In our Corporate Taxation & Dividends article we briefly described the difference between non-eligible dividends and eligible dividends.
This is an important topic to understand fully before we discuss the new legislation that is affecting access to the small business deduction (SBD) which means you could be paying increased taxes if not managed properly. The SBD is the reduced small business corporate tax rate (11% in AB for example-2020) that Canadian controlled private corporations with an annual income under $500k are taxed at instead of the general corporate tax rate (23% in AB for example-2020). Our financial advisors in Calgary can help.
There are essentially two types of income that a corporation can earn:
- Active income from the active business operations of the corporation
- Passive income from passive assets such as real estate, investments, ect.
When your corporation or any associated corporations earn passive income, any dollar earned above and beyond a $50,000 threshold will start to “grind down” your access to the SBD.
For every passive $1 that you earn, $5 will be subtracted from your SBD limit.
For example, let’s say you have an investment portfolio of $1,000,000 in an associated company of your operating company.
You are earning 7% interest within that portfolio and at the end of the year you have earned passive income of $70,000.
- You have made $20,000 over the $50,000 limit.
- $20,000X5 = $100,000
- $500,000(Your SBD limit) – $100,000 = $400,000
- New SBD limit = $400,000
Let’s use this example and assume that your operating company earns a before tax profit of $450,000.
The first $400,000 will be taxed at the SBD (11% in AB 2020)
- Taxes payable of $44,000
- LRIP increased by $356,000
The next $50,000 will be taxed at the General Rate (23% in AB 2020)
- Taxes payable of $11,500
- GRIP increased by $38,500
From this you can see you have $356,000 that you can pay out as non-eligible dividends and $38,500 you can pay out as eligible dividends.
As we know eligible dividends have a much more preferential tax credit than non-eligible dividends and you will be able to take out more dividends and pay less tax using your “eligible dividend pool”.
As you can see from this example, these taxes paid are not “lost” forever.
They are utilized when you pay out eligible dividends.
However, if your intention is not to pay out profits in dividends then from this grind down you have significantly less capital to reinvest back into your business.
These rules are much more complicated than I’ve illustrated here, but this gives you a good baseline to understand the impacts this will have on your business.
If you have questions about financial planning in Calgary and wealth management in Calgary or would like to explore your options, connect with us to speak with a financial advisor in Calgary and get the answers you need to achieve your goals.