Ontario Small Business Deduction

Definition

The Ontario Small Business Deduction (SBD) reduces the provincial corporate income tax rate on the first $500,000 of active business income earned by a Canadian-controlled private corporation (CCPC) with a permanent establishment in Ontario. It parallels the federal SBD under section 125 of the Income Tax Act (Canada) and is calculated on Schedule 500 of the T2 return. The federal and Ontario $500,000 business limits align, and both must be shared among associated corporations. The Ontario SBD effectively lowers the Ontario corporate rate from the general 11.5% to 3.2% on qualifying income.

Key rules

• The Ontario business limit is $500,000, matching the federal limit. The two limits are not additive; the same pool of income is eligible for both.
• Only active business income earned in Canada qualifies. Investment income, specified investment business income, and income from a personal services business are excluded.
• The business limit is shared among all associated corporations under ITA section 256 tests. See .
• The limit grinds based on federal taxable capital employed in Canada: reduction starts at $10 million of taxable capital and the limit reaches zero at $50 million.
• The passive income grind (ITA 125(5.1)) reduces the business limit by $5 for every $1 of adjusted aggregate investment income above $50,000, eliminating the limit entirely at $150,000 of passive income.

Example

A Mississauga CCPC earns $450,000 of active business income in 2026. It has no associated corporations, $4 million in taxable capital, and $30,000 in passive investment income. The full $500,000 limit is available. Ontario tax on the $450,000 is $450,000 × 3.2% = $14,400. Federal tax at 9% adds $40,500. Combined $54,900 at 12.2%. Had the SBD been denied (for example, by associated-corporation allocation), Ontario tax would rise to $51,750 (11.5%) and federal to $67,500 (15%), a combined $119,250 at 26.5%.

Common mistakes

• Failing to file Schedule 23 (agreement among associated corporations) when associated. Without a filed allocation, the CRA may deny the SBD to all affiliated entities.
• Double counting: some practitioners treat the federal and Ontario limits as additive ($1 million). They are aligned at $500,000.
• Ignoring the passive income grind. A holding company earning $180,000 of dividend and interest income eliminates the SBD for its operating associate.
• Claiming the SBD on income from a personal services business (PSB). PSB income is not eligible for the SBD and is taxed at the federal PSB rate of 33%, plus the Ontario general rate.

Related concepts