How Are Corporations Taxed in Canada?

Incorporating a business in Canada can provide important advantages—from liability protection to tax deferral opportunities. But it also comes with a separate set of tax rules. A corporation is considered a separate legal entity, and as such, it must file its own tax return and pay tax on its income independently from its shareholders.

Understanding how corporate income is taxed—and how it differs from personal tax—is key to managing your business cash flow and long-term planning.

Corporate Tax Basics

A corporation in Canada is required to file a T2 Corporation Income Tax Return annually. It must report all sources of income, calculate eligible deductions, and pay income tax on its taxable income.

Corporate tax rates vary based on:

The type of income earned (active business, investment, or capital gains)
The size of the corporation (small business vs. large corporation)
Whether the corporation qualifies for the small business deduction (SBD)
The province or territory in which the business operates

Corporations do not have a personal exemption or graduated tax brackets like individuals. Instead, they are subject to flat rates, with certain preferential rates available for eligible small businesses.

Types of Corporate Income

Not all corporate income is taxed the same way. The tax treatment depends on how the income is earned.

1. Active Business Income (ABI)

This is income from regular business operations—such as sales, services, or manufacturing.

If the corporation is a Canadian-controlled private corporation (CCPC) and qualifies for the small business deduction, the first $500,000 of ABI is taxed at a reduced rate (around 9% federally, plus provincial rates)
Income above this threshold is taxed at the general corporate rate, typically 15% federally

2. Investment Income

Interest, dividends, and rental income are taxed at higher rates within a corporation, often exceeding 50%. This is because investment income does not qualify for the small business deduction.

The government applies refundable taxes to discourage passive income accumulation in corporations
A portion of these taxes may be refunded when the corporation pays out dividends to shareholders

3. Capital Gains

Only 50% of a capital gain is taxable inside the corporation, just like with individuals. However, the non-taxable half is added to the Capital Dividend Account (CDA) and can be paid to shareholders tax-free as a capital dividend.

Tip: Managing investment income inside a corporation requires careful planning to avoid triggering higher tax rates or affecting small business deduction eligibility.

Tax Treatment by Income Type in a Corporation

Income Type	Federal Tax Treatment	Key Features
Active business income (under $500,000)	~9% + provincial (SBD applies)	Reduced small business tax rate
Active business income (over $500,000)	~15% + provincial	General corporate rate
Investment income	~38.7% + provincial	Includes refundable portion on eligible dividends
Capital gains	50% taxable; 50% added to CDA	Non-taxable portion can be paid out tax-free

Dividends and Shareholder Taxation

Once the corporation pays tax on its income, it may distribute the after-tax profit to shareholders as dividends. Shareholders then pay personal tax on these dividends, based on whether they are:

Eligible dividends (from income taxed at the general rate)
Non-eligible dividends (from income taxed at the small business rate)

Canada’s system uses gross-up and dividend tax credit mechanisms to reduce double taxation, but shareholders still pay tax on dividend income at their marginal tax rate.

Important: The combined corporate and personal tax paid on income distributed as dividends is designed to approximate the tax that would have been paid had the income been earned personally. However, timing and structure can create opportunities for tax deferral or planning.

Planning Considerations for Corporate Tax

Incorporating your business is not just about tax rates. It’s about managing cash flow, liability, and retained earningsefficiently. Some key strategies include:

Leaving income in the corporation to defer personal tax until needed
Using salary vs. dividends to balance corporate deductions and personal income
Investing excess cash within the corporation through tax-efficient portfolios
Keeping passive investment income below the $50,000 threshold to preserve the small business deduction
Using a holding company to manage retained earnings or isolate business risks