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Small Business Deductions and their Limitations

Small Business Deductions and their Limitations

How the SBD Works

Small businesses are central to the Canadian economy, which is why Federal and Provincial taxation schemes offer favorable tax treatments targeted at small business corporations. The Small Business Deduction (SBD) allows eligible businesses to allocate tax savings towards investments in their growth.

The SBD allows an amount of eligible corporations’ Active Business Income (ABI) to be taxed at the reduced SBD-rate. The maximum ABI that can be taxed at the SBD-rate is called the Business Limit (BL), and is currently $500,000, federally.

This deduction is only available to Canadian-Controlled Private Corporations (CCPC) with less than $15 million in taxable capital currently employed in Canada. A CCPC’s BL will decrease linearly from $500,000 to $0 as their taxable capital increases from $10 – 15 million.

Preventing Abusive SBD Multiplication

The SBD rules prevent taxpayers from structuring their business with multiple CCPCs to multiply accessible BL amounts. While these rules are complex, they broadly target associated CCPCs, CCPCs earning passive income, and CCPCs earning income from a partnership.

Associated CCPCs

To prevent a business benefitting from operating through several CCPCs, associated CCPCs must agree to split a single SBD limit. The BL of each associated CCPC is limited to their allotment, and all the allotments among a group of associated corporations must add up to $500,000.

Two CCPCs are considered associated if one CCPC controls the other, both are controlled by a third-party, or the people controlling each are related to those controlling the other and one of the controlling parties owns more than 25% of both CCPCs.

Passive Income

The SBD only applies to Active Business Income, which excludes passive income by definition. SBD rules generally presume income is active and exclude businesses intended primarily to passively collect interest from properties – or Specified Investment Businesses (SIB).

Some passive income is exempted from the SIB characterization and can thus benefit from SBD. The following businesses can consider their income as active for the purposes of SBD rules: businesses which lease certain property, credit unions, or businesses employing five or more full-time employees a year (or using equivalent services from an associated corporation).

SBD rules also exclude from ABI income earned from a Personal Services Business (PSB), referred to commonly as an incorporated employee. This anticipates a situation where employees incorporate into single-person corporations simply to access the SBD benefit but are otherwise normally employed.

Partnership Income

Like the rules for associated CCPCs, rules exist to prevent a partnership from multiplying SBD access by incorporating its partners. A single BL applies to a partnership’s ABI, which is then automatically split amongst partner CCPCs in proportion to their partnership stale. Each partner CCPC’s allotment is called its Specified Partnership Income (SPI), and can be added to any other non-SPI ABI that CCPC might earn (up to its normal BL).

Even where a CCPC is not actually a partner, they are deemed such for SBD purposes if they meet the following criteria. If the CCPC earns most or all of its income from providing services or property to the partnership, and the CCPC or its shareholder does not deal at arm’s length with the partnership, the CCPC is deemed a partner. However, unlike actual partner CCPCs, deemed-partner CCPCs are not entitled to any SPI deduction by default, and can only apply SBD rates to their partnership income if they are allotted a portion of the partnership BL. SBD rules are complex, and other limitations exist. Speak to one of our lawyers to help understand the best way to structure your small business.

FAQ’s:

What is the purpose of the Small Business Deduction?
The Small Business Deduction (SBD) allows eligible businesses to allocate tax savings towards investments in their growth. The SBD allows an amount of eligible corporations’ Active Business Income (ABI) to be taxed at the reduced SBD-rate.
What is the maximum income that can be taxed under the Small Business Deduction rate?
The maximum ABI that can be taxed at the SBD-rate is called the Business Limit (BL), and is currently $500,000, federally.
Is the Small Business Deduction available to my corporation?
This deduction is only available to Canadian-Controlled Private Corporations (CCPC) with less than $15 million in taxable capital currently employed in Canada. A CCPC’s BL will decrease linearly from $500,000 to $0 as their taxable capital increases from $10 – 15 million.
How do the SBD rules treat associated CCPCs for the purpose of the SBD limit?
To prevent a business benefitting from operating through several CCPCs, associated CCPCs must agree to split a single SBD limit. The BL of each associated CCPC is limited to their allotment of the overall SBD limit, and all the allotments among a group of associated corporations must add up to $500,000. Two CCPCs are considered associated if one CCPC controls the other, both are controlled by a third-party, or the people controlling each are related to those controlling the other and one of the controlling parties owns more than 25% of both CCPCs.
My business income is passive. Can I still benefit from the Small Business deduction rules?
The SBD only applies to ABI, which excludes passive income by definition. SBD rules generally presume income is active and exclude businesses intended primarily to passively collect interest from properties – or Specified Investment Businesses (SIB). Some passive income is exempted from the SIB characterization. The following businesses can consider their income as active for the purposes of SBD rules: businesses which lease certain property, credit unions, or businesses employing five or more full-time employees a year (or using equivalent services from an associated corporation).

-Shira Kalfa, BA, JD, Partner and Founder

Shira Kalfa is the founding partner of Kalfa Law. Shira’s practice is focused in corporate-commercial and tax law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law. Shira graduated from York University achieving the highest academic accolade of Summa Cum Laude in 2012. She graduated from Western Law in 2015, with a specialization in business law. Shira is licensed to practice by the Law Society of Ontario. She is also a member of the Ontario Bar Association, the Canadian Tax FoundationWomen’s Law Association of Ontario, and the Toronto Jewish Law Society. 

© Kalfa Law, 2021

The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.

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