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.