The Small Business Deduction (SBD) in Canada: How It Works and Who Qualifies

The small business deduction is one of the most significant tax advantages available to Canadian-controlled private corporations (CCPCs). It reduces the federal corporate tax rate from 15% down to 9% on the first $500,000 of active business income. Combined with provincial small business rates, this can bring the total corporate tax rate to as low as roughly 11% depending on where you operate.

Here is how the SBD works, who qualifies, and what can reduce or eliminate it.

What Is the Small Business Deduction?

The small business deduction (SBD) is a tax reduction under Section 125 of the Income Tax Act that applies to the active business income of Canadian-controlled private corporations. It is not a deduction from income but rather a reduction in the federal tax rate.

Without the SBD, a CCPC pays the general federal corporate tax rate of 15% (after the general rate reduction). With the SBD, the rate on qualifying income drops to 9%, saving the corporation 6 cents on every dollar of eligible income.

Who Qualifies?

To claim the SBD, a corporation must meet all of the following:

• It must be a Canadian-controlled private corporation (CCPC) throughout the tax year
• The income must be active business income earned in Canada
• The corporation must file its tax return and calculate the deduction on Schedule 7

A CCPC is a private corporation that is not controlled by non-residents, public corporations, or any combination of the two. If your corporation is owned entirely by Canadian residents and is not listed on a stock exchange, it almost certainly qualifies as a CCPC.

The $500,000 Business Limit

The SBD applies to the first $500,000 of active business income per year. Income above this threshold is taxed at the general federal rate of 15%.

This $500,000 is called the "business limit." It is not per shareholder or per business activity. It is a single limit for the corporation.

Associated Corporations Must Share

If two or more corporations are associated under the Income Tax Act, they must share the $500,000 business limit among them. The allocation is reported on Schedule 23 (Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Business Limit).

Corporations are generally associated if:

• The same person or group controls both corporations
• A person who controls one corporation is related to a person who controls the other, and either person owns at least 25% of the shares of the other corporation
• Cross-ownership thresholds are met between the corporations

This rule prevents business owners from splitting income across multiple corporations to multiply the $500,000 limit.

Example: Two Associated Corporations

Sarah owns 100% of Corporation A and 100% of Corporation B. The two corporations are associated and must share one $500,000 limit. If they allocate $300,000 to Corporation A and $200,000 to Corporation B, each corporation applies the SBD only up to its allocated amount.

Corporation	Active Business Income	Allocated Limit	Income at SBD Rate (9%)	Income at General Rate (15%)
Corp A	$400,000	$300,000	$300,000	$100,000
Corp B	$150,000	$200,000	$150,000	$0

The Passive Income Grind

Starting in 2019, the federal government introduced a rule that grinds down the $500,000 business limit when a CCPC and its associated corporations earn more than $50,000 in adjusted aggregate investment income (AAII) in the previous tax year.

How the Grind Works

For every $1 of AAII above $50,000, the business limit is reduced by $5. This means the business limit reaches zero once AAII hits $150,000.

AAII in Previous Year	Business Limit Reduction	Remaining Business Limit
$50,000 or less	$0	$500,000
$75,000	$125,000	$375,000
$100,000	$250,000	$250,000
$125,000	$375,000	$125,000
$150,000 or more	$500,000	$0

What Counts as Adusted Aggregate Investment Income?

AAII generally includes:

• Interest income from investments
• Rental income (net of expenses)
• Taxable capital gains (net of allowable capital losses)
• Income from property not connected to active business operations
• Foreign investment income

It does not include dividends from connected Canadian corporations, which are generally deducted in computing AAII.

This rule is designed to discourage CCPCs from accumulating large passive investment portfolios while benefiting from the small business rate on active income.

The Taxable Capital Grind

There is a second grind based on the taxable capital employed in Canada by the corporation and its associated corporations. If the group's combined taxable capital exceeds $10 million, the business limit begins to decrease. It reaches zero at $15 million in taxable capital.

This grind primarily affects larger corporations. Most small businesses and freelancer-owned corporations are well below these thresholds.

Provincial Small Business Rates

Each province and territory applies its own small business tax rate on top of the federal rate. The combined rate (federal SBD rate plus provincial small business rate) is what your corporation actually pays on qualifying income.

Here are the provincial and territorial small business rates as of 2025:

Province / Territory	Provincial SBD Rate	Combined Rate (Federal + Provincial)
Alberta	2.0%	11.0%
British Columbia	2.0%	11.0%
Saskatchewan	1.0%	10.0%
Manitoba	0.0%	9.0%
Ontario	3.2%	12.2%
Quebec	3.2%	12.2%
New Brunswick	2.5%	11.5%
Nova Scotia	2.5%	11.5%
Prince Edward Island	1.0%	10.0%
Newfoundland and Labrador	3.0%	12.0%
Northwest Territories	2.0%	11.0%
Nunavut	3.0%	12.0%
Yukon	0.0%	9.0%

Note that provincial business limits and eligibility rules may differ from the federal rules. Some provinces have their own passive income or capital thresholds that affect the provincial SBD.

How the Deduction Is Calculated on Schedule 7

The SBD is calculated on Schedule 7 of the T2 corporate tax return. The calculation determines the least of three amounts:

1. The income amount - the corporation's active business income for the year earned in Canada (net of losses)
2. The business limit - $500,000 (or the allocated share if associated), reduced by any passive income or taxable capital grinds
3. The taxable income amount - the corporation's taxable income for the year, reduced by certain amounts like foreign income eligible for a foreign tax credit

The SBD equals the smallest of these three amounts multiplied by the SBD rate reduction percentage. The result is a direct reduction in federal tax payable.

Active Business Income vs Investment Income

The distinction between active business income and investment income is critical because the SBD only applies to active business income.

Active business income includes income from a business carried on by the corporation, including the provision of services. If your incorporated consulting firm bills clients $400,000 in a year, that is active business income.

Investment income includes interest, rents (in most cases), royalties, and capital gains from property that is not used in an active business. This income is taxed at higher rates and can trigger the passive income grind.

There are exceptions. Rental income can be considered active business income if the corporation employs more than five full-time employees in the rental business. Income from an associated corporation can also have special treatment.

Planning Considerations

Avoid exceeding the $50,000 AAII threshold unnecessarily. If your corporation holds investments, be aware that crossing this line erodes your SBD. Some business owners choose to pay out investment income as dividends or salary rather than retaining it in the corporation.

Review associated corporation allocations annually. If your group's income mix changes from year to year, the optimal allocation of the $500,000 business limit may shift.

Track your taxable capital. While most small businesses are not near the $10 million threshold, growth through retained earnings and asset accumulation can push you closer over time.

Consider incorporation timing. If you are a sole proprietor earning well above your personal spending needs, the SBD is one of the key reasons incorporation can provide a tax deferral advantage. But the benefit depends on your full tax picture, including how and when you extract funds from the corporation.

Sources

1. Income Tax Act, Section 125 - Small Business Deduction
2. CRA Corporation Tax Rates
3. CRA Schedule 7 - Aggregate Investment Income and Income Eligible for the Small Business Deduction
4. CRA Guide T4012 - T2 Corporation Income Tax Guide
5. CRA Associated Corporations