The small business deduction — lower tax rate for CCPCs
Small business deduction
Section 125 provides a deduction from corporate tax for Canadian-controlled private corporations (CCPCs) on the first $500,000 of active business income earned in Canada — resulting in a federal corporate rate of 9% instead of 15%.
Plain-language explanation
Section 125 is the primary tax incentive for small and medium-sized private businesses in Canada. It reduces the federal corporate income tax rate from 15% to 9% on up to $500,000 of active business income.
The SBD rate: Basic federal corporate rate: 15% SBD deduction: 6 percentage points Effective federal rate on SBD income: 9%
Combined with provincial rates (which also have SBD equivalents), most provinces have a combined federal+provincial rate of 11–13% on the first $500,000 of active business income.
Business limit: $500,000 The maximum active business income eligible for the SBD is $500,000 (the "business limit"). This limit is shared among associated corporations — a common anti-avoidance provision to prevent business owners from multiplying the deduction.
Phase-out at high passive income: Since 2019, the business limit is reduced when a CCPC earns significant passive income. For each dollar of passive investment income above $50,000, the business limit is reduced by $5 (eliminated entirely above $150,000 of passive income).
Phase-out at high taxable capital: The business limit is also phased out as the CCPC's taxable capital employed in Canada exceeds $10 million, eliminated above $50 million.
Why it matters: The SBD is the fundamental reason why incorporation can be tax-advantaged for active businesses. You can earn $500,000 in the corporation at 9–13% federal+provincial, and defer personal tax on that income until you take it out as salary or dividends.
Example
Westbrook Consulting Inc. earns $400,000 of active business income in 2026. Federal tax without SBD: 15% × $400,000 = $60,000. With SBD: 9% × $400,000 = $36,000. Ontario provincial SBD brings the combined rate to ~12.2%. Combined tax: ~$48,800 vs. ~$80,000 without SBD.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Business limit phase-out based on passive income introduced. Reduces the SBD business limit by $5 for each $1 of adjusted aggregate investment income above $50,000.
Before
Full $500,000 business limit regardless of passive income
After
$500,000 phased out starting at $50,000 passive income; fully eliminated at $150,000
Common questions
What is the small business deduction limit in 2026? +
The federal SBD reduces the corporate rate from 15% to 9% on the first $500,000 of active business income. However, this limit is shared among associated corporations and phases out at high passive income or high taxable capital.
Do all corporations qualify for the small business deduction? +
No. Only CCPCs (Canadian-controlled private corporations) qualify. A CCPC is a private corporation incorporated in Canada, controlled by Canadian residents, and not controlled by a public company or non-resident. Foreign-owned companies and public companies do not get the SBD.
How does high passive income affect the SBD? +
For every dollar of passive investment income above $50,000 earned by the CCPC (or associated group), the $500,000 business limit is reduced by $5. At $150,000 of passive income, the business limit is fully eliminated and the company pays full 15% federal corporate tax.
Key terms
Related sections
Related guides
CPA recommendation
Structuring to maximize the SBD while managing passive income accumulation requires ongoing tax planning. Speak with a CPA who specializes in corporate tax.
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 125. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.