Getting the most from a small business tax break

This column fleshes out the technical definition of a Canadian Controlled Private Corporation (CCPC) and in particular its tax advantages.

My last few columns on small business have struck a chord with readers. This column fleshes out the technical definition of a Canadian Controlled Private Corporation (CCPC) and in particular its tax advantages.

If a corporation meets all of the following criteria, then it qualifies by Canada Revenue Agency (CRA) as a CCPC.  The corporation must be resident in Canada and not controlled, directly or indirectly, by a non-resident, a publicly traded company or a Canadian company that lists its shares on a foreign exchange.  And it must not have any class of its own shares traded on any stock exchange.

Lastly, and often misunderstood, the corporation cannot fall within the definition of a Personal Services Business (PSB).  That is, a business supplying a service to a third party where, but not for the corporation itself, the person would be considered an employee of that third party (more on the CRA’s PSB rules in a future column).

As a qualified CCPC, CRA allows a small business deduction applicable to the first $500,000 of gross active income – “active” meaning revenues generated by conducting business activities, not rental or investment income the business may be paid or earn.  This deduction comes in the form of a lower tax rate.

Rather than the normal 26.5 per cent corporate rate for BC, for a CCPC’s first 500k of active income the combined federal and BC corporate rate is 13.5 per cent for 2011, second only to PEI with its 12 per cent for the lowest rate across Canada.

However, when considering the tax rate above 500k, BC’s 26.5 per cent compares attractively to PEI’s 32.5 per cent.

And, according to BC’s 2011 budget, as of April 2012, the rate drops to 11 per cent giving BC the number-one small business tax regime in Canada. That’s good for BC small business owners, and this is good for investment in BC, but I digress.

Not to miss the point here, without this small business tax break, a small business owner would have to remit 26.5 per cent tax on the net profits of the company.

Instead, that amount is basically cut in half with the CCPC small business deduction – a bottom line difference often yielding the opportunity for expanding the business, and other times simply making the distinction between survival and closure.

Relating this to the choice of business ownership, this CCPC tax advantage is particularly poignant when one considers an unincorporated business and the personal tax rate of up to 43.7 per cent in BC on a proprietor’s net earnings. Remember though, if all the “profits” have to be paid out to the business owner to meet personal living obligations, then the CCPC tax rate is moot.  The owner will be paying under the personal tax regime and not be able to take advantage of the 13.5 per cent CCPC rate.

Ignoring this hand-to-mouth profitability scenario that is all too often true, when a small business is profitable, there are longer term tax advantages for a CCPC.  A CCPC can pay dividends to the owner which is more favourably taxed than wages paid to the owner.

In addition, dividends can be paid to other shareholders including family, although CRA watches carefully for the proper use (read:  abuse) of this method of sharing profits among next of kin.

Finally, the sale of CCPC shares qualifies under the lifetime capital gains exemption so when the CCPC owner sells, his or her blood, sweat and tears put into the business for years is paid to him or her in  non-taxable funds.  But not all 10 million of that capital gain! … only the first $750,000.

Ron Clarke has his MBA and is a business owner in Trail, providing accounting and tax services. Email him at ron.clarke@JBSbiz.ca. To read previous Tax Tips & Pits columns visit www.JBSbiz.net.