2019 Tax Rules on Investment Income for Canadian Controlled Private Corporations
Allan Madan, CA
The Liberal Government of Canada recently introduced new tax rules, which come into effect in 2019, for the taxation of investment income earned by Canadian controlled private corporations (CCPCs). If you are a Canadian business owner that invests through your company, then keep reading to learn more.
What is passive investment income?
Passive investment income includes dividends, interest, capital gains, and royalties. Canadian companies often invest their surplus cash in passive investments, such as real estate, stocks, bonds, and mutual funds, to earn a decent rate of return on their capital. The government of Canada has enacted new rules applicable to 2019 that impact the taxation of this income.
The Old Rules
Canadian controlled private corporations already pay a high rate of tax on investment income, i.e. 50%. Some types of investment income are taxed at a lower rate, such as capital gains, which have a tax rate of 25%. These tax rates have not changed. What has changed is the tax rate applied to corporate business profits generated from day-to-day operations by a CCPC, where the business profits are re-invested in passive investments.
The New Rules
To understand the new rules for Canadian corporate taxation of investment income, let’s look at an example. Pineapple Express Inc. is a CCPC, with a single owner, Sethy Rogan. Pineapple Express Inc. invested $1,000,000 of its savings into a passive investment making interest income of 9% or $90,000 for the 2019 year. In addition, Pineapple Express Inc. also made profits from its main business of $300,000 for the 2019 year.
The tax rate on the passive investment income is 50%, which is the same under the old and new rules. BUT, the tax rate on the business income made has gone up from 13.5% under the old rules, to 21.8% under the new rules. Why is this case?
The reason is the Liberal Government of Canada passed a tax law, effective 2019, that imposes a higher rate of tax on business income of a CCPC, where the corporation is earning more than $50,000 of passive investment income in the year. They are penalizing CCPCs for saving lots of cash and investing that cash in passive investments. Let me explain further.
CCPCs can claim the small business deduction on business profits of up to $500,000, which reduces the tax rate to 13.5% on those profits. However, for every dollar of passive investment income earned by a Canadian private corporation over $50,000, the small business deduction is reduced by $5. Once the passive investment income reaches $150,000, the small business deduction is reduced to $0.
Let’s apply these rules to Pineapple Express Inc. Pineapple Express Inc. earned $90,000 of passive investment income, which is $40,000 over the threshold of $50,000. As a result, the small business deduction limit will be reduced by $200,000. After the reduction the small business deduction limit becomes $100,000 from $300,000.
The business taxes of Pineapple Express Inc. are impacted as follows:
• The first $100,000 of business profit earned by Pineapple Express Inc. will be taxed at 13.5%, which is the same under the old and new rules.
• The next $200,000 of business profit earned by Pineapple Express Inc. will be taxed at 26% under the new rules, compared to 13.5% under the old rules
• When you add up the total taxes paid by Pineapple Express Inc on its business profits of $300,000, the tax rate comes to 21.8% under the new rules compared to 13.5% under the old rules.
Disclaimer
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.
ABOUT THE AUTHOR
ALLAN MADAN
CA.CPA.CGA
Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.
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Thank you
Thank you, great post i understand it now.
I love this blog
Quick question in general about passive income / stocks.
I bought a bunch of dividend paying stocks ( Td bank , Sunlife etc). Through my corporate direct investing account.
Do i add the total amount i get in dividends for my corporations year to year (Aug to Aug) ? or calender year for tax purposes.
And what about capital gains.? Some stocks i have sold. Others like TD bank i dont plan on selling anytime soon.
Thanks!
Hi Russ,
Include the dividend income earned and capital gains realized during the fiscal period (August to August) of your company in your company’s taxable income. Canadian portfolio dividends (like the ones that your company is receiving) are tax deductible under Section 112 of the Canadian Income Tax Act. However, they will be subject to Part 4 tax.
Note that for capital gains, only 1/2 of the gain is included in your company’s taxable income.
Are there any implications of this change on a Corp that has no active income and only has passive income?
Hi David, no, there won’t be any impact to your company based on your case-facts.
This was really helpful, thank you. Has there been any changes to any other areas of the ccpc for 2019?
Hi Eric,
Thank you for your positive feedback. Yes, there have been other changes. Please see this link for a webinar that I hosted on 2019 tax changes for Canadian corporations: http://madanca.com/blog/webinar-tax-changes-for-2019-small-business-corporations-in-canada/
Great info.
So it makes no sense anymore investing for passive income through corporation. Is that a reasonable statement?
Not necessarily. If your available cash is trapped in your corporate bank account, then it still makes sense to purchase real estate through a corporation. Otherwise, you will have to withdraw your corporate cash and pay personal taxes on it.
Hello Allan,
What if you sell real estate owned by your corporation?
What would be the tax treatment on the capital gain for the corporation and then to you when you draw the profits?
Thank you
Hi Stan,
When your corporation sells an investment property for profit, the following will occur:
(1) One half of the capital gain will be included in the corporation’s taxable income for the year
(2) The corporation will pay tax at an approximate rate of 50% on the taxable portion of the gain
(3) The non-taxable portion of the gain will be added to the corporation’s capital dividend account
(4) A capital dividend can be paid tax-free to the shareholder(s) from the capital dividend account
(5) A taxable dividend can be paid from the after-tax profits of the corporation to the shareholder
Once you factor all of the corporate taxes and personal taxes payable, the end result is that the total tax burden will be approximately 25% of the total gain.
The deduction is from the $500,000 original maximum small business cap. So $90,000 in passive income reduces $200,000 from the maximum $500,000 and NOT the ACTUAL active income of $300,000, which is $500k-200k=$300k will be taxed under the low 13.5% tax bracket, so the actual active business income of $300,000 is ALL taxed under the lower tax rate and is still 13.5%
Hi,
The SBD limit is the lower of (A) the ABI earned in the year and (B) $500,000. In this example, the ABI earned in the year is $300,000, which means that the SBD limit before the reduction is $300,000. Since the investment income earned in the year is $90,000, the SBD limit of $300,000 will be reduced by $200,000. As a result, $100,000 of ABI will be taxed at a lower rate of 12.5%, and the remaining $200,000 of taxable income will be taxed at approximately 26%.
Hi,
My wife and I own all shares of a CC corporation. In 2019 our revenue will be about $340,000 with income before tax of about $160,000. We are thinking of selling the business as an asset sale in 2019 for $500,000. How much tax will the company have to pay? Thanks
Hi Terry,
Your corporation will have to pay a tax of 25% on the profits made on the sale of its assets, including capital assets and goodwill. For a more accurate tax estimate, I will need a copy of the financial statements and most recent corporate tax return filed. My email address is amadan@madanca.com