Understanding the Small Business Deduction

By QuickBooks Canada Team

2 min read

The small business tax deduction can lower your business’s tax rate. To qualify for this deduction, your business must be a corporation, and it must meet specific criteria. In most cases, this is the most valuable corporate deduction, and it’s critical to claim it if you qualify.

Qualifying

To qualify for the small business deduction, your business must be a Canadian-controlled private corporation. In other words, it can’t be publicly traded, and it can’t be based in another country. Your corporation must also have less than $10 million in taxable capital employed in the Canada. Corporations with between $10 and $15 million in taxable capital qualify for a partial small business deduction, and businesses over the $15 million limit don’t qualify.

Calculating

As of 2016, the Small Business Deduction is worth 17.5% of your business’s taxable income. If some of your corporation’s income is from active business carried on in other countries, you can only use the taxable income from business in Canada. In addition, there’s also a business limit; if your business’s annual taxable income exceeds the limit, you can only claim the deduction on the portion under the limit. The small business limit is $500,000. To explain how the limit works, imagine your corporation has $600,000 in taxable income. In this case, you can only apply the small business deduction to the first $500,000 of income. You can’t take the remaining $100,000 into account. In this case, your small business deduction would be $87,500.

Purpose

The purpose of this deduction is to lower your effective tax rate. Corporations face a top-line income tax rate of 38%. Most income earned in Canada qualifies for a federal tax abatement, which lowers the effective corporate income tax rate to 28%. If you qualify for the small business deduction, that again lowers your tax rate to 10.5%. To illustrate the effect on your corporate tax liability, imagine your corporation has $100,000 in taxable income. With the corporate tax rate of 38%, your corporation owes $38,000 in tax. When you take the federal tax abatement into account, the lowers the tax liability to $28,000. After the small business deduction, your tax bill is only $10,500. As you can see, that’s significantly lower.

Provincial Rates

In addition to federal tax, most corporations have to pay provincial income tax. Most provincial governments have two rates: a higher rate and a lower rate. If you qualify for the small business deduction, you get to claim the lower rate; if you don’t qualify for the deduction, you face the higher rate. For example, if your corporation is in Nova Scotia and you qualify for the small business deduction, you face a 3% tax rate. In contrast, the higher rate is 16%. Some provinces also set a limit on how much income you can take into account when using the lower rate. In most cases, provinces use the federal rate of $500,000, but some provinces set their own rates. Manitoba only has a higher rate. The small business deduction offers generous tax reductions for small and medium-sized enterprises. If your corporation meets the initial criteria, you should look more closely at this deduction. It can help your business save a lot of money every year.

References & Resources

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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