Small Business Deduction: Qualifying for the Low Corporate Tax Rate on Active Business Income — CPA Firm Near You, Montreal

Introduction

One of the biggest tax advantages for Quebec corporations is the Small Business Deduction (SBD), which reduces the corporate tax rate on the first $500,000 of active business income. But the rules for qualifying are strict, and many corporations lose access without realizing it — either through passive investment income, ineligible revenue, or improper corporate structures. Losing the SBD can cost a business thousands of dollars annually. This guide explains how to qualify for the SBD and how a CPA near you in Montreal can help you maintain eligibility.

Legal and Regulatory Framework

Under the Income Tax Act and the Quebec Taxation Act, Canadian-controlled private corporations (CCPCs) may claim the SBD on qualifying active business income up to the federal and provincial limits. To qualify, the corporation must: be a CCPC throughout the year; earn active business income (not investment income); maintain payroll levels required for Quebec’s SBD rules; avoid excessive passive income that erodes the SBD; avoid being classified as a corporation providing “specified investment business” or “personal services business.” Quebec’s SBD rules require a minimum amount of wages paid during the year or specific exceptions for manufacturing and primary sectors.

Key Court Decisions

Courts have ruled that improperly characterizing income can result in losing the SBD. Judges confirmed that businesses must show evidence of active operations, employees, and commercial intent. In several cases, corporations providing services to one client were reclassified as Personal Services Businesses (PSBs), losing access to the SBD and facing punitive tax treatment. Courts also upheld CRA decisions denying SBD to corporations with insufficient payroll or with income predominantly from passive investments.

Why CRA and Revenu Québec Scrutinize SBD Claims

The SBD significantly reduces tax, making it a high-risk audit area. CRA and RQ examine: whether income is active or passive; whether payroll levels meet Quebec’s thresholds; whether corporations are service companies reliant on one client; whether the corporation is a PSB; whether passive income in a holding company or Opco-Holdco structure exceeds $50,000; whether management fees between related corporations reflect real activity. Inconsistencies trigger audits and reassessments.

What Qualifies as Active Business Income

Operating revenue

Income from selling goods, providing services, and ongoing commercial activity.

Not investment income

Interest, dividends, rental income, or capital gains generally do not qualify unless exceptions apply.

Manufacturing and industrial activity

Often eligible even with lower payroll requirements.

Multi-entity structures

Intercompany fees must reflect real business activity.

Factors That Can Make You Lose the SBD

Passive investment income over $50,000

Reduces the SBD and increases corporate tax rates.

Low payroll in Quebec

Corporations must meet Quebec’s wage requirements to claim the full provincial SBD.

Classified as a PSB

Corporations with only one major client may lose SBD eligibility.

Income from related corporations

Management fees must reflect actual work.

Holding company structures

Passive income in Holdco may affect Opco’s SBD.

Incorrect income classification

Mislabeling passive income as active triggers reassessments.

How to Maintain SBD Eligibility

Increase or maintain payroll levels

Quebec requires a minimum threshold of wages paid to employees.

Keep business activity diversified

Avoid reliance on one major client to prevent PSB classification.

Manage passive income

Limit passive investment income in Holdcos or restructure investments.

Document business activity

Maintain contracts, invoices, and employee records.

Use proper intercompany agreements

Management fees must be supported by real activity.

Structure reorganizations carefully

Estate freezes, Holdcos, and multi-corporation structures must be coordinated to preserve SBD.

Mackisen Strategy

At Mackisen CPA Montreal, we analyze corporate structures, payroll levels, passive income exposure, and business activity to ensure SBD eligibility. We restructure shareholding, plan compensation, coordinate Opco-Holdco arrangements, limit passive income erosion, prepare documentation, and defend SBD claims during audits. Our strategies help preserve the low tax rate on your corporation’s income.

Real Client Experience

A Montreal consulting corporation lost its SBD after CRA classified it as a PSB due to reliance on one client. We restructured operations, diversified revenues, and restored SBD eligibility. Another client exceeded passive income limits in their Holdco; we reorganized investments and implemented planning to prevent further erosion.

Common Questions

Is rental income eligible for the SBD?

Generally no, unless the corporation provides significant services.

How much payroll does Quebec require for SBD?

Corporations must meet annual wage thresholds or fall under specific exceptions.

Does passive income in a holding company affect SBD?

Yes. Passive income over $50,000 reduces SBD eligibility.

Can a corporation with one client qualify?

Rarely. It risks being classified as a PSB.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps corporations qualify for the SBD, minimize tax, and structure operations to maintain long-term eligibility. We protect your low corporate tax rate through proactive planning.