In this blog post, we will dive into how investment income is taxed in a corporation. Tax around Investment income is complex and convoluted. However, we at Vertical CPA firmly believe that it is our responsibility to explain these concepts simply and clearly to our clients.

So here it goes, part one of a two-part blog post series on how investment income is taxed in a corporation in Canada.

Should you invest in a corporation in Canada?

I’m sorry to disappoint, but there is no clear-cut answer here. It depends on your personal tax and corporate tax situation. Investing through a corporation in Canada has advantages and disadvantages. The decision of whether to invest through a corporation depends on your financial goals, tax situation, and the type of investment income you expect to earn.

Pros of investing through a corporation

Tax Deferral through Lower Corporate Tax Rates

Corporations pay a lower tax rate on active business income, allowing you to invest more after-tax earnings. Therefore, if you have more after tax earnings in a corporation, you will have a higher starting capital base which can start to compound at a faster clip, compared to your personal after-tax income. We discuss tax deferral in depth in our blog post here.

Flexibility for Retirement Planning

Corporate investments can serve as a pool of funds for retirement without being tied to RRSP contribution limits or withdrawal rules.

Cons of investing through a corporation

High Tax Rates on Passive Investment Income

Passive investment income earned in a corporation is taxed at a much higher rate (e.g., 50.17% in Ontario as of 2024). There are two components to this tax. One is permanent tax and the other is temporary tax. More on this in the “How is investment income taxed in a corporation?” section below.

Reduced Small Business Deduction (SBD)

If a corporation earns more than $50,000 in passive income, the Small Business Deduction (SBD) is gradually clawed back. For every $1 of passive income above $50,000, $5 of active business income becomes ineligible for the lower small business tax rate.

Example:

• Passive income: $70,000.
• Reduction in Small Business Deduction limit: $70,000 – $50,000 = $20,000 × 5 = $100,000.

A few terms you need to understand

Before we dive into how investment income is taxed in a corporation, let’s establish some definitions that will help you follow along.

Eligible Dividends

Eligible dividends are paid by Canadian corporations that have been taxed at the general corporate tax rate, which applies to most large corporations or public companies and certain private corporations. 

• • Eligible Dividend Tax Credit: Eligible dividends qualify for a higher dividend tax credit to offset the higher corporate taxes paid by the corporation. This means individuals receiving these dividends pay a lower personal income tax rate on eligible dividends.
  • Gross-Up Rate: For eligible dividends, the amount is “grossed up” by 38%, and then the eligible dividend tax credit is applied to reduce the overall tax payable.
    • • Example: If an individual receives an eligible dividend of $100, they would report $138 (gross up by 38%) on their tax return, and a dividend tax credit would apply to reduce their tax owing on this amount.

Non-Eligible Dividends

Non-eligible dividends are typically paid out by Canadian-controlled private corporations (CCPCs) that have received income taxed at the small business tax rate. Since these corporations pay lower taxes on their income, individuals who receive non-eligible dividends are granted a smaller tax credit.

• • Non-Eligible Dividend Tax Credit: The tax credit for non-eligible dividends is smaller than for eligible dividends because less corporate tax has been paid at the corporate level. This means individuals receiving these dividends pay a higher personal income tax rate on eligible dividends.
  • Gross-Up Rate: Non-eligible dividends are “grossed up” by 15%, and then the smaller non-eligible dividend tax credit is applied.
    • • Example: If an individual receives a non-eligible dividend of $100, they would report $115 (gross up by 15%)  on their tax return, with a lower dividend tax credit applied to offset the taxes on this amount.

General Rate Income Pool (GRIP)

The General Rate Income Pool (GRIP) balance allows Canadian-controlled private corporations (CCPCs), to pay out eligible dividends to shareholders under specific conditions. 

The GRIP balance is essentially a reserve of after-tax income that was taxed at the general corporate tax rate (not the lower small business tax rate), and it determines how much a CCPC can designate as eligible dividends.

How GRIP Works:

• The GRIP balance accumulates from corporate income that was taxed at the higher, general corporate tax rate rather than the small business tax rate.
  • • Example: Income exceeding the small business deduction (SBD) limit (often $500,000 in most provinces).

• A CCPC can pay eligible dividends (which are taxed more favorably for shareholders) up to the limit of its GRIP balance. This allows the corporation to pass on the tax advantage of previously paid general-rate taxes to shareholders in the form of eligible dividends, which qualify for a higher dividend tax credit.

Why GRIP is Important:

• Tax Efficiency for Shareholders: By designating dividends as eligible, corporations provide shareholders with a higher dividend tax credit, which reduces their personal tax liability.
• Annual GRIP Balance Report: Corporations are required to calculate and report their GRIP balance annually on their tax return (Schedule 53 in Canada). This ensures they have accurate tracking of how much can be paid as eligible dividends.

Why are taxes on investment income in a corporation so high in Canada?

Discouraging Tax Shelters

The primary goal is to prevent corporations from being used primarily as tax shelters.

