How Canadian Corporations Are Taxed: Rates and Dividends

What is a Canadian-controlled private corporation, and why does it matter?

A Canadian-controlled private corporation (CCPC) is a private corporation resident in Canada that meets the Canadian-control tests. CCPC status matters for the federal small business deduction. Refundable tax on investment income can also apply to a non-CCPC that meets the substantive CCPC test (CRA: Type of corporation; CRA: T2 Guide, Chapter 7).

Being incorporated in Canada alone does not establish CCPC status. The corporation must be private, resident in Canada, and generally incorporated here or continuously resident here since the statutory date. No share class may be listed on a designated stock exchange. The CRA tests corporation type at year-end, while some deductions require CCPC status throughout the year. A change in ownership during the year therefore needs review (CRA: Type of corporation).

What if non-residents or a public company control the corporation?

A corporation controlled directly or indirectly by non-residents, public corporations, or a combination of them generally is not a CCPC. The test can also fail when shares held by these persons would confer control if one person held them all, even if no single foreign shareholder controls the company (CRA: Type of corporation).

A shareholder's Canadian tax residence, not citizenship or immigration status, matters here. A parent living abroad may be a non-resident; check residence and control rights before counting their shares as Canadian-held (CRA: Residency status). Review voting rights, share classes, shareholder agreements and indirect ownership before assuming the lower rate applies. A corporation that is not a CCPC may still be resident in Canada and owe Canadian corporate tax; it simply does not get the federal CCPC small business deduction (CRA: Type of corporation). A US citizen owner may also face separate US rules; see American owners of Canadian corporations.

What tax rate does a Canadian corporation pay?

The federal net rate is 15% for income earned in a Canadian province or territory and subject to the general tax reduction. A CCPC's qualifying active business income can instead have a 9% federal rate, within its business limit; provincial or territorial tax is added. Income earned outside Canada does not get the federal provincial-income abatement (CRA: Corporation tax rates; CRA: T2 Guide, Chapter 7).

For a combined rate, add the federal rate for that income to the applicable lower or higher provincial rate below.

Qualifying zero-emission technology manufacturing profits can face reduced federal rates: 4.5% where the small business rate otherwise applies, or 7.5% where the general rate otherwise applies. Eligibility depends on the activity and revenue tests (CRA: T2 Guide, Chapter 7).

These are income-tax rates, not the total tax paid by an owner. Credits, deductions, the type of income, and tax in the provinces where the corporation has a permanent establishment can change the result (CRA: Provincial and territorial corporation tax).

What is the small business deduction, and who qualifies?

The federal small business deduction reduces tax on a CCPC's active business income earned in Canada, up to the least of eligible active business income, adjusted taxable income, and its available business limit after reductions and assignments. The ordinary federal limit is $500,000 for an unassociated corporation before reductions (CRA: T2 Guide, Chapter 4).

A CCPC must generally remain a CCPC throughout the tax year to claim it. A corporation can elect on Form T2002 to be treated as a non-CCPC for eligible-dividend purposes, losing the deduction while the election applies. An authorized officer signs the form and files it by the T2 due date, generally six months after year-end (CRA: CCPC election; Form T2002; CRA: T2 filing date). Passive property income, such as ordinary interest or rent, generally does not qualify as active business income. A business whose main purpose is earning property income can qualify in limited cases, including when it has more than five full-time employees throughout the year. Income from services to a private corporation in which the CCPC, a shareholder, or a person not dealing at arm's length with either has an interest can lose SBD eligibility unless specific conditions are met (CRA: T2 Guide, Chapter 4). Personal services business income is generally ineligible for both the small business deduction and the general rate reduction; see Personal services businesses to check the classification (CRA: What is a PSB).

What shrinks the small business limit?

Associated CCPCs share the federal business limit, and taxable capital or passive investment income can reduce it further. Family ownership can cause association even when different relatives hold the corporations; Schedule 23 allocates the limit among associated CCPCs (CRA: Relationships and the small business deduction; CRA: T2 Guide, Chapter 4). If two corporations are associated only through a third CCPC, that third corporation may elect on Schedule 28, filed with its T2 by the six-month filing deadline, to separate the two for SBD purposes; the third then has no business limit (CRA: Schedule 28).

The investment-income threshold measures income, not the value of cash or investments held. The larger of the two reductions applies; they are not simply added. Taxable capital is generally measured in the preceding tax year, but association changes can change that timing. A tax year shorter than 51 weeks also prorates the limit. For the mechanics of investing retained earnings, see Holding and investment corporations (Income Tax Act, section 125; CRA: T2 Guide, Chapter 4).

Does the province tax the corporation differently?

Yes. Provincial and territorial corporate tax is added to federal tax, and the lower provincial rate can have its own business limit and conditions. Ontario does not apply the federal passive-income reduction to its provincial small-business limit, so a corporation can lose the federal lower rate yet keep Ontario's if it meets the other conditions (CRA: Ontario small business deduction). Where a corporation has permanent establishments in more than one place, its income may need to be allocated among them. A permanent establishment is usually a fixed business place, such as an office or warehouse; an employee or agent with general authority to contract can also create one (CRA: Permanent establishment).

