• Investment Taxation

Corporate Taxation: Getting Proactive With Your Active Business Income

Albert Einstein once reportedly said something like, “The hardest thing in the world to understand is the income tax.” (His theory of relativity must have been a close second.)  Al was likely just kidding around, but he wasn’t far off.

It’s all relative. Your tax situation probably started out simple enough. (Remember the good old days when you only had a T4 slip to worry about?) As your career took off, your accountant encouraged you to set up a corporation to defer taxes.  But even as your corporate savings accumulated, you were hesitant to invest the cash.  The tax implications of buying your favourite ETFs was hazy; you wanted to learn more before committing.

Next thing you know, several years have flown by. You’re working as hard as ever, but your corporate savings are still lazing about, earning next to nothing. Shouldn’t these assets be working at least as hard as you do toward your thriving business or eventual retirement? Whether the assets remain in your business or are distributed to shareholders, that often calls for tax-efficiently investing a portion of them in our capital markets.

But where to begin? In this next series of blog posts, I’ll explain the basics of corporate taxation. We’ll then discuss the different types of investment income and how they’re taxed within the corporation.  Finally, we’ll look at some smart corporate investment strategies that will help reduce your tax bills.

We’ll kick off today’s lesson by getting proactive with the active business income taxed within your corporation.

For our example, we’ll assume your corporation earned $100,000 of 2016 taxable income in Ontario.  I’ll focus on Canadian-controlled private corporations (CCPCs), as these are the most common type (and likely relevant to most of you).

 

Back to basics

Most corporations are charged a basic federal tax rate of 38% on taxable income. That’s the base amount of Part I tax.  In our example, $100,000 x 38% = $38,000.

Your corporation’s taxable income and base amount of Part I tax can respectively be found on line 360 and 550 of the T2 Corporation Income Tax Return.

Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)

Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)

 

Small potatoes

Canadian-controlled private corporations (CCPCs) are also eligible for a federal small business deduction of 17.5% on the first $500,000 of active business income earned in Canada.  In our example, you could use this deduction to reduce your taxes due by $17,500: $100,000 x 17.5% = $17,500.

The corporation’s active business income amount can be found on Schedule 7, or on line 400 of the T2 Corporation Income Tax Return.  The small business deduction amount can be found on line 430 of the T2 Corporation Income Tax Return.

Source: Corporate Taxprep – Schedule 7 (2016)

Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)

 

Making a federal case out of it

Thanks to Canada’s federal tax abatement (to approximately offset provincial taxes), you can apply another 10% reduction in your basic federal tax rate for income earned in a Canadian jurisdiction.  In our example, that’s $100,000 x 10% = $10,000.

 

After the dust settles

After the small business deduction and federal tax abatement are subtracted from the basic federal tax rate, your remainder is called the Part I tax payable, and is 10.5% of taxable income, or $10,500 in our example.

Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)

 

Provincial piece of the pie

Provincial taxes are then applied on line 760 of the T2 Corporation Income Tax Return. Ontario adds 4.5% of taxable income to the corporate tax bill, increasing the total taxes payable to 15%, or $15,000 in our example (line 770).

Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)

 

The big picture

Whew. Once you and your accountant are through, here’s what all this looks like in summary:

Corporate Taxation of Active Business Income: Summary

General FormulaAmountCalculation
Remainder:
After-tax business income
$85,000$100,000 - $15,000
Base amount of Part I tax
$38,000$100,000 × 38%
Deduct:
Small business deduction
($17,500)$100,000 × 17.5%
Deduct:
Federal tax abatement
($10,000)$100,000 × 10%
Equals:
Part I tax payable
$10,500$38,000 - $17,500 - $10,000
Add:
Provincial or territorial tax
$4,500$100,000 × 4.5% (Ontario)
Equals:
Total tax payable
$15,000$10,500 + $4,500

 

This leaves your corporation with $85,000 of after-tax business income to retain and invest within the company, or distribute to shareholders such as yourself.

Circling back to the beginning, the next logical step is deciding how to make best use of this after-tax income. In my next post, I’ll explain how dividends from active business income can be distributed and how they’re taxed in the hands of the shareholder. At first glance, it may seem like they’re being hit by a double tax-whammy, but I’ll show you how the integration between business and personal income works, and why receiving dividends from your corporation can be managed as tax-efficiently as earning income personally.

 

I would like to thank Theresa Martin, CPA, CGA, for her assistance in writing this post. If you wish to engage Theresa for individual tax planning, she can be reached at tmartin@inbalance.org

By | 2017-06-09T21:22:18+00:00 June 7th, 2017|Categories: Investment Taxation|6 Comments

6 Comments

  1. Park June 10, 2017 at 4:38 pm - Reply

    I look forward to your posts, but I wouldn’t be surprised if corporate taxation changes in the near future. There were hints in the last budget that income splitting and tax deferral through corporations are on the chopping block.

    • Justin June 10, 2017 at 4:47 pm - Reply

      @Park: It does sound like there will be corporate taxation changes in the future (perhaps they will levy a penalty tax of ~35% for business owners that invest the retained earnings in passive investments instead of back into their business). If this does happen, it will definitely keep me busy with blog updates 😉

  2. Chris June 10, 2017 at 1:05 pm - Reply

    You might find useful my spreadsheet linked showing
    * the tax integration of different types of income
    * the tax integration of income earned personally vs inside corp that gets distributed
    * the relative outcomes of investing un-needed profits inside corp vs personally.
    * input sheet to overwrite generic tax rates with your personal provincial rates.

    You are free to edit it for use with examples you will probably discuss further here.

    • Justin June 10, 2017 at 4:20 pm - Reply

      @Chris: Thanks for the link – very cool spreadsheet. I’ll be using the 2016 Corporate and Personal Taxprep software for the examples, but this is a great tool for other investors to try out.

  3. Michael June 9, 2017 at 3:38 am - Reply

    Justin I have been following Dan’s and your blog for a long time eagerly awaiting for someone to address corporate investing.

    I am estatic that you are undertaking this and look forward to the future blog posts. Thank you for sharing your unbiased expertise as it is invaluable for investors like myself and so many others.

    • Justin June 9, 2017 at 1:17 pm - Reply

      @Michael: It’s definitely a monster of a topic to cover, but I’m really looking forward to getting the information out there. Thanks for reading! 🙂

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