Canadian-controlled private corporations earning business income can enjoy significant tax advantages.
Small business deduction
The small business deduction is the most significant advantage. The federal tax rate on the first $500,000 of business net income is reduced to 11 per cent from a general rate of 15 per cent. In addition, all provinces assess a general business tax rate ranging from 10 to 16 per cent, depending on the province. Each province also provides a significant rate reduction on the first $500,000 of business income (with the exception of Manitoba and Nova Scotia, which have lower thresholds).
For example, the combined federal/provincial general tax rate on corporate business income in Ontario is 26.5 per cent, but the combined rate for income qualifying for the small business deduction is reduced to 15.5 per cent.
The low small business tax rate can result in a significant deferral of personal taxes until funds are withdrawn by the owner as a salary, bonus or dividend. The government has provided this incentive to encourage small businesses to reinvest profits for business expansion, job creation and investment.
The government has arbitrarily defined the level at which a private corporate group is no longer considered "small" for purposes of the tax benefit. The small business deduction threshold is reduced on a straight-line basis when an associated corporate group's taxable capital employed in Canada in the preceding year is between $10 million and $15 million, and completely eliminated when capital exceeds $15 million. A corporation's taxable capital essentially consists of its debt and equity, less deductions for certain investment assets.
Many otherwise-small businesses can unexpectedly find themselves no longer eligible for the small business deduction. For example, farmland values in the agriculture sector have skyrocketed nationwide in recent years. Farmers have used the increased values to finance the purchase of new farms and equipment, which has added debt and equity to the balance sheets of many farm corporations. Many family farm corporations are now exceeding the taxable capital threshold and are having their preferential small business tax rate eliminated.
Non-resident controlled corporations and public corporations do not qualify for the deduction, even if they are very small businesses. Investment income earned by a private corporation also does not qualify for the small business deduction and is subject to an immediate tax rate of 45-50 per cent, depending on the province.
SR&ED benefits
The level of taxable income and taxable capital in a corporation (and its associated corporate group) can also impact tax credits available from the Scientific Research and Experimental Development (SR&ED) program. The general federal tax credit for eligible SR&ED expenditures is 20 per cent. Small businesses receive an enhanced 35 per cent federal credit, plus a provincial credit of another 10-20 per cent in most provinces. This credit is refundable even if the business has insufficient taxes to absorb the credit.
The high federal tax credit rate applies to an SR&ED expenditure limit of $3 million. This limit is reduced on a straight-line basis for corporations with taxable income of $500,000-$800,000 or taxable capital of $10-$50 million in the preceding year.
There are no gross revenue tests for purposes of qualifying for either the small business deduction or enhanced SR&ED credits. For example, a Canadian-controlled private corporate group with $30 million of annual gross revenue could potentially qualify for the high SR&ED tax credit rate if taxable income and capital are kept below the claw-back thresholds, perhaps by accruing large bonuses to the owner-manager(s).
Capital gains exemption on sale of shares
Yet another set of rules permits shareholders of Canadian-controlled private corporations to exempt up to $800,000 of lifetime capital gains on the sale of qualified small business corporation shares. Certain farm and fishing properties also qualify. The definition of a qualified small business corporation is complex and beyond the scope of this article, but the criteria are completely different than those for the small business deduction and enhanced SR&ED credits.
Summary
More and more growing businesses are finding they are no longer considered "small" under these rules and are paying higher taxes as a result. Businesses in expansion mode or that regularly retain and reinvest profits must heed these rules or risk facing unpleasant tax results. Your Collins Barrow advisor can help you navigate these complex rules and can offer recommendations and planning techniques to minimize your tax burden.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
