Small Business Deduction
Small business tax credit
At a glance
Eligible Funding
- No Condition
Timeline
- Open Date : November 14, 2019
Financing Type
Tax Credits
Eligible Industries
- All industries
Grant Providers
- Canada Revenue Agency
- Government of Canada
Status
Open
Overview
You can get a reduced tax rate on your first $500, 000 in revenues if you own a Canadian-controlled small business corporation.
Eligibility criteria
The eligibility criteria for the small business deduction (SBD) grant include being a Canadian-controlled private corporation (CCPC) with a business limit and conditions related to investment income and taxable capital employed in Canada.
- Must be a Canadian-controlled private corporation (CCPC).
- Business limit for a taxation year is $500,000, prorated for the number of days in the year if there are less than 51 weeks in the year.
- Business limit must be allocated amongst corporations that are associated in a taxation year.
- Business limit is reduced by any portion that the CCPC assigns to another corporation.
- CCPC’s remaining business limit is reduced on a straight-line basis if the combined taxable capital employed in Canada of the CCPC and any associated corporations is between $10 million and $15 million.
- Business limit is phased-out if the adjusted aggregate investment income of the CCPC and any associated corporations is between $50,000 and $150,000.
- Reduction in business limit for a taxation year will be the greater of its taxable capital business limit reduction and its passive income business limit reduction for the year.
Who is eligible
The Small Business Deduction (SBD) is available for Canadian-controlled private corporations (CCPCs) that meet specific criteria set out by the Canada Revenue Agency. Eligible types of companies must engage in active business primarily in Canada and fall within certain income and capital thresholds.
- Canadian-controlled private corporations (CCPCs)
- Corporations engaged in active business carried on in Canada
- Corporations with business limits allocated among associated corporations
- Corporations within the taxable capital range of $10 million to $15 million
- Corporations with adjusted aggregate investment income between $50,000 and $150,000
Eligible expenses
There are eligible expenses for this grant. Applicants can claim expenses related to active business carried out in Canada, excluding certain income and exceeding certain losses. Eligible expenses include:
- Income for the year from an active business carried on in Canada
- Taxable income for the year
- Business limit for the year
Evaluation & selection criteria
There are evaluation and selection criteria for this grant. The evaluation and selection criteria include:
- Calculation of the adjusted aggregate investment income of the corporation and any associated corporations
- Calculation of the passive income business limit reduction for the corporation
- Demonstration that passive investments were not transferred to related corporations to avoid the passive income business limit reduction
- Evidence of active assets and their use in the corporation's active business
- Avoidance of transactions aimed at deferring the application of the SBD rule changes
Apply to this program
Overview of the Small Business Deduction (SBD)
The Small Business Deduction (SBD) reduces the corporate income tax for Canadian-controlled private corporations (CCPCs) with active businesses in Canada. Changes proposed in Budget 2018 adjust the SBD rules, including introducing a phase-out based on passive investment income.
Detailed Explanation of the Small Business Deduction (SBD) and Recent Changes
The Small Business Deduction (SBD) is an essential component of Canada's taxation framework explicitly geared towards Canadian-controlled private corporations (CCPCs). This deduction significantly lowers the corporate income tax that these corporations are required to pay if they are engaged in active business within Canada throughout the taxation year. This guide offers an in-depth understanding of the SBD, the parameters that define its application, and the recent changes proposed in Budget 2018.
1. What Constitutes the Small Business Deduction (SBD)?
The SBD allows eligible CCPCs to reduce their corporate income tax. The deduction is calculated by applying the SBD rate to the lesser of three critical amounts:
- Income for the year from an active business carried on in Canada, with specific exclusions for certain types of income and losses
- Taxable income for the year
- Business limit for the year
Understanding these components is crucial for CCPCs aiming to maximize their tax benefits.2. Determining the Business Limit
The business limit for a CCPC is standardized at $500,000 for a taxation year. However, this limit is subject to proration if the taxation year has fewer than 51 weeks. Notably, if a corporation has associations with others, the business limit must be allocated among them. Additionally, the business limit will experience a gradual reduction if the combined taxable capital employed in Canada by the CCPC and its associated corporations ranges between $10 million and $15 million.
