Small Business Deduction

Definition

The Small Business Deduction (SBD) under ITA s.125 is a federal tax reduction available to Canadian-Controlled Private Corporations on the first $500,000 of active business income earned in Canada. It effectively lowers the federal corporate tax rate from the general 15% to 9%, giving CCPCs a combined federal plus provincial rate of roughly 11% in most provinces in 2026.

Key rules

• Business limit: $500,000 of active business income per year (ITA s.125(1)).
• Federal rate impact: 15% general rate minus 6% deduction equals a 9% federal SBD rate.
• Qualifying income: only active business income carried on in Canada by the CCPC. Investment income, specified investment business income, and personal services business income are excluded.
• Associated-corp sharing (ITA s.125(3)): associated corporations must share one $500,000 business limit. See .
• Taxable capital grind (ITA s.125(5.1)): the business limit is reduced when the associated group's taxable capital employed in Canada in the prior year is between $10 million and $50 million, and eliminated at $50 million.
• Passive income grind (ITA s.125(5.1)(b)): the business limit is reduced by $5 for every $1 of Adjusted Aggregate Investment Income (AAII) over $50,000, fully eliminating the SBD once AAII reaches $150,000.
• Both grinds apply: the reduction is the greater of the two.

Example

Northshore Consulting Inc. (a BC CCPC) earned $620,000 of active business income in its 2026 year. The associated group has $12 million taxable capital in 2025 and $40,000 AAII in 2025.

Step 1: Full SBD-eligible amount

Active business income: $620,000, capped at the $500,000 business limit.

Step 2: Taxable capital grind

Reduction = $500,000 × (($12,000,000 − $10,000,000) / $40,000,000) = $25,000.

Step 3: Passive income grind

AAII of $40,000 is below the $50,000 floor, so no passive grind.

Step 4: Adjusted business limit

$500,000 − $25,000 = $475,000.

Step 5: Federal tax

The $25,000 that did not qualify for the SBD is taxed at the general rate and feeds , which supports future eligible dividends.

Common mistakes

• Treating the $500,000 as per corporation rather than per associated group.
• Ignoring personal services business (PSB) income. PSB income is excluded from the SBD and taxed at a federal rate of 33%.
• Missing the passive income grind. A single year of AAII above $50,000 shrinks next year's business limit.
• Forgetting that the taxable capital grind uses the prior year's taxable capital of the associated group, not the current year's.
• Applying the SBD to specified investment business income. Rental and investment income earned by a corporation with fewer than six full-time employees is excluded.

Related concepts