Passive Income and the Small Business Deduction

In short

Investment income inside a corporation is taxed at about 50% up front. Part of that is refunded when the corporation pays you taxable dividends.
Once passive income passes $50,000 in a year, the corporation starts losing access to the small business tax rate on its active income.
The rule is federal. Ontario did not adopt it, so the cost there is smaller than headlines suggest.

How investment income is taxed in a corporation

Interest, rent, royalties and the taxable half of capital gains are taxed at roughly 50% when a Canadian-controlled private corporation earns them. The rate is high on purpose, so that holding investments in a company doesn't beat holding them personally.

Part of that tax is refundable. It goes into a notional account, and the corporation gets some of it back when it pays you taxable dividends. If the money stays in the corporation, the refund waits.

The $50,000 line

The small business deduction gives a low tax rate on the first $500,000 of active business income. Since 2019 that $500,000 limit shrinks when the corporation and its associated corporations earn too much passive income:

The limit is reduced by $5 for every $1 of passive income over $50,000 in the prior year.
At $150,000 of passive income the federal limit is gone.
Only the taxable half of a capital gain counts, and only gains on investments. Selling an asset used in the business doesn't count.

A simple example

Step	Amount
Passive income last year	$80,000
Amount over $50,000	$30,000
Business limit lost ($5 for each $1)	$150,000
Remaining federal business limit	$350,000

If the corporation earns $500,000 of active income, $150,000 of it is now taxed at the general federal rate of 15% in place of the 9% small business rate. That is about $9,000 of extra federal tax for the year.

If the corporation earns only $300,000 of active income, the reduced limit still covers all of it and the grind costs nothing.

Ontario is different

Ontario and New Brunswick did not adopt the passive income rule for their provincial small business rates. An Ontario corporation that loses federal access keeps its provincial small business rate. Alberta and British Columbia follow the federal rule.

What doesn't count

Growth inside an exempt life insurance policy isn't passive income for this test. That's one reason some owners move part of their fixed-income holdings into corporate-owned life insurance. Contributions to an Individual Pension Plan also move money out of the corporation's taxable portfolio.

Should I just stop investing inside my corporation?

Usually not. Paying the money out to invest personally means paying personal tax first, which often costs more than the grind. The useful questions are how close you are to $50,000, whether your active income is high enough for the grind to bite, and which holdings are producing the passive income. Sometimes the answer is to change what the corporation holds, not to stop investing.

Who it fits, and who it doesn't

A reasonable fit if

Your corporation holds a sizeable investment portfolio and earns active income near or above $500,000
Passive income is approaching or already past $50,000 a year
You hold a lot of interest-bearing investments, which produce the most passive income per dollar

Probably not for you if

Your passive income is well under $50,000
Your active income is low enough that the reduced limit still covers it
You're in Ontario and the federal-only cost is small next to the cost of restructuring

Run your own numbers

Corporate Tax Leak Calculator. See what passive income is costing your corporation each year, including the small business deduction grind.

Open the calculator

Questions to ask your accountant

What was our adjusted aggregate investment income last year, across all associated corporations?
How much of our business limit did we actually use?
What would the grind cost us this year in dollars, federally and provincially?
Which holdings produce the most passive income for the least return?

Related guides

Figures are current as of 2026 and are general information, not tax, legal or investment advice. Rules and rates change, and how they apply depends on your facts. Confirm anything here with your accountant before acting. Dundas Wealth is an insurance brokerage (Dundas Life Inc., FSRA #37628M). We are paid by the insurance carrier if and when a policy is placed.