T2 Corporation – Income Tax Guide – Chapter 4: Page 4 of the T2 return

From: Canada Revenue Agency

Small business deduction

Corporations that were Canadian-controlled private corporations (CCPCs) throughout the tax year may be able to claim the small business deduction (SBD). The SBD reduces Part I tax that the corporation would otherwise have to pay.

The SBD is 18% (17.5% before 2018) of whichever of the following amounts is less:

  • the income from active business carried on in Canada (line 400)
  • the taxable income (line 405)
  • the business limit (line 410)
  • the reduced business limit on line 425 less the amount of the business limit you assigned under subsection 125(3.2) (line 427)

The following sections explain each of the above amounts.

This 18% SBD rate results in a tax rate of 10%. And the 17.5% SBD rate results in a tax rate of 10.5%.

The SBD rate will further increase to 19% effective January 1, 2019, resulting in a tax rate of 9%.

If the rate changes during the tax year, you have to base your calculation on the number of days in the year that each rate is in effect.

Once you have calculated the SBD, enter it on line 430.

Avoidance of the business limit and taxable capital limit

Where two corporations (Corps A and B) are deemed to be associated because they are associated with the same third corporation (Corp C), but because the third corporation, a CCPC, has filed a Schedule 28 election, they are deemed not to be associated with each other for determining the SBD, the following applies:

  • investment income derived from an associated corporation’s active business is not eligible for the SBD and is taxed at the general corporation income rate
  • Corps A and B remain associated with Corp C. They must include the taxable capital limit of Corp C when calculating the SBD.

Preventing multiplication of the small business deduction

To address concerns about partnership structures that multiply access to the SBD, the specified partnership income rules have been expanded for tax years that begin after March 21, 2016. For example, these  rules also apply to partnership structures in which a CCPC provides services or property to a partnership during the tax year of the CCPC, where the CCPC or a shareholder of the CCPC is a member of the partnership. A similar measure also applies for corporate structures that multiply access to the SBD.

Line 400 – Income from active business carried on in Canada

Complete Schedule 7, Aggregate Investment Income and Active Business Income, to determine the following amounts:

  • the aggregate investment income and foreign investment income for determining the refundable portion of Part I tax (see Refundable portion of Part I tax, Lines 440, 445, and 450 for details)
  • the specified partnership income for members (or designated members) of a partnership
  • the income from an active business carried on in Canada for the SBD

For tax years that begin after March 21, 2016, CCPCs may assign all or part of their business limit under subsection 125(3.2) or specified partnership business limit under subsection 125(8) to another corporation.

Use Schedule 7 to assign all or part of your specified partnership business limit to another corporation.

Also file Schedule 7 if another corporation assigned all or part of its business limit to your CCPC or if a member of a partnership assigned all or part of the member’s specified partnership business limit to your CCPC.

If you are assigning all or part of your business limit to another corporation, report it on page 4 of the T2 return.

Note

If claiming a deduction for patronage dividends on line 416 of Schedule 1, complete Part 5 of Schedule 16 to establish active business income carried on in Canada.

Active business income

Generally, active business income is income earned from a business source, including any income incidental to the business.

Income from a specified investment business or from a personal services business, and income described in subparagraph (a)(i) of the definition of specified corporate income in subsection 125(7) for the year are generally not considered active business income and are not eligible for the SBD. The following three sections explain when income from these types of businesses may be considered active business income and eligible for the SBD.

Specified investment business

A specified investment business is a business with the principal purpose of deriving income from property, including interest, dividends, rents, or royalties. It also includes a business carried on by a prescribed labour-sponsored venture capital corporation, the principal purpose of which is to derive income from property.

Except for a prescribed labour-sponsored venture capital corporation, income from a specified investment business is considered to be active business income, and is therefore eligible for the SBD if:

  • the corporation employs more than five full-time employees in the business throughout the year, or
  • an associated corporation provides managerial, financial, administrative, maintenance, or other similar services to the corporation while carrying on an active business, and the corporation would have to engage more than five full-time employees to perform these services if the associated corporation were not providing them

Note

The business a credit union carries on, or the business of leasing property other than real property, is not considered specified investment business.

