What happens to investment income earned inside my Ontario corporation?

Investment income — interest, rent, capital gains, and most dividends from unrelated companies — earned inside a private corporation is not active business income and does not benefit from the small business deduction. Instead, it is taxed at a significantly higher combined rate at the corporate level. Part of that higher tax is refundable to the corporation when it later pays taxable dividends to shareholders, a mechanism called the refundable dividend tax on hand system.

The intent is to prevent high-earning individuals from sheltering investment returns inside a corporation at a lower rate and deferring personal tax indefinitely. The rules also reduce the small business deduction limit available to a CCPC in a year when the corporation (or an associated group) earns too much passive income in the prior year.

For corporations accumulating significant investment assets — retained earnings, insurance policies, or a real estate holding — the passive income rules require careful planning. Money that will sit idle inside the company for years should be reviewed with an accountant to understand the effective after-tax return compared with investing personally.