Canadian entrepreneurs urged to protect their small-business tax deduction

A new report highlights steps for small-business owners to take before new investment-income rules kick in

By Leo Almazora

Oct 19, 2018

There’s little time left for Canadian business owners who have over $50,000 of investment income from their corporations prepare for new corporate tax rules that could take away their small-business tax deduction in 2019, warns a recognized Canadian tax expert.

“Under the new tax rules, if your corporation has more than $50,000 of investment income in 2018, it may lose some, or all, of the small business deduction in 2019 – and the valuable, enhanced tax deferral that goes with it,” said Jamie Golombek, managing director of Tax and Estate Planning, CIBC Financial Planning and Advice.

Starting in 2019, corporations who had more than $50,000 of investment income in the previous year may be subject to the higher, general corporate rate. For every $1 of investment income over $50,000, the small-business deduction will be pared by $5, effectively reaching zero at $150,000 of investment income. CCPCs with over $150,000 of investment income in 2018, therefore, could see the amount of tax they can defer — and consequently, the amount that may be invested in the corporation — by some $49,000 to $90,000, depending on which province they’re based in.

In a new report, Golombek and Debbie Pearl-Weinberg, executive director for Tax & Estate Planning, CIBC Financial Planning and Advice, highlight possible strategies for business owners with passive income in their corporations to avoid the small-business deduction and retain the associated enhanced tax deferral.

TFSA and RRSPs can be a good vessel for excess corporate funds. According to Golombek, business owners may want to consider taking sufficient funds to maximize their RRSP and TFSA contributions rather than having them in the corporation. Over time, he noted, the tax-free compounding in an RRSP or TFSA will typically result in outperformance over taxable corporate investments.

“Consider whether any tax-free withdrawals can be made from the corporation,” added Pearl-Weinberg. As an example, she explained that the corporation may reduce its passive-income-generating funds by paying back loans from shareholders or declaring a tax-free capital dividend. She went on to say that corporations may consider using an individual pension plan (IPP) to lower the amount of passive income in a company.

Corporations may also think about adjusting their investment portfolio strategy. Golombek suggested several options, such as tilting toward investments with growth rather than interest or dividends, deferring capital gains, staggering dispositions of investments among calendar years, and triggering capital gains and losses in the same year.

Finally, business owners may also consider purchasing life insurance inside a corporation. That transaction usually results in a lower after-tax cost, Golombek argued, since premiums can be paid with lower-taxed dollars than if the premiums were paid with high, personal after-tax funds.

“And, investment income earned in an exempt, permanent life insurance policy does not count as passive income that could impact the small business deduction,” he added.

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