Personal services business

A personal services business is a business that a corporation carries on to provide services to another entity (such as a person or a partnership) that an officer or employee of that entity would usually perform. Instead, an individual performs the services on behalf of the corporation. That individual is called an incorporated employee.

Any income the corporation derives from providing the services is considered income from a personal services business, as long as both of the following conditions are met:

  • the incorporated employee who is performing the services, or any person related to him or her, is a specified shareholder of the corporation
  • the incorporated employee would, if it were not for the existence of the corporation, reasonably be considered an officer or employee of the entity receiving the services

However, if the corporation employs more than five full-time employees throughout the year or provides the services to an associated corporation, the income is not considered to be from a personal services business. Therefore, the income is eligible for the SBD.

Deductions in computing income for a personal services business are restricted to the following:

  • salary, wages or other remuneration of the incorporated employee
  • cost of other benefits or allowances provided to the incorporated employee
  • certain expenses of the corporation associated with selling property or negotiating contracts
  • legal expenses paid in the year by the corporation in collecting amounts owed for services rendered

Note

Any expenses denied must be added back on Schedule 1.

For more information on the factors to take into account when a person is considered an employee, see Guide RC4110, Employee or self-employed? or go to Canada Pension Plan (CPP) and Employment Insurance (EI) Rulings.

Reference
Paragraph 18(1)(p)

Specified corporate income

Generally, where a CCPC earns income that would otherwise be considered as income from an active business from providing property or services to another private corporation and it (or one of its shareholders) or a person who does not deal at arm's length with the CCPC (or one of its shareholders) holds a direct or indirect interest in that other private corporation, the income would not be considered as being eligible for the SBD unless certain conditions are met.

For more information, see the definition of specified corporate income in subsection 125(7).

Specified cooperative income

The definition of specified corporate income was amended to exclude specified cooperative income, so that such income stays eligible for the SBD by default.

Specified cooperative income of a corporation (the selling corporation) means its income (other than patronage dividends paid to it by a cooperative out of its profits to its members) from the sale of the farming products or fishing catches of the corporation's farming or fishing business to an arm’s length corporation that is either:

  • a cooperative corporation (for this purpose, the meaning of cooperative corporation under the Income Tax Act is extended to include fishing businesses) 
  • held directly or indirectly by a cooperative corporation (extended to include fishing businesses) that is itself held directly or indirectly by the selling corporation (or one of its shareholders) or a person who does not deal at arm’s length with the selling corporation (or one of its shareholders)

Specified shareholder

A specified shareholder is a taxpayer who owns, directly or indirectly at any time in the year, at least 10% of the issued shares of any class of capital stock of the corporation or a related corporation.

How to calculate income from an active business carried on in Canada

Generally, to calculate active business income from carrying on a business in Canada, you have to deduct from net income for income tax purposes any of the following amounts that apply:

  • taxable capital gains minus allowable capital losses
  • dividends that are deductible from income under sections 112 and 113, and subsection 138(6)
  • property income minus property losses
  • property income from an interest in a trust
  • foreign business income
  • income from a specified investment business
  • income from a personal services business
  • income described in subparagraph (a)(i) of the definition of specified corporate income in subsection 125(7) for the year where certain conditions are not met

Specified partnership income

A corporation that is a member (or a designated member) of a partnership has to complete Schedule 7 to calculate its active business income.

The specified partnership income rules impose a limit on the amount of active business income earned by a corporation as a member or designated member of a partnership that is eligible for the SBD. The eligible amount is referred to as specified partnership income and is added to the corporation’s active business income from other sources, if any.

For members of a partnership, their specified partnership business limit is normally their pro rata share of a notional $500,000 business limit for the partnership.

For designated members of a partnership, their specified partnership business limit is nil, unless they get an amount assigned from a member of the partnership.

If the partnership incurs a loss from carrying on an active business, you have to deduct the corporation's share of that loss from its active business income. This is referred to as a specified partnership loss.

If your corporation is a member of a partnership in respect of which it filed a Schedule 73, you have to add or deduct the total active business income determined under section 34.2.

