Passive investments inside a corporation: how they’re taxed

Why investing inside the company is a tax question

Corporate profit that you do not withdraw stays in the company, and many owners invest it to earn something while it waits. That is allowed, and there is no special form to file just for holding investments. The difference is how the income is taxed and what it does to the company’s other tax results.

The right comparison is not only the corporate tax on the income. It is the combined result of corporate tax, the refund you may later receive, the personal tax when money is paid out as a dividend, and any effect on the small business deduction. Looking at only one of those can give a misleading picture.

What counts as passive income

For this purpose the CRA works with aggregate investment income. In broad terms it is the net taxable portion of capital gains plus income from property, such as interest, rent and royalties, less property losses. It is measured on a world-source basis, so foreign interest or rent is included.

Income from property that is incident to, or used mainly to earn income from, the active business is generally not counted. A gain on an asset that was actively used in the business is also treated differently from a gain on a pure investment. These distinctions turn on facts, so keep records of how each asset was used.

Taxable dividends are handled separately, in a different part of the T2. Dividends from a connected corporation can be excluded from the adjusted figure, which matters if you own more than one company.

How the tax works and what comes back

A Canadian-controlled private corporation (CCPC) pays corporate tax on its investment income at a higher effective rate than on active business income, and part of that tax is refundable. The CRA tracks the refundable portion in the non-eligible refundable dividend tax on hand account (NERDTOH), one of two accounts that make up the refundable dividend tax on hand system, or RDTOH. Ask your accountant for the current combined rate, since it depends on the type of income and the province.

The company recovers that money by paying taxable dividends. For a non-eligible dividend, the refund is generally limited to the smaller of 38 1/3% of the dividends paid and the NERDTOH balance, with some further rules that can draw on the eligible account. The company has to file its T2 within three years of the tax year-end to claim the refund; after that it is barred.

Paying the dividend also triggers personal tax for the shareholder. A corporate refund that looks attractive on its own may be offset by what you owe personally, so the two should be reviewed together. Our salary vs dividends guide covers the personal side.

The $50,000 threshold and your small business limit

The small business deduction reduces tax on the first $500,000 of active business income for most CCPCs. That limit shrinks when adjusted aggregate investment income is between $50,000 and $150,000. The reduction is $5 of business limit for every $1 above $50,000, so the limit is gone at $150,000.

The measurement uses the investment income from tax years that ended in the previous calendar year. A company with a December year-end therefore looks at last year’s investment income to set this year’s limit. Ontario’s small business rate is 2.2% from July 1, 2026, and the federal rate for CCPCs claiming the deduction is 9%, so losing part of the limit has a real cost.

The test counts all associated corporations together. A holding company or a second family company can therefore reduce the limit of your operating company.

An illustration with round numbers

Suppose, for illustration, a company that is not associated with any other has $75,000 of adjusted aggregate investment income in its prior year. That is $25,000 above the threshold, and five times that is $125,000. Its business limit falls from $500,000 to $375,000.

Now suppose it is associated with a second company that had $55,000. The combined figure is $130,000, which is $80,000 over the threshold, so the reduction is $400,000 and only $100,000 of limit remains. These are the CRA’s own worked cases, and they ignore other rules that can also reduce the limit, so use them to see the direction and not to forecast your own result.

Capital gains and the inclusion rate

A proposed increase in the capital gains inclusion rate from one-half to two-thirds was cancelled, so one-half of a gain is still the taxable portion. For corporations, the taxable half counts toward investment income and the refundable tax regime described above.

The other half is not simply ignored. The non-taxable part of capital gains is tracked in the capital dividend account, and the company can elect to pay it out as a capital dividend. That is a separate filing with its own deadline, so ask before you declare one. Realizing a large gain in one year can also raise the following year’s threshold test, which is why timing matters.

Records and filings to keep in order

Keep statements for every investment account, a record of each purchase and sale with the cost, and a note of whether any asset was used in the business. Schedule 7 is where the company calculates aggregate investment income and the income eligible for the small business deduction, and Schedule 3 reports dividends received, dividends paid and any dividend refund.

Check your RDTOH balances on each T2, and keep the prior year’s schedules with your working papers. If there is more than one corporation in your group, keep a simple chart showing who owns what, since association drives the combined test.

Questions to ask your accountant

Ask how much investment income the company is likely to earn this year and how close the group is to $50,000. Ask what the combined corporate and personal tax would be if the cash stayed invested, compared with paying it out and investing personally, including your RRSP and TFSA room.

Also ask whether a holding company would change the answer. Our article on holding company pros and cons looks at that structure, and the corporate tax service page explains how Sora can prepare the schedules. Bring your latest financial statements, last year’s T2 and any plans to sell the business or realize a large gain.