Simple Tax Strategies for Canadian-Controlled Private Corporations
Understanding the ins and outs of taxes may not be everyone’s cup of tea. However, business owners should learn and understand the policies that govern their taxes. Your accountant put all the financial statements together and can help you file taxes, but they might not know some advanced tax strategies to increase your cash flow.
If you want to know more about reducing taxes as well as the best money management strategies, then you’ve come to the right place.
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There are many advantages private Canadian corporations enjoy, especially when it comes to taxes. After all, they do receive the best corporate tax deals. So, let’s dive in.
The first thing you need to do is to choose which type of Canadian corporation you fall under by the end of the tax year in your T2 income tax form. Tick the Canadian-Controlled Private Corporation or CCPC because this category usually receives the best tax deals.
What Is a Canadian-Controlled Private Corporation?
A Canadian-Controlled Private Corporation (CCPC) is a form of a private corporation controlled by Canada. If a corporation is managed either directly or indirectly by non-residents or public corporation qualify as a CCPC.
A small business deduction applies to CCPCs to help reduce their corporate tax income on their business income. The dividends received from CCPCs are eligible to a small business dividend tax credit.
Once the shares of a CCPC are sold, shareholders can now avoid getting capital gains tax by using their Lifetime Capital Gains Exemption (LCGE) which can amount to $800,000. Previously, the government limited the use of the and increased the tax on passive income earned by a CCPC. However, the government abandoned the proposed changes to the LCGE.
Small Business Deduction
As a Canadian-controlled private corporation, you become eligible for small business deduction which you should maximize. Generally, the small business
Here’s a guide on how you can compute your corporate tax deduction.
Corporate Tax Deduction
Formula: Multiply the small business deduction rate (19%*) by:
- Active business income
- Taxable income
- Business limit for the same year
- Reduced business limit for the same year
*as of January 2019.
Canada recently updated their tax rules on the taxation on the investment income of CCPCs which came into effect this 2019.
Understanding Passive Investment Income
What exactly is passive investment income? When Canadian companies invest their cash in passive investments including real estate, bonds, stocks, or mutual funds, they earn a rate on their capital return. Hence, the Canadian government created new rules affecting the income tax.
Old Vs New Rules
Based on the older rules, CCPCs pay a higher rate of investment income tax at 50%. Meanwhile, certain investments have lower rates including capital gains at 25%. To be clear, the tax rates remain the same.
However, the difference is the tax rate which is applied to the corporate profits from daily operations of a CCPC. These profits are reinvested through passive investments.
Meanwhile, the new rules under the investment income of the Canadian corporate taxation highlight that the tax rate on the business income is higher. Why?
The government of Canada passed a law that carries out a higher tax rate on a CCPC’s business income wherein the corporation is earning passive investment income of over $50,000 in the year. CCPCs are penalized for saving cash and investing it through passive investments.
However, they can claim a small business deduction up to $500,000 on business profits reducing the tax rates to 13.5%. For each dollar earned in passive investment income over $50,000, the small business deduction is lowered by $5. When the passive investment income goes up to $150,000, then there is no deduction. The small business deduction specifically applies to the first $500,000 of business income.
Other Tax Advantages
Aside from the small business deduction, here are other advantages CCPCs can enjoy.
- Shareholders are entitled to the exemption of capital gains on qualified small corporate shares.
- CCPCs receive one more month to pay-off their tax balance for the year
- An employee’s taxable benefit is deferred due to the stock options granted by a CCPC.
- CCPCs receive investment tax credits which are refundable for qualified expenses on scientific research.
When it comes to expenses on development and research, CCPCs are entitled to claim research and development credits based on a rate of 35%. This claim can go up to a maximum amount of $3 million. The purpose of this claim is to reduce corporate taxes which is better compared to other corporations which can claim only up to 15%.
Meanwhile, shareholders who are referred to the owners of CCPC are allowed to claim a capital gain exemption of $750,000. Small business income with lower taxes which are distributed to high-income owners as dividends are often taxed less than the salary income.
When you compare the corporate tax advantages of CCPCs to net corporate tax rates, the CCPCs have a lower small business deduction at 11% compared to a net tax rate of 11%. On the other hand, some types of corporations have a 15% net tax rate.
Criteria for Becoming a Canadian-Controlled Private Corporation
- The private corporation is a resident in Canada incorporated from June 18, 1971, up to the end of the tax year.
- The private corporation is not controlled by a resident Canadian corporation whose shares are listed on stock exchange outside Canada.
- The private corporation is not controlled by a non-resident whether directly or indirectly.
- The private corporation is not controlled by a public corporation directly or indirectly apart from a venture capital corporation.
- The private corporation is not controlled either directly or indirectly by a combination of persons mentioned above.
- The private corporation’s shares do not have its capital stock listed in the stock exchange.
- The private corporation’s shares owned by a non-resident, public corporation or a corporation with a class of shares listed in stock exchange are owned by one person.
Corporate Tax Planning
Now that you are familiar with the basic requirements and tax advantages of a Canadian-Controlled Private Corporation, it’s easier to understand and strategize your tax planning. Educating yourself with the various types of corporations and potential tax issues can help you decide your tax strategy. At the end of the day, the Canadian-controlled private corporation has advantages you should take advantage of.
