Passive income is investment income earned inside a corporation, interest, rental income, and taxable capital gains, that does not qualify for the Small Business Deduction and is taxed at a high investment income rate.
The CRA taxes passive income inside a private corporation at a high rate, approximately 50 percent in most provinces, with a portion refundable when taxable dividends are paid to shareholders. The intent is to remove the tax advantage of earning investment income inside a corporation compared to earning it personally.
The planning consequence that catches most owners off guard is the passive income threshold: when passive income inside the corporation exceeds $50,000 annually, the Small Business Deduction begins to erode at a rate of $5 for every $1 of passive income above the threshold. At $150,000 of passive income, the SBD is eliminated entirely. For growing businesses accumulating retained earnings inside the corporation, monitoring passive income levels is an annual discipline with a direct impact on the corporate tax rate.
See also: Active Business Income · Small Business Deduction (SBD) · HoldCo vs OpCoPassive income accumulating inside an operating company is a tax efficiency issue a HoldCo structure can address. See how Wefinx approaches tax planning.