If the corporation received an information slip T5013, Statement of Partnership Income, that shows its share of partnership income or loss, keep it in case we ask for it later. Do not include this form with the return. For more information, see information slip T5013 and Guide T4068, Guide for the Partnership Information Return.

On line 400, enter the total active business income you calculated on Schedule 7.

References
Subsections 125(1), 125(7), 125(8), and 248(1)
Section 251
IT‑73, The Small Business Deduction

Line 405 – Taxable income for the SBD

The taxable income you use to calculate the SBD is usually the amount entered on line 360. However, if you have claimed a foreign non-business income tax credit, a foreign business income tax credit, or both, you have to reduce the taxable income by:

  • 100/28 of the amount that would be deductible as a federal foreign non-business income tax credit on line 632, if that credit was determined without the refundable tax on the CCPC's investment income (line 604) and without reference to the corporate tax reduction under section 123.4, and
  • four times the amount that would be deductible as a federal foreign business income tax credit (line 636) if that credit was determined without reference to the corporate tax reduction under section 123.4. See general rate reduction percentage

You also have to reduce taxable income by any amount that, because of federal law, is exempt from Part I tax.

On line 405, enter your taxable income for the purposes of calculating the SBD.

References
Paragraph 125(1)(b)
Subsection 126(7)

Line 410 – Business limit

The maximum allowable business limit for a corporation that is not associated with any other corporation is $500,000.

CCPCs that are associated with one or more corporations during the tax year have to file Schedule 23, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Business Limit. On this schedule, a percentage of the business limit is allocated to each corporation, and the total of all percentages cannot be more than 100%. For more information about this schedule, see Schedule 23.

On line 410, enter the business limit for the year. If applicable, enter the amount from Schedule 23.

Notes

If the tax year is shorter than 51 weeks, you have to prorate the business limit, based on the number of days in the tax year divided by 365, before you enter it on line 410.

If a CCPC is associated with two other corporations and elects for the two other corporations not to be associated with each other for the purpose of the small business deduction, it has to file Schedule 28, Election not to be Associated Through a Third Corporation. For more details, see Schedule 28

References
Subsections 125(2), 125(3), 125(5), and 256(2)
IT‑64, Corporations: Association and Control

Line 425 – Reduced business limit

Large CCPCs that have taxable capital employed in Canada of $15 million or more do not qualify for the SBD. The business limit is reduced on a straight-line basis for CCPCs that have taxable capital employed in Canada of between $10 million and $15 million in the previous year. Similar restrictions apply to any CCPC that is a member of an associated group that has, in total, more than $10 million of taxable capital employed in Canada.

For tax years that begin after 2018, the business limit of a CCPC is also reduced if the CCPC, and any other corporation it is associated with, earn combined income from passive investments between $50,000 and $150,000. This income is calculated on Schedule 7, Aggregate Investment Income and Active Business Income, and is referred to as the adjusted aggregate investment income.

The reduction in the CCPC’s business limit is then the greater of its taxable capital business limit reduction and its passive income business limit reduction for the year.

To calculate the total taxable capital employed in Canada, use whichever one of the following schedules that applies:

If your taxable capital employed in Canada is more than $10 million, file the appropriate schedule with your return.

Use Schedule 23, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Business Limit, if you are an associated CCPC. For more information about this schedule, see Schedule 23.

Reference
Subsections 125(5.1) and 125(7)

Assignment of the business limit under subsection 125(3.2)

For tax years that begin after March 21, 2016, CCPCs can assign all or part of their business limit under subsection 125(3.2) to another corporation.

Enter the amount of the business limit you assign and the business number of the corporation to which you assign such an amount on page 4 of the T2 return. Deduct the amount you assign from line 425. Enter the result on line 427.

If another corporation assigned all or part of its business limit to your CCPC, file Schedule 7.

References
Subsections 125(3.1), (3.2), and (7)

Line 430 – Small business deduction

Multiply the least of lines 400, 405, 410, and 427 by 18% (17.5% before 2018). This rate will increase to 19% in 2019.

If the rate changes during the tax year, you have to base your calculation on the number of days in the year that each rate is in effect. Enter the result on line 430, and at amount J on page 7 of the return.

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