The taxation of small business is perennially a hot topic, in
the news, on social media and among Canadians in general,
especially around election time. A narrative introduced into
this election is that small businesses are a vehicle utilized by
the wealthy to avoid tax.
Earning income through a small business does not in any way
reduce taxes- it merely defers taxes on active business income
until dividends are paid out to shareholders. There is no reduction
or deferral of taxes on investment income earned in a corporation.
Further, the deductions available to corporations are also
available to individuals operating as sole proprietors, so tax
savings do not simply occur just by virtue of operating through a
A basic concept of the Canadian income tax system, called
integration, is that there is supposed to be no tax difference
between business income earned personally and income earned through
a corporation. Because corporate tax rates are constantly
changing and the applicable tax rate often depends on the type of
business a corporation is engaged in, perfect integration might
very well be impossible. With current tax rates, there is a
slightly lower tax liability for small business corporations
operating in Ontario which are eligible for the small-business
deduction, though any tax savings that result are extremely
nominal. Results vary slightly for different
There is a tax benefit that comes by way of delaying taxes,
referred to as tax deferral. For an individual who earns income
through a corporation, there are two levels of taxes: tax paid in
the corporation on income earned during the corporation's
taxation year, and tax paid at a shareholder's individual
marginal rates when corporate profits are paid out in the form of
dividends. A dividend tax credit in effect offsets the corporate
taxes already paid on the income, so that the overall tax is the
same as if the income had been earned personally. There is a
deferral of tax on corporate profits that are not paid out to
shareholders, however the deferral advantage comes to an end when
dividends are taken out of the corporation and taxed to the
shareholder. Tax deferrals on active business income did not come
into being by chance; there are practical justifications for their
existence. The policy reason for lower tax rates on profits
retained within a corporation incentivizes spending on business
expansion, for equipment purchases, research and development and
hiring personnel. A tax deferral is only possible on active
business income earned through a Canadian-Controlled Private
Corporation -investment income earned is effectively taxed at the
highest marginal rate for individuals. Wealthy individuals cannot
hold their stock portfolios through their corporation to achieve a
tax deferral advantage.
Aside from the ability to defer taxes on active business income,
individuals carrying on business as sole proprietors are entitled
to the same deductions as incorporated businesses. They are able to
claim reasonable expenses for equipment and supplies used to
produce active business income and can claim tax depreciation on
capital assets. While there may be other advantages to
incorporation, such as limiting personal liability, they have
nothing to do with the tax treatment of small businesses and are
separate issues of their own.
Earning business income through a corporation instead of as an
individual allows for the deferral of tax, but taxes are not
reduced. Corporations, and especially small businesses, enjoy low
tax rates on active business income to allow them more flexibility
for operations and to encourage investment, but whenever income
gets moved out to shareholders by way of a dividend, CRA is ready,
willing and able to levy tax.
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.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).