Earn more than $50,000 of passive investment income in your corporation and the federal small business limit starts to disappear — $5 of limit for every $1 over. At $150,000 of passive income the federal limit is gone entirely. Ontario, usefully, did not adopt the rule.
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From $563.87 taxes included
The measure is adjusted aggregate investment income, or AAII, of the corporation and every corporation it is associated with. Interest, most rents, portfolio dividends and the taxable half of capital gains are in. Income from an active business is out, as are dividends received from connected corporations.
Above $50,000 of AAII, the federal $500,000 business limit falls by $5 for every $1 of excess, reaching zero at $150,000. There is no softening at the top: a corporation with $151,000 of passive income has exactly the same federal limit as one with $1 million of it — none.
The timing catches people out. The grind for a given year runs on the prior year's AAII of the associated group. A large capital gain realized in the corporation this year does not cost you the deduction this year. It costs you next year, by which point most owners have stopped thinking about it.
Ontario has not adopted the passive income grind into its own small business deduction. Neither has New Brunswick. The other provinces and territories generally have.
The practical result is that an Ontario CCPC with heavy investment income can lose the federal small business deduction entirely and still claim the Ontario one on the first $500,000 of active business income. That changes the arithmetic of how hard you should plan around the grind. It is a meaningful hit, not a catastrophic one.
It also means the combined rate you are quoted needs checking. Losing the federal deduction moves the federal component from 9% to 15% while the Ontario component stays where it was. You do not jump straight to the full general rate.
Manage the timing. Because the grind runs on the prior year's income, moving a large gain across a year end can preserve a full limit in the year you most need it. Realizing gains in a year when the corporation has little active business income costs you nothing at all.
Change the asset mix. Corporate-owned permanent life insurance accumulates outside AAII. An individual pension plan moves investment income out of the corporation into a registered structure. Investments producing deferred growth rather than annual interest keep AAII down without changing your risk profile much.
Reconsider where the money sits. Paying more out as salary or dividends moves the investment income to you personally: you pay tax sooner, but the corporation keeps its limit. Moving investments into a separate corporation does not help if the two are associated, which they usually are. Any structure built purely to sidestep the grind should be tested against the general anti-avoidance rule before it is implemented, not after.
The taxable portion does, and on its own it can be enough to wipe out the federal limit for the following year. If the sale is planned, model next year's active business income before you close. Sometimes the answer is to close after year end. Sometimes it is to accept the loss of the federal deduction for a single year and move on.
Dividends received from a connected corporation are generally excluded from AAII, which is what makes the classic operating company and holding company structure workable. Portfolio dividends from public company shares are a different matter and are included in the calculation.
No. It applies across the whole associated group. Splitting investments among several corporations you control does not create several thresholds — the group's AAII is aggregated for the test, which is precisely what the rule was designed to prevent.
Sometimes, but it is rarely free. Extracting the capital triggers personal tax now, which is the deferral you incorporated for in the first place. The right comparison is the cost of the lost federal deduction against the cost of paying personal tax years early — and because Ontario keeps its deduction, that comparison often favours leaving the money where it is.
Open your file tonight — a licensed Ontario lawyer will confirm everything with you by tomorrow.