What is the small business deduction in Canada?

How much the deduction is worth

The small business deduction reduces the federal rate on active business income from 15% to 9%, on the first $500,000 earned in a year. That six-point federal saving, plus the lower provincial small business rate most provinces offer, is worth tens of thousands of dollars a year to a profitable small corporation.

On the full $500,000, the difference between the small business combined rate and the general rate is commonly around $60,000 to $90,000 in tax. Preserving access to this deduction is therefore one of the highest-value planning objectives a small corporation has.

Who qualifies

The deduction is available to a Canadian-controlled private corporation, a CCPC. Broadly that means a private corporation resident in Canada that is not controlled by non-residents or public companies. The income must be active business income, not passive investment income, which is taxed under a different and higher regime.

Personal services business income does not qualify, and neither does most investment income. The distinction between active and passive income is where many assessments turn.

The $500,000 limit is shared

The $500,000 business limit is not per corporation, it is shared among associated corporations. If you control several companies, they divide one $500,000 limit between them rather than each getting their own. This prevents multiplying the deduction by splitting a business across entities.

Association rules are broad and catch common structures like a holding company and its operating subsidiary, or corporations owned by the same family. Getting the associated-corporation analysis wrong is a frequent and expensive error.

How passive income grinds it down

Since 2019, a CCPC that earns more than $50,000 of passive investment income in a year sees its business limit reduced by $5 for every $1 over that threshold. At $150,000 of passive income, the $500,000 limit is eliminated entirely and all active income is taxed at the general rate.

This grind is why the mix of active and passive income inside a corporation matters, and why owners with significant retained investments need to plan around it rather than let it erode the deduction unnoticed.

The taxable capital limit

A second grind applies based on taxable capital employed in Canada. Historically the deduction phased out between $10 million and $15 million of taxable capital; the upper end was extended to $50 million in recent years. Most small businesses are far below this, but growing companies should watch it as they accumulate assets.