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How investment income is taxed in a corporation

Understand how interest, dividends, and capital gains are taxed differently inside a corporation, and how to manage passive income effectively

While corporations can hold investments just like individuals, the tax treatment of investment income inside a corporation is more complex and generally less favourable. Investment income is considered passive, not active business income, which means it is taxed at higher rates and can affect your corporation’s eligibility for the small business deduction (SBD).

If your incorporated business earns more than just active business income—such as interest from savings, dividends from stocks, or gains from selling investments—it's essential to understand the tax rules that apply.

What Counts as Investment Income in a Corporation?

Investment income includes earnings from property that is not used in an active business. Common sources include:

  • Interest income from savings, bonds, or loans

  • Dividends from Canadian or foreign corporations

  • Rental income from real estate (unless it meets active business criteria)

  • Capital gains from selling investments such as stocks or real estate

These types of income are treated differently from active business income, and are not eligible for the small business deduction.

How Investment Income Is Taxed Inside a Corporation

Passive income is subject to high tax rates at the corporate level, especially when it comes from interest or foreign dividends. The CRA discourages corporations from accumulating too much passive income, and uses a combination of non-refundable and refundable taxes to recover tax when income is eventually paid out.

Interest and Foreign Dividends

  • Taxed at over 50% combined (federal + provincial)

  • A portion of the tax is refundable when dividends are paid to shareholders

  • The rest is permanent corporate tax

Capital Gains

  • Only 50% of a capital gain is taxable

  • The non-taxable half goes into the Capital Dividend Account (CDA), which can be distributed tax-free to shareholders

  • The taxable half is subject to the investment income tax rules

Canadian Dividends

  • Eligible for refundable dividend tax on hand (RDTOH)

  • A portion of the corporate tax is refunded when the corporation pays taxable dividends

Tax Treatment of Investment Income in a Corporation

Income Type Tax Rate (Approx.) Refundable Portion? Key Considerations
Interest income ~50%+ Yes (when dividends paid) High upfront tax, but partially refunded later
Foreign dividends ~50%+ Yes (partial) Not eligible for dividend tax credit
Canadian dividends ~38.33% Yes (via RDTOH) Refundable when dividends are paid to owners
Capital gains 50% of gain taxed Yes (partial via CDA + RDTOH) Half non-taxable, can be paid tax-free via CDA
Rental income (passive) ~50%+ Yes (if passive) Active rental businesses with 6+ employees may qualify as active income
 

Impact on the Small Business Deduction (SBD)

One of the most important rules to watch is the passive income threshold. If your corporation earns more than $50,000 in investment income in a year, your access to the small business deduction on active business income starts to decline.

  • For every $1 above $50,000 in passive income, your $500,000 small business limit is reduced by $5

  • At $150,000 of investment income, your access to the SBD is completely eliminated

This creates a powerful incentive to manage passive income exposure carefully within a CCPC.

Tip: If your corporation is holding significant investments, consider using a holding company to separate active business income from passive investments and preserve your small business deduction in the operating company.

Managing Investment Income Strategically

While the tax rates on passive income are high, corporations can still use investment accounts effectively with good planning. Here are a few ways to manage it:

  • Use the Capital Dividend Account (CDA): Distribute the non-taxable portion of capital gains tax-free to shareholders

  • Track your RDTOH balance: Refundable taxes can be recovered when dividends are paid

  • Limit passive income to under $50,000/year: Helps preserve the SBD in your active business

  • Structure excess profits through a holding company: Allows investment activity without harming the operating company’s tax position

  • Reinvest dividends and capital gains efficiently: Use low-turnover, tax-efficient portfolios to reduce annual income realization

Tip: If your corporate portfolio is growing or you hold cash beyond operating needs, review your investment strategy each year to ensure it doesn’t unintentionally impact your business tax rates.