Holding Passive Investments in a Private Corporation —
Impact on the Small Business Deduction
By Maninder Dhadda, CPA, CGA
Maninder Dhadda is a senior
tax manager at Smythe LLP in
Vancouver. He specializes in
Canadian taxation and
primarily focuses on advising
the shareholders of privately
owned companies with regard
to their Canadian corporate and
personal income tax planning
and compliance matters.
Maninder would like to thank
Tom Morton, CPA, CA, a tax
partner at Smythe LLP, for his
advice and guidance on this
article.
Note to readers: The consultation paper described in this article generated
considerable concern among many in the profession in the summer and
fall of 2017. To review CPA Canada’s response to the proposed legislation,
visit the Members’ Area of the cpacanada.ca website and choose “Taxation
of private corporations” under News from the profession. As of this writing,
the latest update was made on May 16, 2018.
O
n July 18, 2017, Canada’s Department of Finance released a
consultation document about the use of tax-planning
strategies involving private corporations. The government’s
stated intention in releasing the document was to increase the fairness
of the tax s ystem, which is foundational to the Income Tax Act (ITA).
At issue was the perception that private company owners can accumu-
late investment wealth faster than employees earning the equivalent
income—specifically, that private companies taxed at lower tax rates than
individuals can use these tax savings to accumulate passive investments
rather than reinvesting the after-tax earnings in their business to
stimulate growth, create more employment, etc.
The consultation document proposed three possible solutions to this
perceived inequity, which amounted to three very complex—some would
say unworkable—proposals to levy additional income taxes on any pas-
sive investment income earned by private companies. Several months
of consultation followed. Then came the release of the February 27,
2018, Federal Budget and accompanying Notice of Ways and Means
Motion, which included substantive tax changes to reduce the perceived
advantage to private corporations holding passive investments.
The proposed new tax rules differ from those in the July 2017 consul-
tation document in that they do not directly levy additional income
taxes; instead, the government proposed changes to the ITA that
would limit deferral advantages to private corporations “in a more
targeted and simpler manner.” 1
The proposed new rules
Under the legislation proposed on February 27,
2018 (the proposed legislation), 2 a corporation
and its “associated corporations” 3 that earn
more than $50,000 of passive investment in-
come in a year will find their access to the
small business deduction (SBD) 4 reduced.
To understand the mechanics of how passive
investment income grinds down the SBD, a
brief refresher of the SBD rules may be helpful.
At its simplest, the SBD is a credit against in-
come taxes otherwise payable by a Canadian-
controlled private corporation (CCPC) 5 that
reduces the combined federal and BC corpo-
rate income tax rates from 27% to 12% (2018
rates) on the first $500,000 6 of the CCPC’s
income from “active business” 7 carried on in
Canada. The $500,000 SBD business limit is
shared among associated corporations.
Under the existing legislation, the $500,000
SBD business limit for a particular taxation
year is reduced if the CCPC or associated
CCPCs’ “taxable capital employed in Canada” 8
in the preceding taxation year exceeds $10 mil-
lion. If the taxable capital employed in Canada
in the preceding taxation year reaches $15
million, the limit is ground to $0. 9
1 Department of Finance Canada, Equality + Growth: A Strong Middle Class (Budget Plan), 2018 (page 73).
2 The proposed legislation, Bill C-74, had its first reading on March 27, 2018.
3 ITA, Part XVII, Subsection 256 (1).
4 ITA, Subdivision B, Subsection 125 (1).
5 ITA, Subdivision B, Subsection 125 (7).
6 A CCPC’s business limit for a taxation year is $500,000. The $500,000 business limit is shared among associated
7 ITA, Subdivision B, Subsection 125 (7).
8 ITA, Part I.3, Section 181.2.
9 ITA, Subdivision B, Subsection 125 (5.1).
CCPCs, pursuant to Subdivision B, Subsection 125 (2) of the ITA.
40 CPABC in Focus • July/August 2018