Thursday, March 24, 2016

Steady As She Goes For Small Businesses

The 2016 federal budget did not make the small business rate unavailable for professional businesses, despite the rumours that suggested it would.  However, the budget did include changes that will affect small business corporations.

Small business corporations are Canadian-controlled private corporations that earn income from an active business carried on in Canada and that have taxable capital of less than $10 million.  The first $500,000 of active business income qualifies for a low rate of tax.  In British Columbia, this low rate is 13%.  This consists of a 10.5% federal rate and a 2.5% provincial rate.

The former government had proposed to reduce the federal component of this tax rate in stages between 2017 and 2019.  The 2016 budget cancels those planned rate reductions.  As a result, the low rate of tax will remain at 13% for British Columbia small business corporations.  In order to integrate the tax paid by a small business corporation and the tax paid by shareholders on dividends received from those corporations, the dividend gross-up and tax credit rates will also remain at 2016 levels.

The low rate of tax applies only to active business income – for example, income from a retail store or a service business.  Except in the case of real estate rentals, it does not matter how many people are employed by the business corporation.  If a corporation is in the business of renting real estate, however, rental income qualifies for the low rate of tax only if the rental business employs more than five full-time employees.  This restriction applies to corporate landlords as well as corporations that rent storage units.

In 2015, the federal government announced a review of the active business classification rules.  It has now completed that review and will not make any changes to the active business income concept at this time.  This means that incorporated real estate rental businesses will still have to employ more than five full-time employees in order to gain access to the low rate of tax on that income.

The low rate of tax is an advantage because it leaves a small business corporation with more after-tax cash.  The rate applies only to the first $500,000 of profit in any one year.  This creates an incentive for taxpayers to try to multiply access to that $500,000 threshold.  Various anti-avoidance rules seek to prevent this.  For example, associated corporations must share the $500,000 limit.  Associated corporations are corporations that have an element of common ownership or that are separate purely for tax purposes. 

The 2016 federal budget adds to these anti-avoidance rules.  These new rules will be addressed in the next blog.

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The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.