The small business Clawback
In 2018, Canadian-controlled private corporations (CCPCs) pay corporate income tax on small business income at 12 percent in Alberta. This rate is to be reduced to 11 percent in 2019. The small business limit (the amount of income annually that is eligible for the small business rate) is $500,000 in Alberta
Under the Proposals, the small business limit will be reduced by $5 for every $1 of investment income above a $50,000 threshold. Under this formula, the SBD will be eliminated when investment income reaches $150,000 in a given taxation year. The chart below shows the reduction of the small business limit at selected passive income levels.
To quantify this clawback, let’s consider a corporation taxable in Alberta, assuming no change in the projected tax rates for 2019, and assuming that Alberta follows the federal changes in the Proposals.
The combined federal and provincial small business tax rate in 2019 will be 11 percent. The combined general corporate income tax rate will be 27 percent (15 percent federal tax plus 12 percent Alberta tax). Therefore, in 2019, the difference in combined tax rates between general rate income and small business income is 16 percent. Where the small business limit of $500,000 is fully clawed back under the Proposals, the increased annual corporate tax cost will be $80,000 for 2019 calendar-year corporations taxable in Alberta (the costs will vary by province).
First of all, it is important to determine what type of investments you hold inside your corporation, and whether their income is in the preferred tax arena. Interest, rents and dividend passive income will all count 100% towards your total passive investment income number. Capital gain passive investment income is much more preferred. Not only is only the entire gain only taxed at half of the corporate investment income tax rate…but only half of the total gain will count towards your total passive investment income annual threshold. So, to clarify, if $50,000 is the passive investment income threshold, you could ultimately have an annual capital gain of $100,000 before potentially clawing back your small business deduction. If you were making a 5% annual return on your investments, the difference here is huge. In an interest or dividend paying investment, you would be only able to have $1,000,000 in your investment before the threshold is hit. If your investment is in the capital gains arena, you wouldn’t be hitting the maximum threshold until you have $2,000,000 held in your corporate investment account.
There are also ways to invest tax-sheltered inside your corporation, much like an RRSP.
One way to invest on a tax-sheltered basis inside your corporation is by using life insurance.
Permanent insurance products, such as Whole Life or Universal Life insurance have an investment component to the insurance policy. Investments inside the policy grow tax sheltered and can provide an income stream for you at retirement and a tax-free benefit to your family at death.
All deposits made to the policy are done via your corporation, which can save you thousands of tax dollars compared to paying for these policies personally. The growth in the cash/investment value inside the policy grows tax free and is not viewed as passive investment income…and upon death of the life insured, both the death benefit and cash/investment value is paid to the corporation tax free. Ultimately, the total proceeds can be paid to the remaining shareholders personally tax efficiently and potentially 100% tax free.