Quebec cuts access to small business tax rate – Will other provinces follow?

In last month’s article, I commented on the prudence of being aware of tax initiatives in other provinces, as one’s own province could choose to adopt or adapt what is going on elsewhere.  That was illustrated at the personal income tax level in the move over the last five years toward higher provincial brackets and 50% combined marginal rates.

Consider now the future of corporate tax –  or more to the point, the small business corporate tax rate.  

While setting forth a plan to reduce general corporate tax rates over the next few years, the 2015 Quebec Budget imposes tighter qualification criteria for its small business deduction.  Could this development, as detailed following, be predicting the direction of tax policy in the coming years?   

Corporate tax rates in Quebec

The current provincial general corporate rate is 11.9%, with a 3.9% small business deduction (SBD) that takes that down to 8%.  In an effort to stimulate economic development, beginning in 2017 the general corporate tax rate will be reduced by 0.1% annually, arriving at 11.5% in 2020.  The small business deduction will move in lockstep, so that it will be 3.5% in 2020, maintaining the small business rate throughout at 8%.

That’s the good news.

However, from 2017 there will be a “refocusing of the small business deduction … on corporations in primary and manufacturing sectors”.  To be entitled to the Quebec SBD, a corporation must be in those mentioned sectors, or employ more than three full-time employees.  Corporations operating at least 25% in primary, manufacturing and processing activities will be entitled to a sliding scale of the SBD, with full entitlement once a 50% proportion is met.  

With respect to professional corporations, it is difficult to envision how they could meet those sector definitions.  Accordingly, their entitlement to the SBD would appear to rest on meeting the employment requirement, which may be impractical or impossible in many cases.

Thus, beginning in 2017 some Quebec corporations will face a general rate provincially and a small business rate federally.  Per the 2015 Federal Budget, the federal SBD is rising by 0.5% each year from 2016 to 2019, bringing its small business rate down from 11% to 9%.  Interestingly, once the dust settles five years out, a corporation losing Quebec SBD eligibility will only see a 1.5% rise.  Assuming no further changes, the potential combined rates are summarized in the table here.  

Federal-Quebec corporate tax rates (%)

                                           2015        2016        2017        2018        2019        2020

General rate,
federal and QC            26.9         26.9         26.8         26.7         26.6         26.5

Federal small rate,
QC general                      n/a          n/a          21.8         21.2         20.6         20.5

Small rate,
federal and QC            19.0        18.5          18.0         17.5         17.0         17.0


Other provinces? 

At 3.9% presently, the disparity from the general to the small business corporate rates is narrow in Quebec compared to all the other provinces.  The other provinces range from a low of 7% in Ontario and Alberta to a high of 13% in Nova Scotia.  If other provinces introduce similar rules in future, the impact in Quebec could look relatively benign in comparison.

Provincial corporate tax rates, 2015 (%)

                     BC        AB        SK        MB        ON        QC        NB        NS        PE        NL

General   11.0      10.0      12.0       12.0       11.5       11.9      12.0       16.0      16.0      14.0

SBD          2.5        3.0        2.0         0.0         4.5         8.0        4.0         3.0        4.5        3.0        

Diff’ce      8.5        7.0      10.0       12.0           7.0         2.9        8.0        13.0       11.5       11.0

Paying small business corporation dividends – Federal budget may be a call to action

One of the surprises in this year’s Federal Budget was the announced increase in the small business deduction for corporations.  Or in more common language, the small business tax rate is coming down.

This will be welcome news to small business owners who will benefit from being able to reinvest more of their after-tax dollars within their corporations.  While this is a win in the context of required reinvestment for business purposes, the effect is not so clear where it is a discretionary decision to forego dividends and invest to earn passive income.

And beyond that, this development could cause a reconsideration of existing investment accounts held at the corporate level.  Continuing to hold these funds in the corporation could result in the shareholder paying up to 2% more if dividends are delayed beyond this year.

Small business tax adjustments

The small business rate on the first $500,000 per year of qualifying active business income of a Canadian-controlled private corporation (CCPC) is going down from 11% to 9%.  The reduction will be implemented in half-percentage point in stages from 2016 to 2019.

In turn, corporate income that has benefited from the small business rate is treated as a non-eligible Canadian dividend when paid out to the shareholder.  To maintain balance for the integration of corporate and personal taxes, the gross-up and dividend tax credit (DTC) for non-eligible dividends will also be adjusted. (See table.)

These are changes at the federal level.  However, as the same gross-up is applied when calculating the shareholder’s provincial tax on the dividend, one would expect provinces to adjust their dividend credit rates accordingly.

Federal small business tax adjustments

                                                      2015        2016        2017        2018        2019

Small business rate              11%      10.5%        10%        9.5%          9%

Gross-up                                 18%         17%        17%         16%        15%

DTC                                            11%      10.5%       10%         9.5%         9%


Implications for dividend policies

In a given year, a shareholder (as director) may declare a dividend out of retained earnings, or continue to retain such funds in the corporation.  All else being equal (so the saying goes), the shareholder portion of income tax is deferred by retaining those funds corporately.  However, all else is not equal as we come into 2016 and roll through the next three years.

Consider a corporation that earns income in the current year, paying the 11% small business rate (focused on federal portion only).  On dividend of those funds in the current year, the DTC will be an equivalent of 11%.  However, if the dividend is delayed one year to 2016, the DTC will be the reduced 10.5%, meaning corporation and shareholder bear an extra 0.5% tax.  And of course that becomes as much as 2% if one delays to 2019.

This adds a wrinkle to the dividend/retention decision this year and in the next three years, though of course it is for the particular business owner to decide whether it is material. An obvious tradeoff arises if current dividends push the shareholder up through marginal tax brackets.

With respect to existing corporate investment accounts, the need for a decision is arguably more pressing.  This is retained money that has already paid its corporate tax, and has essentially been waiting to be subject to personal tax on dividend to shareholder.  As the corporate investments are likely part of eventual retirement, an early withdrawal may be undesirable, even in the face of this additional tax cost.   On the other hand, the reduction of the gross-up from 18% to eventually 15% will mean that later dividends will have less of a clawback effect on income tested benefits.

A thorough review will be necessary to determine the net effect on a given business owner.  And to repeat, it remains that person’s prerogative whether this is sufficiently material to take action.