The Canadian tax system aims for integration, meaning an individual should end up with the same after-tax income whether income is earned personally or through a corporation and then distributed as dividends.
Integration is implemented through the dividend gross-up and tax credit at the individual level, the refundable tax components for corporations on certain income (e.g., passive investment income) and differentiating between eligible vs. ineligible dividends which affects the dividend gross up and tax credit.
Corporations enjoy lower tax rates on active business income (especially the first $500,000 via the Small Business Deduction), creating a deferral advantage when income is retained in the corporation. On a fully integrated basis, this advantage disappears in most provinces and due to provincial rate variations, perfect integration is rarely achieved—sometimes resulting in a slight tax disadvantage.
This article explores the principles of tax integration in Canada, focusing on how active business income earned through Canadian-controlled private corporations (CCPCs) compares that same business income earned personally. It outlines the mechanisms designed to achieve tax neutrality, including dividend gross-up and tax credit systems.
“Integration” refers to the income tax principle that an individual should yield the same after-tax income whether income is earned individually or through a corporation. In other words, the same amount of taxes should be paid whether income is earned individually or through a Canadian-controlled private corporation (CCPC) that then distributes its after-tax income to the individual as a shareholder.
Under the Income Tax Act (ITA) of Canada, a corporation is a separate legal entity from the shareholders who own it and is subject to tax on the income it generates. Income is first taxed within the corporation before it can be passed to the shareholders in the form of dividends, out of its retained earnings. The shareholder will then pay individual income taxes on income received from the corporation.
To avoid double taxation on income that passes through a corporation to individuals as shareholders and to prevent any unintended tax advantages, a dividend gross-up and tax credit model is applied at the individual level, along with a tax refund mechanism to the corporation on passive investment income1. This is designed to integrate the tax system between the two entities, individual and corporation. Ideally, perfect integration is achieved when after-tax income is the same whether it is earned individually or through a corporation. Due to the varying levels of provincial tax rates, seldom do the combined Federal and Provincial tax mechanisms achieve perfect integration.
Below is an illustration of perfect integration. In this example, we assume the individual is in a 50% marginal tax bracket.
| Professional income earned personally | |
|---|---|
Income |
$1,000 |
Personal tax (50%) |
($500) |
After-tax cash |
$500 |
| Professional income earned by corporation | |
|---|---|
Income (A) |
$1,000 |
Corporate tax (13%) (B) |
($130) |
Net income |
$870 |
| Dividend to shareholder | $870 |
| Gross-up (15% rate) | $130 |
| Taxable dividend | $1,000 |
| Personal tax (50%) | ($500) |
| Dividend tax credit | $130 |
| Net personal tax (C) | ($370) |
| After-tax cash (A - B - C) | $500 |
To integrate the income as it flows from the corporation to the shareholder, Canadian dividends that are issued are first grossed up and are then subject to taxation with a subsequent dividend tax credit claim at the individual level. This mechanism is designed to integrate the income via the corporate entity to achieve tax parity. The actual gross-up and tax credit amounts will depend on whether the dividend issued is eligible or ineligible (also referred to as “dividends other than eligible dividends”).
A private corporation could have some of its active business income (ABI) taxed at the small business tax rates and some of its ABI amounts taxed at the general corporate tax rates. Theoretically, eligible dividends are issued from the corporation on income that has not benefited from the small business deduction (SBD). In other words, they are issued from the corporation’s ABI taxed at the general corporate tax rates. Eligible dividends are grossed up by 38% and provide a higher tax credit rate (15.02% of the grossed up eligible dividends). Conversely, ineligible dividends are those issued from retained earnings within the corporation that have benefited from the preferred small business tax rates (ABI eligible for the SBD). Ineligible dividends are grossed up by 15% and are subject to a lower tax credit rate (9.03% of the grossed up ineligible dividends).
Passive investment income (income generated from the investment of retained earnings) is taxed at higher rates that includes a refundable tax component, discussed later.
To encourage small business development through re-investment of earnings within Canada, the federal and provincial governments offer a low tax rate on business income generated within a small private corporation. This lower business tax rate is courtesy of the SBD, which stands at 19% (federally) for 2025. The federal general corporate tax rate is 38%, which is reduced by 10% to allow provinces to levy their own corporate tax rates if desired. The SBD of 19% is then applied, resulting in a net federal rate of 9% on the first $500,000 of ABI. Most provinces also use this $500,000 ceiling, except Saskatchewan and PEI ($600,000) and Nova Scotia ($700,000 effective April 1, 2025). For perspective, below are the combined federal and provincial tax rates for ABI eligible for the SBD across Canada, along with comparative personal tax rates.