The table gives provincial or territorial rates only, before federal tax. The CRA rate table covers most rows; later changes for Newfoundland and Labrador and Ontario, plus Alberta and Quebec, have separate sources.

Quebec's lower rate is a minimum: its small business deduction can be reduced based on remunerated hours and certain industry conditions. The newer minimum applies only when the tax year begins after April 29 (Revenu Québec). A tax year spanning Ontario's July 1 or Newfoundland and Labrador's January 1 rate change uses a day-weighted rate (CRA: Corporation tax rates; Newfoundland and Labrador: Income Tax Act). Nova Scotia's provincial business limit is $700,000; Prince Edward Island's and Saskatchewan's are $600,000 and $600,000. These higher provincial limits do not increase the federal limit (CRA: Corporation tax rates). Alberta and Quebec administer their own corporate income tax; other provincial and territorial income tax generally goes on the federal T2 (CRA: Provincial and territorial corporation tax).

How is investment income taxed inside a corporation?

A CCPC, or a non-CCPC that meets the substantive CCPC test, can face additional refundable federal tax on investment income. It cannot simply apply the small business rate to interest, rent or most portfolio income (CRA: T2 Guide, Chapter 4; CRA: T2 Guide, Chapter 7).

A partial refund depends on the corporation's refundable-tax balance and taxable dividends paid. The T2 must be filed within three years after year-end to claim it. See Holding and investment corporations for the account rules and Filing your corporate return for the regular T2 deadline (CRA: T2 Guide, Chapter 6).

How is money taxed when it leaves as salary or dividends?

Salary is employment income to the owner and generally reduces the corporation's income when it is reasonable pay for work. A dividend is a distribution from corporate profits, so the corporation does not deduct it. A Canadian-resident individual generally reports a taxable dividend with a gross-up and dividend tax credit; for a non-resident shareholder, the corporation generally withholds Canadian tax, which a treaty may reduce (Income Tax Act, section 67; CRA: Taxable dividends folio; CRA: Non-resident dividend withholding).

The full outcome depends on the owner's province, other income, payroll contributions, and the corporation's tax accounts. See Salary or dividends for the choice.

What is the difference between eligible and non-eligible dividends?

For Canadian-resident individuals, eligible and non-eligible dividends receive different personal gross-ups and dividend tax credits. A CCPC generally pays eligible dividends from its general rate income pool (GRIP), which broadly tracks income taxed at the general corporate rate and eligible dividends received; small-business-rate profits generally lead to non-eligible dividends (CRA: Eligible dividends; CRA: GRIP).

The corporation must designate an eligible dividend and notify shareholders in writing before or when it pays the dividend. A CCPC that designates more eligible dividends than its year-end GRIP supports can owe Part III.1 tax. A non-CCPC uses a different low rate income pool test, so changing corporate status does not make all dividends eligible (CRA: Designation of eligible dividends; CRA: Taxable dividends folio; CRA: Part III.1 tax).

Can a corporation pay tax-free capital dividends?

A private corporation may pay a capital dividend without Canadian income tax to a Canadian-resident shareholder if its capital dividend account (CDA) supports the amount and it makes a valid election. An authorized officer signs Form T2054, due by the earlier of the dividend's payable date and its first payment date (Form T2054). If a formerly non-resident-controlled corporation becomes a CCPC, its existing CDA can reset to nil, except when the change results from a shareholder's change of residence. Anti-avoidance rules can still make the dividend taxable. A non-resident shareholder faces Canadian withholding tax. See Holding and investment corporations for the CDA calculation and excess-dividend consequences (CRA: Capital Dividends Folio).

Example

Illustrative amounts in Canadian dollars. An Alberta CCPC with one owner earns $300,000 of qualifying active business income, has no associated corporation, and stays below both grind thresholds. Its federal tax at 9% is $27,000; Alberta tax at 2% is $6,000. The combined corporate income tax is $33,000, leaving $267,000 in the corporation before any later dividend or owner-level tax. If the same income fails the small-business test but qualifies for the general rate, 15% federal tax plus 8% Alberta tax would be $69,000. The result changes if its income mix, available limit, provincial allocation, or credits differ.

Different for you?

• Unsure whether to incorporate: compare structures in Sole proprietorship or corporation.
• Several companies, family shareholders, or investors abroad: gather the share register, voting agreements, related-company list, prior-year taxable capital, investment-income figures and tax account balances before deciding the rate. Get corporate tax preparation help if control or association is unclear.
• One-client contracting: Personal services businesses covers the classification that can remove the small business deduction.
• Retained earnings invested inside a company: see Holding and investment corporations.
• Choosing owner pay: see Salary or dividends.
• Preparing the return or checking instalments: see Filing your corporate return and Which returns your business files.
• A US citizen owns the corporation: see American owners of Canadian corporations.
• A regulated professional practice: see Professional corporations.