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How business income is taxed inside a corporation

Understand how active business income is taxed, when reduced rates apply, and how your corporation’s size and structure affect the final tax bill

When a corporation earns money from running a business—whether it’s selling products, providing professional services, or managing contracts—that revenue is classified as active business income (ABI). This income is subject to corporate income tax, but the rate you pay depends on a few key factors, including your company’s structure, revenue size, and province of operation.

Understanding how business income is taxed inside a corporation helps owners make better decisions about paying salaries, reinvesting profits, and drawing dividends.

What Counts as Active Business Income?

Active business income (ABI) includes any income earned from a business that provides goods or services with a reasonable expectation of profit. It typically covers:

  • Professional services (consulting, legal, tech, healthcare)

  • Retail, manufacturing, or wholesale operations

  • Construction, trades, and contracting

  • Independent contractors operating through a corporation

ABI does not include:

  • Passive investment income (e.g., dividends, interest)

  • Rental income (unless from an active real estate business with 6+ employees)

  • Royalties or capital gains (unless generated in the course of active operations)

Important: If your corporation’s primary source of income is passive (such as from investments or rental properties), you won’t qualify for the small business deduction, and a higher tax rate will apply.

How Active Business Income Is Taxed

The CRA applies different tax rates to business income depending on the corporation’s size and control structure. Most small, private corporations qualify for the small business deduction (SBD), which significantly reduces the corporate tax rate on the first portion of business income.

Small Business Deduction (SBD)

If your company is a Canadian-controlled private corporation (CCPC) and earns less than $500,000 in ABI, you may qualify for the SBD. This lowers your federal tax rate from 15% to 9%, plus a reduced provincial rate.

  • Federal rate on first $500,000 of ABI: 9%

  • Combined rate with province: typically 12%–14%, depending on location

  • Income over $500,000: taxed at the general federal rate of 15%, plus provincial

This makes incorporation particularly attractive for entrepreneurs who can leave some profits inside the business and reinvest them.

Tip: Even if your personal tax rate is higher, leaving income in the corporation can result in substantial tax deferral—especially if you don’t need all the earnings right away for personal use.

Corporate Tax Rates on Active Business Income (2024, Approx.)

Income Range Tax Rate (Federal) Tax Rate (Typical Provincial Total) Qualifies for SBD?
First $500,000 (CCPC) 9% ~12% to 14% total Yes
Over $500,000 (CCPC) 15% ~26% to 31% total No (general rate)
Investment income ~38.7% Over 50% combined (includes refundable) Not applicable
 

*Rates vary by province and are approximate for illustrative purposes.

How to Optimize the Tax on Business Income

For business owners, the structure and use of corporate income have long-term implications. Here are some strategies to manage tax effectively:

1. Leave excess profits inside the corporation

  • Pay corporate tax at the small business rate

  • Defer personal tax by postponing dividend payments

  • Reinvest funds into business growth or new ventures

2. Watch the $50,000 passive income threshold

  • If your corporation earns more than $50,000 in passive investment income in a year, your access to the SBD will be reduced

  • Keeping investment income within this threshold helps preserve your small business rate on ABI

3. Use salaries and dividends strategically

  • Paying a salary reduces corporate income and allows the owner to build RRSP contribution room

  • Dividends are taxed personally but are not deductible to the corporation

  • A blended approach often works best depending on your cash needs and long-term goals

Tip: As your corporation grows or earns different types of income, revisit your tax strategy each year. Planning ahead ensures you take full advantage of preferential rates while avoiding traps that limit your access to the small business deduction.