Normally, a private corporation in Ontario earning less than $500,000 will be taxed favorably under the Small Business Deduction rate of 15.5%. This rate compares well against the top marginal tax rates paid by individuals receiving salaries and bonuses.
Some business owners incorporate their businesses and operate through a corporation with the view that they will benefit from the lower Small Business Deduction rate, and will also be able to claim deductions available to businesses.
However, the Canada Revenue Agency monitors “incorporated employees” and calls them “Personal Service Businesses”. A Personal Service Business is a corporation that is subjected to a higher corporate tax rate (39.5% in Ontario) and for which most usual deductions are denied. For example, an IT consultant with a single client who incorporates runs a high risk of being labeled a Personal Service Business and assessed as such for tax purposes.
Once a company is classified as a Personal Service Business, only a few deductions are permitted to reduce the corporate income subjected to the higher tax rate. The key deductions are salaries paid by the corporation to the employee and contributions to benefit plans including pension plans.
Therefore, if an individual’s corporation were to be considered a Personal Service Business, the establishment of a personal pension plan would enable the individual to deduct the value of contributions made to the plan based on the higher tax rate.
For example, a $1,000 contribution to the personal pension plan would trigger a corporate tax refund of $395.
In light of the new tax rules that penalize passive investments within CCPCs, advisors must understand how pension legislation can become a powerful tool to deal with wealth succession, business succession, and tax optimization within a corporate environment.Learn more about the ppp101 course