Subsection 125(7) defines active business carried on by a corporation: “any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade”. Such an income is known as Active Business Income (ABI).
Canadian Controlled Private Corporations (CCPC), carrying a business in Canada, can deduct from the tax otherwise payable an amount known as a small business deduction. This deduction will apply to the ABI as defined above up to the business limit. The limit is set in subsection 125(2) and it is currently $500,000. The deduction rate is set in subsection 125(1.1) and it is currently 17%.
The business limit should be shared among associated corporations as defined in subsection 256(1). This is to prevent multiplying the small business deduction by creating multiple CCPCs.
Let’s illustrate by using an example. Corporation X and corporation Y are associated. They have agreed to share the business limit by assigning $300,000 to corporation X and $200,000 to corporation Y. Corporation X and Y’s ABI are $400,000 and $250,000 respectively. They will calculate part I federal tax payables as per the following schedule:
|Corporation X||Corporation Y|
|Basic federal tax @38%||152,000||95,000|
|Federal tax abatement @10%||(40,000)||(25,000)|
|Small business deduction @17%||(51,000)||(34,000)|
|General tax deduction on income over the business limit @13%||(13,000)||(6,500)|
|Part I federal tax payable||48,000||29,500|
As mentioned above, the Income Tax Act excludes a specified investment business and a personal services business from the definition of an active business. It means that the income from these two businesses will not be subject to a small business deduction.
Subsection 125(7) defines both notions of specified investment business and personal services business.
A specified investment business is carried on by a corporation whose principal purpose is to derive income (interest, rent, dividends and royalties) from property, unless the business employs more than 5 full time employees. Income from property would include rental or leasing income from land or buildings, but would exclude income from renting or leasing moveable property such as machinery and equipment.
A personal services business is a business that a corporation carries on to provide services to another entity that an employee of that entity would usually perform. The individual performing the services on behalf of the corporation is called an incorporated employee. If this individual is a specified shareholder (defined below) of the corporation and the corporation do not hire more than 5 full time employees, the small business deduction will be disallowed. Additionally, all expenses other than a salary will be denied.
A specified shareholder is a taxpayer who owns, directly or indirectly at any time in the year, at least 10% of the issued shares of any class of capital stock of the corporation or a related corporation.
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