Filing corporate taxes in Quebec can be complex and confusing. To help Quebec companies better understand this crucial part of running a successful business, we’ve put together a corporate taxation guide. Read on to learn about tax rates for companies incorporated in Quebec, the different types of taxable income, and common mistakes to avoid.
Tax rates for companies incorporated in Quebec
In Quebec, incorporated businesses are taxed at combined federal and provincial rates. Understanding these rates is essential to effective corporate tax management. Here are the main points to consider.
Understanding combined federal and provincial tax rates
Combined tax rates represent the total percentage of taxes that incorporated companies must pay on their taxable income. These rates are calculated by aggregating federal and provincial tax rates.
Tax rates for the first $500,000 of taxable income
For companies incorporated in Quebec, the first $500,000 of taxable income is subject to a favourable combined tax rate of approximately 20.5%. This preferential rate is designed to support small businesses and start-ups and help them succeed.
Tax rates for taxable income over $500,000
Incorporated businesses are subject to a different tax rate if they pass the $500,000 taxable income threshold. Taxable income above this amount is taxed at around 27%. This is how the government differentiates between small and large businesses.
The 5500-hour rule (SBD)
The Small Business Deduction (SBD) is a tax measure designed to support small businesses by reducing their tax burden. It allows companies that meet certain conditions to benefit from an advantageous tax rate on a portion of their taxable income.
When a business pays employees for 5500 hours of work annually, their provincial corporate tax rate drops from 11.5% to a much lower 3.2%.
The different types of corporate income
The government identifies many different sources of income and they are all taxed separately. Here are some examples:
- Active business income
- Dividend income
- Rental income
- Capital gains income
- Investment income (interest, royalties, etc.)
Active business income
In most cases, active business income is derived from a commercial source. A company pays tax at a rate of around 20.5% on its taxable income in this category. This includes both federal (9%) and provincial (11.5% in QC) tax.
The refundable dividend tax on hand (RDTOH), dividend refunds, and dividends subject to Part IV are tax mechanisms applied to corporations with the goal of maintaining the principle of tax integration. Here's how these mechanisms work:
- Corporations earning investment income pay a high tax rate of 50%. This rate includes a refundable amount of 26.67%.
- If a corporation receives dividends from a non-affiliated corporation, it will pay Part IV tax of 33.33% of the dividend, which will be added to the RDTOH account.
- If a corporation receives dividends from a connected corporation, it will pay a tax equivalent to its share of the dividend refund received by the paying corporation, which will also be added to the RDTOH account.
- When a corporation pays taxable dividends, it is entitled to a dividend refund equivalent to $1 for every $3 of dividends paid, up to the limit of the RDTOH account.
In short, these mechanisms are designed to limit the use of corporations to generate investment income and dividends. The RDTOH can be thought of as an interest-free loan to the federal government, to be repaid when the corporation pays taxable dividends.
Investment income includes all interest income, plus the taxable portion of capital gains, rents, royalties and all other property income.
In 2023, investment income will be taxed at a rate of approximately 38% at the federal level, plus 11.5% at the provincial level. For Quebec, this means a tax rate of around 50%.
Capital gains income
Capital gains income is similar to investment income, but with a difference.
When a company realizes capital gains, it increases its capital account. This account is a cumulative balance that allows for the payment of tax-free capital dividends. This is another way for a company to reduce its taxes.
Avoiding corporate taxation mistakes in Québec
Several common tax filing errors in Quebec can have unintended consequences. To avoid problems, be aware of the following pitfalls.
Trying to avoid personal income tax by choosing active business income
The Quebec tax system allows small and medium-sized businesses (SMBs) to include approximately 20,5% of their taxable income (taxable profit) in their active business income. It is therefore tempting to choose this option to reduce corporate taxes.
The first reflex for those of us who are trying to be clever might be to consider paying around 35%-48% personal tax with employment income at work, and creating a company to handle real estate income and/or investment income.
Unfortunately, it's not that simple. To understand why, we need to ask ourselves the following question: what is active business income?
What is the difference between a Specified Investment Business (SIB) and a Personal Services Business (PSB)?
The Income Tax Act defines an "active business" as any business operated by a taxpayer resident in Canada other than a Specified Investment Business (SIB) or a Personal Services Business (PSB). But what exactly does this mean?
Specified Investment Business (SIB)
An SIB is an entity whose primary purpose is to invest its funds in investments, rather than carry on active business activities. The income generated by an SIB comes mainly from investment income, such as interest, dividends, capital gains, rents and other similar income. This investment income is generally taxed at higher rates than active business income.
Personal service business (PSB)
A PSB is an entity that primarily provides professional, technical or consulting services through its shareholders or employees. The primary objective of a PSB is to provide services rather than to invest in commercial activities. The income of an PSB is derived primarily from the provision of services, and this income is generally taxed at higher rates than active business income.
Therefore, taxpayers in charge of SIBs and PSBs cannot avoid paying personal income tax. Avoid making this mistake when filing your CO-17 tax return.
T2inc can help with your corporate tax return
To make tax management easier for companies in Quebec, T2inc has set up an online tax software solution.
These services are designed to provide all-inclusive assistance tailored to your company's specific needs. Our team of experts is trained to study your file in detail so we can propose an optimized and efficient tax calculation. Thanks to our expertise, we help companies identify the best tax options to reduce taxes while complying with current laws and regulations.
By working with T2Inc, companies can save time and benefit from expert advice. Whether it's to help you understand combined tax rates, properly declare different types of income or avoid common mistakes, our team is here to support you with your Quebec business tax return, every step of the way.