The Small Business Deduction can cut your corporate tax rate on active business income. But the $500,000 limit can shrink fast if you have associated companies, passive investment income, or high taxable capital.
The Small Business Deduction (SBD) is a tax break for certain Canadian private corporations.
If your corporation qualifies, it can pay a lower corporate tax rate on some of its active business income earned in Canada.
For many owner managed companies, this is the difference between a “small business” corporate tax rate and the higher general corporate tax rate.
In most cases, the SBD is for a Canadian-controlled private corporation (CCPC) that earns active business income in Canada.
A CCPC is a private corporation that is resident in Canada and is not controlled by non-residents or public corporations, with other detailed tests.
The SBD does not apply to unlimited income.
For 2025/2026, the federal business limit is $500,000 of qualifying active business income (ABI), before any reductions.
If your tax year is shorter than 51 weeks, the $500,000 is prorated based on days in the year.
Also, if you have associated corporations, they generally share a single $500,000 limit across the group.
If you are in Ontario, the basic provincial corporate rate is 11.5%.
Ontario’s small business deduction can reduce that to 3.2% on eligible Ontario small business income.
Federally, the SBD rate produces a 9% federal rate on income eligible for the SBD.
The general federal corporate rate is 15%.
Simple Ontario rate snapshot (2025)
(Actual rates can vary by province and facts. This is just the common Ontario comparison.)
The point is not the exact decimal. The point is the SBD is valuable. Losing it is expensive.
CRA’s plain-English starting point is this:
Active business income is generally income earned from a business source, including income incidental to that business.
So, a typical operating company selling products or services usually earns ABI.
Some types of corporate income are generally not ABI for SBD purposes.
A specified investment business is a business whose principal purpose is earning income from property, like interest, dividends, rents, or royalties.
That income is generally not eligible for the SBD.
There is an important exception. If you employ more than five full-time employees in that business, or you meet certain associated-corporation service conditions, it may be treated as active business income.
A personal services business is basically “incorporated employee” income in many cases.
CRA’s guidance says PSB income is not eligible for the SBD and is also not eligible for the general rate reduction, and it can face an additional 5% federal tax.
If you have a one-person corporation providing services mainly to one client, you need to pay attention here.
Most owners know about the $500,000 business limit.
Fewer owners understand how easily it can shrink.
There are three common reducers:
If your CCPC is associated with other CCPCs, the group generally shares one combined $500,000 business limit.
Plain example.
Opco earns $400,000 of ABI. Holdco earns $300,000 of ABI (or another opco in the group earns it). Total ABI is $700,000.
The group does not get $500,000 each. They share $500,000 total and must allocate it between them.
If you do not allocate properly, you can create filing problems and unexpected tax.
This is the one that surprises owners who invest inside the corporation.
Your business limit is reduced when the group’s adjusted aggregate investment income (AAII) is between $50,000 and $150,000. Once it is over $150,000, the business limit can be nil.
AAII is measured based on the corporation and associated corporations. It is also based on the preceding calendar year in the CRA explanation of the rules.
How the math works (practical version)
If your business limit is the standard $500,000, the business limit is reduced by $5 for every $1 of AAII above $50,000.
That means:
This rule alone can double your corporate tax rate on a big chunk of income.
If the combined taxable capital employed in Canada of the CCPC and associated corporations is between $10 million and $15 million, the business limit is reduced on a straight-line basis.
At $15 million or more, the limit can be eliminated.
This matters for larger private groups, or groups that have grown and kept assets on corporate balance sheets.
If you have both taxable capital grind and passive income grind, the reduction is generally the greater of the two reductions.
So you do not “average out” to something nicer.
If your corporate tax year is shorter than 51 weeks, the $500,000 limit is prorated based on days in the year.
This comes up when you incorporate mid-year, change a year-end, or wind down.
Use this as your practical next step list.
It is a deduction that reduces corporate tax for a CCPC on qualifying active business income earned in Canada.
Federally, up to the business limit. For many CCPCs that starts at $500,000, before reductions.
Often no. If corporations are associated, they generally share one $500,000 limit across the group.
CRA describes it as income earned from a business source, including income incidental to that business.
Often it is treated as income from property and can be a “specified investment business” unless the facts meet the employee or service exceptions. You need to test it.
AAII is “adjusted aggregate investment income.” It is used to grind down the business limit when passive investment income is high.
The grind starts when combined AAII is between $50,000 and $150,000. The limit can become nil once AAII is more than $150,000.
If you have the standard $500,000 business limit, it generally shrinks by $5 for every $1 of AAII above $50,000, until it reaches $0 at $150,000.
If combined taxable capital employed in Canada is between $10 million and $15 million, your business limit is reduced on a straight-line basis.
The reduction is generally the greater of the two reductions.
Generally no. CRA states PSB income is not eligible for the SBD and faces different tax treatment.
Ontario’s small business deduction can reduce Ontario basic income tax to a 3.2% rate on eligible small business income.
The Small Business Deduction is simple in theory. In practice, it is easy to lose. Associated companies, passive investment income, and balance sheet growth can quietly push your corporate tax rate much higher than expected. If you are incorporated and earning real profits, you should know exactly how much of your income qualifies and how close you are to the grind rules.
If you want clarity on your SBD position and a plan to manage it properly, reach out to Coral CPA. We help Canadian business owners understand their corporate tax rate, model the impact of growth and investments, and plan ahead...before CRA makes that decision for you.