If passive income within a corporation were taxed at the same low rate as active business income (Federal tax rate for corporations eligible for the small business

deduction is 9%), it would incentivize individuals to shift their investment income into corporations to minimize their personal tax burden. 

This would create an unfair advantage for those who structure their affairs this way. Therefore, higher taxes on passive income aim to ensure a more equitable tax system.

Tax Integration and Neutrality

The tax system aims for integration, meaning the total tax paid on income should be approximately the same whether it’s earned personally or through a corporation.

Without higher corporate taxes on passive income, shareholders could use the corporation to invest retained earnings and defer personal taxes indefinitely.

This would provide a tax advantage over individuals who invest directly using their after-tax income. The high tax rate ensures neutrality by aligning the corporate-passive-personal tax system.

What is investment income?

Passive Investment Income refers to income earned from investments or financial assets. It is considered passive because it is not earned through active business operations. 

Passive investment income can come from various sources, and each type is taxed differently under Canadian tax laws.

The most common types of passive income earned include:

• • Interest Income
  • Rental income (from a third party not an associated party)
  • Foreign dividends
  • Dividends from Canadian Public Corporations
  • Dividends from Non-Canadian Public Corporations
  • Capital Gains

Note the distinction I made above. We’re talking about passive investment income here. Not all types of investment income are “passive”. These include:

• • Incidental interest income
  • Income from an associated property

Investment income from non-passive sources, are taxes at the tax rate for active business income in a corporation.

How is investment income taxed in a corporation?

Passive Investment Income is taxed at a high rate of 50.17% (in Ontario, 2024). 

Of the 50.17% some of this tax is permanent tax and the other portion is a refundable tax. The refundable tax is of 30.67% (in 2024). You can get back the refundable tax by paying the shareholder(s) taxable dividends. For every $3 of taxable dividends paid, the corporation gets $1 of RDTOH refunded.

For a full breakdown of the tax of the is permanent tax and the refundable tax by province see below. 

How is different investment income taxed?

Interest Income

• • 100% taxable when earned.
  • Taxed at ~50.17% (varies by province).
  • Refundable Dividend Tax on Hand (RDTOH) applies, meaning a portion is refundable when the corporation pays taxable dividends.

Example:

• • A corporation earns $10,000 in interest income.
  • Pays $5,017 in corporate tax (at 50.17% rate).
  • $3,016 of this tax is refundable when dividends are paid.

Capital Gains

• • At the time of this writing (in 2025) only 50% of a capital gain is taxable (the other 50% is tax-free).
  • The taxable portion is taxed at ~50.17%, so the effective rate on the full gain is ~25%.
  • The non-taxable 50% portion goes into the Capital Dividend Account (CDA) and can be paid out tax-free.

Example:

• • A corporation sells an investment and earns a $20,000 capital gain.
  • 50% ($10,000) is taxable at 50.17% = $5,017 in tax.
  • $10,000 (non-taxable portion) goes into the CDA and can be paid to shareholders tax-free.
  • Refundable tax of $3,016 applies when taxable dividends are paid.

Dividend Income (Canadian Dividends)

Eligible dividends (from public corporations)

• • Taxed at 38.33%.
  • Refundable via the ERDTOH (Eligible Refundable Dividend Tax on Hand) when an eligible dividend is paid.

Non-eligible dividends (from private corporations)

• • Taxed at 38.33%.
  • Refundable via the NERDTOH (Non-Eligible Refundable Dividend Tax on Hand) when a non-eligible dividend is paid.

Example:

• • Corporation receives $10,000 in dividends from a public company.
  • Pays $3,833 in Part IV tax.
  • This $3,833 goes into the ERDTOH account and is refundable when the corporation pays out eligible dividends.

Foreign Dividend Income

• • Fully taxable at ~50.17%.
  • Foreign tax credits may apply if withholding tax was paid to another country.
  • Refundable via NERDTOH.

Example:

• • Corporation receives $10,000 in U.S. dividends.
  • Pays $5,017 in corporate tax (50.17% rate).
  • A portion of this tax is refundable when dividends are paid.

Tax Planning Strategies for Investment Income in a Corporation:

Pay Out Dividends to Recover RDTOH

Holding investment income in the corporation traps refundable taxes. Paying out taxable dividends recovers RDTOH, help you recover the temporary tax that you prepay on investment income

Use the Capital Dividend Account (CDA) for Tax-Free Dividends

The non-taxable portion of capital gains goes into the CDA. You must work with your accountant to make a CDA election to receive tax-free dividends from this account.

Minimize Passive Income to Avoid Small Business Deduction (SBD) Clawback

If a corporation earns more than $50,000 in passive income, its $500,000 Small Business Deduction (SBD) limit is reduced. Keeping passive income below $50,000 avoids this penalty.

Do you need with calculating tax on investment income in a corporation or have any questions? Let us help you. Get in touch with us here or sign up to get more accounting and tax tips in our newsletter here.

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax circumstances and/or objectives.