In 2018, the Federal government introduced limits on passive income for Canadian Controlled Private Corporations. This was an attempt to further limit their utility as a tax-deferral vehicle. Exceeding $50K/yr of passive income causes the small business deduction level for active business income to shrink at a rate of 5:1 and disappear with $150K of passive income.
That effectively bumps the tax rate of small businesses with a combination of higher active and passive income. New Brunswick and Ontario did not mirror this with the provincial portion of the small business tax, creating and intermediate zone that may even lower tax for some. This post describes what counts as passive income for this tax change in English. The Klingon version is in the tax measures document.
How is passive investment income calculated?
This is a key concept since it determines the active business income threshold starting in calendar 2019. Active business income is your income from operations (or clinical practice in the case of doctors). To keep it really simple [sarcasm] passive investment income for this sliding tax scale is going to be called… Adjusted Aggregate Investment Income (AAII).
If you hold multiple related corporations (eg a professional corporation and a holding company), the AAII from all of your companies is pooled do determine if you get SBD shrinkage for your active income.
Does Count as Adjusted Aggregate Investment Income
Interest, Canadian and foreign dividends all count.
This would be at their actual value. Not the gross up – that is for personal taxes.
For foreign dividends, I am not sure how foreign withholding taxes will be accounted for. I suspect that the dividend net of withholding taxes would be used. We do get a full or partial refund of some foreign withholding taxes depending on tax treaties that Canada has with the withholding country. The effect of this is likely small for most people (15% of U.S. dividends and 8-10% for most other developed countries).
The taxable portion (50%) of capital gains from investments count.
It is good that only the taxable portion is counted. That means $100K of realized capital gain would only count as $50K of passive income. However, there was also a nasty little nugget implanted. “Net capital losses from previous taxation years will be excluded“. Previously, if you had realized a loss in a prior year, you could carry that forward and deduct it from a future gain. You can still do that to reduce the tax from the capital gain itself. However, you cannot apply those losses to keep you under the new income threshold.
That is kind of nasty. For example, if you had a $100K realized capital loss a couple of years ago, then the taxable part ($50K) could be applied against the taxable part of a gain in 2019.
Let’s say you realize a $200K capital gain in 2019 which means a $100K taxable gain. You could apply the previous $50K loss to reduce that $100K to $50K to pay tax on, but you would still have $100K of passive income bumping down your permitted active income. That $50K over the passive income limit would reduce your small business threshold to $250K from $500K for 2020.
Does not count as Adjusted Aggregate Investment Income?
Interest from short-term bank deposits that are used for operational purposes do not count.
Realized capital gains from an asset used in the business do not count.
For example, let’s say you own the clinic in which you practice and make money selling it. Doesn’t count for the passive income threshold.
Realized capital gains from donation of appreciated stock to charity do not count.
These donations are excluded from aggregate investment income. Further, they can have the advantage of the whole capital gain being added to your corporation’s capital dividend account instead of just half. The capital dividend account can allow for the election of tax-free capital dividends.
Realized capital gains from selling a share in another CCPC that is connected to your CCPC where all or almost all the assets are from an active business do not count.
What constitutes a related or associated CCPC can be complex, but basically it is when two corps have the same owner(s) or are related to the owner(s) and have to share the small business tax threshold.
“Under the proposal, if a corporation and its associated corporations earn more than $50,000 of passive investment income in a given year, the amount of income eligible for the small business tax rate would be gradually reduced”. This means that if say you have a corp for your active business (OpCo) and one for your investments (HoldCo), that the passive income from both counts towards the thresholds for your OpCo.
May or may not count.
Exempted insurance policies do not count.
Most life insurance with ancillary investment aspects in Canada, like Whole or Universal Life Insurance are structured to be exempt and do not count towards the passive income cap. However, there were law changes in 2016 to make policies used primarily for investment slightly more restricted in the amount of investment component allowed. Manulife has a full summary of exempt insurance policies.
“Income from savings in a life insurance policy that is not an exempt policy will be added, to the extent it is not otherwise included in aggregate investment income.”
This also means that Annuity Payments count & Segregated funds do count.
Rental income, if it is not the active business, does count.
Rental income is considered passive unless rental real estate is the focus of the business. For the CRA, that means it has 5 or more employees to manage the properties. Another way that rental income can be considered active is if the rent covers more than basic services (space & utilities). Additional services that could make it active income would include services like provision of meals, security, and cleaning.
Are Investment Costs Deductible Against Investment Income?
There is nothing that I have found in writing on this. Presumably, the value used for passive investment income will be determined by adding up all of the above included-income. Then, subtracting deductible investment costs to give a net passive investment income.
What is normally deductible?
- Interest on investment loans is deductible.
- Interest, property taxes, maintenance or management costs would be deductible against rental income. Only the net profit from rental income counts as passive income.
- A fee-based or fee-only portfolio manager or investment advisor would be deductible for the portion of the fee applying to your corporate accounts.
- The fees for your taxable personal investment accounts would apply against your personal income (effectively giving you a discount at your highest marginal tax rate).
- Indirect fees, like commissions or management fees buried in ETFs or mutual funds are not deductible.
- Fees for financial planning not related to investment are not deductible.
- Subscriptions to financial newsletters etc are not deductible.
Hopefully, I have helped translate some of the finer details for those who are interested in such.
If you have other information to add or questions, please post in the comments below. I am not an accountant – I am a doctor. However, I will do my best to answer and consult experts when unsure. That said, you will want to work with your tax experts on this. The information may change & I will try to update the post accordingly.