Small Business Tax Rate: Ultimate 2023 Guide
January 11, 2023 Andrew AdolphAudits
What is the small business tax rate in Canada? Find out everything you need to know now…
Back in 1972, the federal government implemented the small business tax rate, also known as the Small Business Deduction (SBD).
What is the Small Business Deduction?
The small business deduction is a temporary reduction in tax that small, incorporated businesses pay on their first $500,000 of income.
Why a temporary reduction and why don’t sole proprietorships qualify?
What is the Small Business Deduction?
The system of corporate taxation is integrated with the personal income tax system through the dividend mechanism. When the corporation pays dividends, the integration formula kicks in.
The integration formula makes it so the same tax is paid on business income whether earned in a corporation or a sole proprietorship.
It is a timing difference and the same tax (in theory) gets paid. The purpose of the deduction and the advantage to being a corporation is that it can pay the lower tax amount but, more importantly, so it can reinvest profits.
How much is the Small Business Deduction?
19% of your first $500,000 taxable income, or $95,000.
Do All Corporations Qualify For The Small Business Tax Rate?
No. Large ones don’t (more than $10 million in assets) or ones controlled by foreigners.
Also, the amount has to be shared among a group of related corporations. You can’t start up more than one and have them all claiming it. The rulebook for what makes one corporation related to another corporation is long and complicated and based on who the shareholders are and who they are related to. Basically, according to the Income Tax Ac, you are related to you, your corporation, your spouse, your children and grandchildren, your spouse’s siblings and their children and grandchildren, your spouse’s siblings and children’s spouse and siblings. You can read all about Section 256 here.
I can think of some families I know who for which this must be a problem. I do not know how the tax department would know who siblings are, but I can see it becoming an issue in the course of an audit.
What Else Do You Need to Know About The Small Business Tax Rate?
The government wants small business corporations to either reinvest their profits or pay them out. Recall it is when dividends are paid out that the other shoe drops and the tax savings are now being paid back. The government does not want small corporations using the savings to invest in things that pay a passive income, like stocks or property income.
If income from passive sources like these exceeds $50,000 in a year, the small business deduction will be clawed back. Also, this type of income does not qualify for the SBD, only active income qualifies.
What If I Don’t Qualify for the Small Business Tax Rate?
If you don’t qualify as a small business, then you will be taxed at the general business rate, which is currently 28% in Canada. Don’t forget to leave room for the province and its taxes, roughly 50% of federal.
This may happen if your active business income exceeds $500,000 for the year and your taxable capital is more than $10 million.
The Small Business Tax Rate And The Bottom Line
Done properly, a small corporation can use the small business deduction to grow faster than a proprietorship. The amount of taxes paid works out the same in theory; nevertheless, this is one of the more important tax planning tools in the toolkit.
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Andrew Adolph is a CPA and former CRA auditor with 25 Years of experience. He helps businesses to not par any more in sales taxs than the law says they must and acts as an advocate for you if you are being audited, so you can fous on your business.