New Rules on Passive Income

The new rules for passive income

When business income is distributed as salary (or when an unincorporated business owner earns business income personally), the business owner must pay full personal tax in the year the income is earned.

When business income is distributed as dividends, the corporate tax on the business income is lower than the personal tax rate on salary, and personal tax on the dividend is only payable when the dividend is paid.

If dividend payments are deferred to a future year, additional funds are available to invest in the corporation in the interim, which may yield more investment income over time compared to a business owner who invests after-tax salary personally.

The government thought that this provided an unfair benefit for owners of CCPCs who chose to defer personal taxes by delaying the payment of dividends and build up significant funds in their corporations. With particularly low SBD Rates, the potential benefit from the large tax deferral with SBD Income (Figure 1) was of most concern.

The tax rules regarding availability of the SBD now, therefore, limit the potential future benefits from the tax deferral on SBD Income by reducing the SBD Limit when a corporation has significant passive income6 in the previous year. Effective from 2019, the federal $500,000 SBD Limit is reduced for CCPCs based on levels of passive income in the previous year.

The SBD Limit is reduced by $5 for each $1 of passive income that exceeds $50,000 and reaches zero once $150,000 of passive income is earned in a year. Additional information regarding passive income and the reduction to the SBD Limit is available in our report, The CCPC tax rules.

In practical terms, this means that if your corporation has at least $50,000 of passive income in 2021, then in 2022 some (or all) of the income that would have qualified as SBD Income will be taxed as General Income.

Just as associated corporations share the SBD Limit, passive income is combined for associated corporations and the $50,000 threshold is shared between them.

You may be surprised to find that another corporation with only a somewhat remote connection may be associated with your corporation. For instance, for the purpose of the new rules you are deemed to personally own shares held by a trust in which you or your minor child is a beneficiary, so your corporation could be associated with another corporation where the only connection is shares held by a family trust.