3. Key Changes Proposed in Budget 2018
Budget 2018 introduces significant modifications to the SBD rules, especially in how the business limit is determined based on passive investment income:
- The business limit will be phased out on a straight-line basis if the total adjusted aggregate investment income (AAII) of the CCPC and its associated corporations lies between $50,000 and $150,000.
- The reduction in the business limit for a taxation year is determined by the greater value between the taxable capital business limit reduction and the passive income business limit reduction.
These adjustments are designed to strike a balance between encouraging active business operations and limiting the tax benefits derived from passive investments.4. Calculating Passive Income Business Limit Reduction
The formula for determining a CCPC’s passive income business limit reduction is as follows:
BL/$500,000 x 5 (AAII - $50,000) Here, BL represents the business limit without the passive income reduction, and AAII stands for the total adjustment aggregate investment income of the CCPC and its associated corporations for the preceding taxation year.Let's elucidate this with some examples:
- Example 1: ABC Company, a standalone CCPC with $75,000 of AAII in the previous year, will see its business limit reduced by $125,000 for the current year, resulting in a new limit of $375,000.
- Example 2: If ABC Company is associated with XYZ Company, and XYZ had $55,000 in AAII the previous year, the collective AAII of $130,000 will be used. This results in a $400,000 reduction, setting ABC Company’s new business limit at $100,000.
5. Understanding Adjusted Aggregate Investment Income (AAII)
Adjusted aggregate investment income incorporates various components:
- Taxable capital gains exceeding allowable capital losses, excluding those from active business assets
- Total income from property, deducting exempt income, certain receipts, specified dividends, and certain trust incomes
- Foreign accrual tax deductions
- Life insurance policy inclusions not already accounted for
This metric deducts total property losses, ensuring the focus remains on net investment income.6. Defining an Active Asset
An active asset of a corporation is defined through multiple lenses:
- Assets mainly used in an active business carried on primarily in Canada
- Shares of connected corporations considered qualified small business corporation shares
- Interests in partnerships meeting specific fair market value criteria
The classification depends on the primary use of the asset, integral to separate active business assets from passive ones.7. Demonstrating an Asset’s Active Use
To establish that a property was an active asset at the time of disposition, a corporation must prove its primary use in the active business. Factors influencing this determination include the actual utilization of the asset, the specific nature of the business, and industry practices. Proper documentation and a clear narrative about the asset's role in the business are advisable.
8. Preventing SBD Reductions Through Passive Investment Transfers
The amended rules include an anti-avoidance provision to prevent lowering the passive income business limit reduction by transferring passive investments to related corporations not associated with the taxpayer. If such a transfer primarily aims to reduce AAII, the corporations will be deemed associated for the business limit calculation.
9. Demonstrating Non-Avoidance of New Rules
Corporations must maintain robust documentation detailing the timing and purpose of transactions involving passive investments. Specifically, transactions initiated before the budget announcement must document their business purposes clearly. This ensures compliance and readiness for any CRA reviews.
10. Effective Dates of SBD Rule Changes
The changes to the SBD rules apply to taxation years beginning after 2018. Notably, these adjustments also affect corporation taxation years that begin in 2018 and end in 2019, provided they experienced shortened years due to strategic transactions. Corporations must demonstrate that these shortened years were not intended to defer the new rules' application.
11. Documentation to Support Non-Deferral
Businesses must keep detailed records that justify the timing and rationale behind transaction-induced short taxation years. The CRA mandates that any fiscal year-end changes require approval, supported by a narrative explaining the shift. Proper documentation ensures a clear audit trail if questioned by the tax authorities.
12. Staying Informed on Changes
For ongoing updates, corporations should regularly check Canada.ca for the latest information on forms, policies, guidelines, and regulatory changes related to the SBD. Keeping abreast of these resources ensures that businesses remain compliant and leverage any available tax benefits effectively.
The changes introduced in Budget 2018 reflect a strategic shift towards balancing tax incentives for active business income while regulating benefits from passive investments. By understanding these adjustments, CCPCs can better navigate the complexities of the SBD and maintain compliance with Canadian tax regulations.
