelters.
Different Treatment: Passive Income (interest, rents, dividends from investments) is taxed at a higher rate inside a CCPC.
The Refund Mechanism: To mitigate double taxation, taxes on passive income build up in refundable accounts (NERDTOH). When the corporation pays out Non-Eligible Dividends to its shareholders, it receives a refund of these taxes.
Anti-Avoidance Rules: The Foreign Accrual Property Income (FAPI) rules are a critical anti-avoidance measure. They attribute passive income earned in a foreign corporation back to the Canadian controlling shareholder immediately, preventing the deferral of Canadian tax.
Shareholder Transactions and Distributions
A sophisticated set of rules governs how money and value flow between a corporation and its owners.
Tax-Efficient Payouts: The Capital Dividend Account (CDA) allows corporations to distribute tax-free amounts (like the tax-free portion of a capital gain) as tax-free dividends to shareholders.
Integration System: Part IV Tax and the ERDTOH/NERDTOH system work together to create “integration”—ensuring that income earned through a corporation is taxed at a similar total amount as if it were earned directly by an individual, whether it’s passive income or business income.
Buybacks and Withdrawals: A Deemed Dividend can occur during a share redemption, and Shareholder Loan rules prevent shareholders from taking tax-free withdrawals disguised as loans.
Capital Assets, Gains, and Losses.
Managing Losses and Incentive
The system provides mechanisms to smooth out profitability and reward specific activities.
.
Loss Carry-Forwards
Non-Capital Losses (typically business operating losses) can be carried forward 20 years to reduce future taxable income. Capital Losses can be carried forward indefinitely to offset future capital gains.
Innovation Incentives
Federal Investment Tax Credits (often from SR&ED) and provincial credits like the Ontario R&D Tax Credit reward companies for investing in research and development. Unused credits can be carried forward for future use.
FAQs
What is Active Business Income (ABI) and how is it taxed?
Active Business Income is money your corporation earns from its core business operations in Canada, not from passive investments. ABI is taxed at lower rates and may be eligible for the Small Business Deduction (SBD), which significantly reduces the tax on the first $500,000 of income.
What is the Small Business Deduction (SBD)?
The SBD is a tax relief for Canadian-controlled private corporations (CCPCs). It lowers the federal tax rate on the first $500,000 of active business income earned in Canada. Provinces offer a similar deduction, making the combined tax rate very favorable for small businessese the future.
What are Associated Corporations?
These are corporations connected through ownership or control by the same person or group. Being “associated” has major tax implications: the corporations must share the $500,000 SBD limit, and their sales are combined to determine GST/HST filing frequency.
What is the difference between Taxable Income and Income Before Taxes?
Income Before Taxes is your accounting profit from operations before applying tax rules.
Taxable Income is the final amount of profit calculated under tax law (after deducting eligible expenses like CCA), which is used to calculate how much tax you owe.
What is the difference between Eligible and Non-Eligible Dividends?
Eligible Dividends are paid from a corporation’s General Rate Income Pool (GRIP)—income taxed at the higher general rate. They are taxed at a lower rate in the shareholder’s hands.
Non-Eligible Dividends are paid from other pools of income (like income that used the SBD) and are taxed at a higher rate for the shareholder.
What is a Capital Dividend Account (CDA)?
The CDA is a special notional account for private corporations that tracks tax-free surpluses (like the non-taxable portion of capital gains). A corporation can pay dividends from this account tax-free to its Canadian resident shareholders.
What is a Shareholder Loan Receivable?
This is money a shareholder borrows from the corporation. The Income Tax Act has strict rules; if the loan is not repaid within one year after the end of the corporation’s tax year, the amount may be included in the shareholder’s personal taxable income.
What is the Adjusted Cost Base (ACB)?
The ACB is the total cost of acquiring a capital property (like shares or buildings), including the purchase price plus commissions and legal fees. It is used to calculate your capital gain or loss when you sell the property.
Taxable Income is the final amount of profit calculated under tax law (after deducting eligible expenses like CCA), which is used to calculate how much tax you owe.
What is the Lifetime Capital Gains Exemption (LCGE)?
The LCGE allows individuals to shelter a certain amount of capital gains from tax when they sell Qualified Small Business Corporation (QSBC) shares. This is a major tax-saving tool for business owners when they sell their company.
What are Qualified Small Business Corporation (QSBC) shares?
These are shares of a small business corporation that meet specific conditions, making them eligible for the LCGE. Key conditions include the company being a Canadian-controlled private corporation (CCPC) and having most of its assets used in active business in Canada.
How long can I carry capital losses forward?
Capital losses can be carried forward indefinitely to offset capital gains in future years. They can only be used against capital gains, not other types of income.
What are Federal Investment Tax Credits?
These are credits earned for certain activities, most notably Scientific Research and Experimental Development (SR&ED). If not used immediately, they can be carried forward for up to 20 years to reduce future federal taxes.
What is the SR&ED Expenditure Pool?
This pool represents the total of a company’s eligible SR&ED expenses that have not yet been deducted from taxable income. This pool carries forward indefinitely until used.
What are ERDTOH and NERDTOH?
These are notional accounts that track taxes a private corporation can get refunded when it pays dividends.
ERDTOH (Eligible Refundable Dividend Tax On Hand) is refunded when the corporation pays eligible dividends.
NERDTOH (Non-Eligible Refundable Dividend Tax On Hand) is refunded when the corporation pays non-eligible dividends.
What is Capital Cost Allowance (CCA)?
CCA is the tax term for depreciation. It’s the annual deduction a business can claim for the wear and tear on its capital assets (like machinery, vehicles, or buildings) based on rates set by the tax act
What are the Attribution Rules?
These are rules designed to prevent income splitting for tax savings. They can attribute income or gains earned by a lower-income family member (like a spouse or child) back to the higher-income person who gave them the money or property, so it is taxed at the higher rate.
What is Part IV Tax?
This is a tax that Canadian private corporations pay on dividends they receive from other Canadian corporations. Its purpose is to prevent multiple layers of tax advantage within corporate structures. The tax paid can often be refunded when the corporation pays dividends to its own shareholders.