Active Business Income vs. Passive Income for a Canadian Corporation: What Small-Business Owners Need to Know

If you own a Canadian corporation, the Canada Revenue Agency (CRA) does not tax every dollar the same way. Whether income is active business income (ABI) or passive income affects your corporate tax rate, your access to the small business deduction (SBD), and how you plan your salary and dividends. This article is written for owners of Canadian-controlled private corporations (CCPCs) and explains the difference in plain language.

Disclaimer: This article is general information only. It is not tax, legal, or accounting advice. Confirm current requirements with the CRA or a qualified Canadian accountant or tax professional before acting.

Assumptions and Scope

• The corporation is a CCPC resident in Canada. Different rules apply to public corporations and non-resident-controlled corporations.
• Rates are described at a high level. Federal rates are set by the Income Tax Act and administered by the CRA. Provincial and territorial rates, limits, and credits vary and are added on top.
• Every rate, threshold, and deadline below must be verified against current CRA guidance and your province or territory before you rely on it.

Understanding Income Types According to the CRA

Active Business Income (ABI)

ABI is income earned from a business your corporation carries on, such as selling products, manufacturing, construction, or providing services. Examples include a retail shop’s sales, a machine shop’s fabrication revenue, or a consulting firm’s fees.

For a CCPC, the first dollars of ABI may qualify for the small business deduction, which sharply lowers the federal rate. The federal small business rate has been 9% in recent years, and the general federal rate on other ABI has been 15%. Verify both against the CRA’s current corporation tax rates page. Provincial tax is added, and provincial small business rates differ across the country.

Passive Income

Passive income comes from property rather than from active business operations. Common types include:

• Interest from savings, GICs, or bonds
• Rental income, in most cases
• Royalties, in many cases
• Dividends from portfolio investments
• Taxable capital gains on investments

Some details matter. Rental income can be treated as active business income if the corporation has more than five full-time employees in the rental business. Dividends from connected corporations may be deductible. The CRA’s term for most investment income of a CCPC is aggregate investment income (AII).

How Passive Income Is Taxed

Investment income earned by a CCPC is taxed at a much higher initial rate than income eligible for the SBD. The federal rate on this income has been about 38.67%, before provincial tax. Verify the current rate with the CRA.

Part of that tax is refundable. It is added to a notional account called refundable dividend tax on hand (RDTOH). When your corporation pays taxable dividends to shareholders, it can recover a portion of that tax, generally $1 for every $3 of taxable dividends paid, subject to your RDTOH balance. Since 2019, RDTOH is tracked in eligible and non-eligible pools. Confirm how this works with your accountant.

For capital gains, only the taxable portion (currently one-half, verify current inclusion rate) is treated as investment income. The non-taxable half may be added to the capital dividend account (CDA) and paid to shareholders tax-free under specific election rules.

Tax Implications for Canadian Corporations

The Small Business Deduction (SBD)

The SBD reduces federal corporate tax on up to the business limit of qualifying ABI. The federal business limit has been $500,000. Verify the current limit. To qualify, the corporation generally must be a CCPC, and the income must be from an active business carried on in Canada. The following do not qualify:

• Investment income
• Income

  Disclaimer: The content on this website is AI-generated for informational and educational purposes only. It does not constitute certified financial, tax, or legal advice. Because accounting standards and local tax codes vary frequently, readers should consult a qualified accountant or certified professional before making any financial decisions based on this material.