Now that your business is going gangbusters, let’s take a look at your corporate investments. I’m talking about your active business income that has not been paid out in taxes or distributed to shareholders. Since that amount can be significant ($85,000 for every $100,000 of active business income in Ontario), it may not take long before you’ve accumulated significant chunks of change in your corporate account. Let’s put that lazy money to work!
As a responsible steward of your corporate investments, you probably won’t want to get too wild and crazy. So let’s say you invest your corporate cash in a sturdy Canadian bond ETF, and after a year you’ve already received $10,000 of Canadian interest income.
Now what? No big surprise: You’ll pay taxes on this passive income by declaring it on your corporate tax return. How does that work?
There are a number of similarities – as well as some notable differences – between how your corporation’s active business income and passive income are taxed. In the example below, I’ve illustrated the tax impact of $10,000 of Canadian interest income earned within a corporation. This aggregate investment income can be found on Schedule 7 of the corporate tax return.
Source: Corporate Taxprep – Schedule 7 (2016)
A work of ART
For starters, your corporation is taxed the same basic federal rate of 38%, whether it’s on your active business income or on passive Canadian interest income. In our example, $10,000 × 38% = $3,800.
But unlike for the active business income, your corporation also pays an additional refundable tax on investment income (ART) of 10 2⁄3% (or 10.67%) on the Canadian interest income. In our example, that’s an additional $10,000 × 10.67% = $1,067.
Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)
As with active business income, the federal tax abatement reduces the basic federal tax rate by 10%, which is intended to approximately offset the taxes levied by the province. In our example, that’s $10,000 × 10% = $1,000.
If we take the basic federal taxes of 38%, include the additional refundable tax of 10.67%, and deduct the federal tax abatement of 10%, we end up with federal Part I tax payable of 38.67%, or $3,867 in our example.
Of the 38.67% of federal Part I tax payable, 8% is considered non-refundable, while 30.67% is refundable when taxable dividends are paid to shareholders. (More on that in my next blog post.)
Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)
Size doesn’t matter
You may have noticed there’s no small business deduction in the tax calculations above. That’s because our federal government wants to encourage small business owners to invest mostly in their active businesses instead of in passive ETF portfolios.
The provincial and territorial governments feel the same way, and offer no deduction for small business owners’ passive investments. Ontario levies the full tax rate of 11.5% on Canadian interest income, instead of the reduced 4.5% rate eligible small businesses incur on their active business income. This full pop amounts to $10,000 × 11.5% = $1,150 in our example.
Once we total the federal and provincial taxes, we end up with total taxes payable of 50.17%, or $5,017 in our example.
Source: Corporate Taxprep – T2 Corporation Income Tax Return (2016)
The taxes on corporate investments are significant, but your company is still left with an extra $4,983 it wouldn’t otherwise have if the cash were left to languish. I’ve included a summary of the results in the chart below.
Next up, you may now be wondering how you get back those refundable taxes. Great question. We’ll look at that in my next blog post which will discuss the dividend refund.
Corporate Taxes on Canadian Interest Income
| General Formula |
Amount |
Calculation |
| Base amount of Part I tax |
$3,800 |
$10,000 × 38% |
Deduct:
Federal tax abatement |
($1,000) |
$10,000 × 10% |
Add:
Additional refundable tax on investment income (ART) |
$1,067 |
$10,000 × 10.67% |
Equals:
Part I tax payable |
$3,867 |
$3,800 – $1,000 + $1,067 |
Add:
Provincial or territorial tax |
$1,150 |
$10,000 × 11.5% (Ontario) |
Equals:
Total tax payable |
$5,017 |
$3,867 + $1,150 |
Equals:
After-tax corporate income |
$4,983 |
$10,000 – $5,017 |