In today's Canadian Taxes A to Z, we finally get to the letter "S". Arguably the most useful of Scrabble letters, and not too shabby from a tax perspective either. S is for Small Business Deduction.
THE SMALL BUSINESS DEDUCTION REDUCES TAXES TO INCREDIBLY LOW RATES
The Small Business Deduction reduces taxes for Canadian Controlled Private Corporations (CCPCs). It unfortunately does nothing for you if you're operating as a sole proprietor or partnership. The reduction is available on the first $500,000 of income. It results in a significant tax reduction off the base corporate tax rate.
This Small Business Deduction is in addition to the already generous Federal Tax Abatement knocked off the base corporate tax rate. What this means is an incredibly low 10% federal tax rate for 2018, plus another few percent provincial tax (in Ontario the rate has dropped to 3.5%). This combined rate can make United States taxes look high by comparison.
WHAT'S THE CATCH TO THE SMALL BUSINESS DEDUCTION?
So what's the catch? First, the corporation must be private (meaning not publicly trading shares) and controlled by Canadian residents. Neither of these are very onerous requirements for incorporated small businesses.
The bigger catch is that you'll get taxed again as an individual when you withdraw income from the corporation, such as being paid as an employee. There are various ways to structure the means through which you pay yourself from the corporation to minimize the taxes paid, but there is always a risk of double taxation: once in the hands of the corporation, and then again when the money passes into your own hands.
Likely the most important factor to keep in mind in considering whether incorporating your business is going to do much for you from a tax perspective is whether you'll be in a position to shelter net income in the corporation, or will need to withdraw all the profits each year for your own living expenses. If you're able to shelter income, then you'll be able to invest those excess profits after losing only 10.5% of them to tax.
So it's kind of like an RRSP, but one where you lose a small amount off the top. Unlike an RRSP, you aren't claiming a deduction for the income you shelter in the corporation, but the effect is the same because you won't personally pay any tax on that income until you take it out of the corporation and place it in your own hands.
While there can be other legal and tax benefits to incorporation, like limiting your personal liability and taking dividends out of the corporation that are taxed at a lower rate than salaries, you should get accounting advice on whether incorporation is really going to save you any money at tax time. It's possible that it might actually cost you money (after increased legal and accounting fees are taken into account).
2016 BUDGET INTRODUCED NEW SMALL BUSINESS ANTI-AVOIDANCE MEASURES
The 2016 Federal Budget introduced a variety of anti-avoidance measures targeting corporate and partnership structures established to take advantage of the Small Business Deduction even though notionally their related incomes supposedly exceed the $500,000 Small Business Deduction threshold. There already were measures in place to address such issues, so it remains unclear how the new measures will affect not only tax planning but legitimate business structures implemented for reasons beyond purely income tax minimization. Read the government's take on the new measures here: Federal 2016 Budget .