The lower ABI rate has a deferral effect when business income is earned through a corporation and kept within the business. Shown in Table A is the deferral advantage of using a corporation versus a top tax bracket individual running the business as a sole proprietorship.
| Table A: Active business income eligible for the small business deduction | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| BC | AB | SK | MB | ON | QC | NB | NS | PE | NL | |
| Provincial rate up to small business limit | 2.00% | 2.00% | 1.00% | 0.00% | 3.20% | 3.20% | 2.50% | 1.75%² | 1.00% | 2.50% |
| Combined with Federal 9% rate | 11.0% | 11.0% | 10.0% | 9.0% | 12.20% | 12.20% | 11.5% | 10.75% | 10% | 11.50% |
| Individual highest marginal tax rate | 53.50% | 48.00% | 47.50% | 50.40% | 53.53% | 53.31% | 52.50% | 54.00% | 52.00% | 54.80% |
| Deferral advantage | 42.50% | 37.0% | 37.5% | 41.4% | 41.33% | 41.11% | 41.0% | 43.25% | 42.0% | 43.3% |
As seen, the deferral advantage is significant, though it effectively disappears once a dividend is paid pursuant to the integration process explained earlier. Due to variances in the tax rates across the provinces, perfect integration is not achieved and on a fully integrated basis, there is a tax disadvantage across most provinces as seen in Table B below.
| Table B: Advantage/(Disadvantage) of earning business income through a private corporation | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| $1,000 ABI [A] | BC | AB | SK | MB | ON | QC | NB | NS | PE | NL |
| Small business tax rate | 11.00% | 11.00% | 10.00% | 9.00% | 12.20% | 12.20% | 11.50% | 10.75% | 10.00% | 11.50% |
| Small business tax | ($110) | ($110) | ($100) | ($90) | ($122) | ($122) | ($115) | ($108) | ($100) | ($115) |
| Business earnings available for non-eligible dividend | $890 | $890 | $900 | $910 | $878 | $878 | $885 | $893 | $900 | $885 |
| Highest marginal tax rate on non-eligible dividend | 48.89% | 42.30% | 41.34% | 46.67% | 47.74% | 48.70% | 46.83% | 48.28% | 47.92% | 48.96% |
| Tax on non-eligible dividend | ($435) | ($376) | ($372) | ($425) | ($419) | ($428) | ($414) | ($431) | ($431) | ($433) |
| Net to individual [B] | $455 | $514 | $528 | $485 | $459 | $450 | $471 | $462 | $469 | $452 |
| Individual highest marginal tax rate | 53.50% | 48.00% | 47.50% | 50.40% | 53.53% | 53.31% | 52.50% | 54.00% | 52.00% | 54.80% |
| Tax payable | ($535) | ($480) | ($475) | ($504) | ($535) | ($533) | ($525) | ($540) | ($520) | ($548) |
| Net to individual [C] | $465 | $520 | $525 | $496 | $465 | $467 | $475 | $460 | $480 | $452 |
| Tax advantage/ (disadvantage) [(B-C)/A] | (1.01%) | (0.65%) | 0.29% | (1.07%) | (0.59%) | (1.65%) | (0.44%) | 0.16% | (1.13%) | (0.03%) |
The preferred lower corporate tax rates applicable to Canadian small businesses results in a significant tax-deferral on active business income earned within a corporation when compared to that same business income being earned by an individual taxed at the highest marginal tax rates. On a fully integrated basis, there is a tax cost incurred by earning the business income through a corporation in most provinces across Canada. Together, these tax outcomes incentivize and encourage business reinvestment.
Furthermore, the Lifetime Capital Gains Exemption (LCGE) is another tax incentive applicable only to Canadian controlled small businesses on the disposition of qualifying shares. Provided the conditions are met, the LCGE can be used to exempt up to $1,250,000 of capital gains. This is the 2025 limit and will be indexed to inflation on an annual basis starting in 2026. General qualifications for the LCGE are that 90% of the fair market value of the assets of the business are used in an active business carried on primarily in Canada immediately before the sale and that more than 50% of the fair market value of those assets must have been used in an active business in Canada during the 24 months immediately preceding the sale.
Personal and Corporate Tax Integration
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