The “Small Business Grind Down” in Ontario, Canada

The small business grind down refers to the way the Canadian tax system gradually removes key tax benefits as a business grows in revenue and profit, making it harder for small businesses to scale. Here’s how it works in Ontario:

1. Loss of the Small Business Deduction (SBD)

What Happens?

  • In Canada, the Small Business Deduction (SBD) reduces the corporate tax rate on the first $500,000 of active business income.

  • Once your business exceeds $10M in taxable capital, this deduction gradually phases out.

  • By $15M, the SBD is completely gone.

Tax Impact:

  • Small businesses under the SBD pay about 12.2% corporate tax in Ontario.

  • Once the SBD is lost, tax jumps to 26.5%.

  • More than double the tax rate!

Who’s Affected?

  • Growing businesses with $10M+ in assets, including cash, equipment, and investments.

  • Those scaling up and crossing the $15M grind-down threshold lose one of their biggest tax breaks.

2. Passive Income Grind Down (Investment Income Penalty)

What Happens?

  • If a business earns over $50,000 in passive income (interest, dividends, capital gains from investments), the SBD begins to phase out.

  • At $150,000+ in passive income, the SBD is completely eliminated.

Tax Impact:

  • Even if your operating business earns less than $500K, too much passive income forces your tax rate up to 26.5%.

  • Passive investment income (like interest) is taxed at up to 50.17% in Ontario.

Who’s Affected?

  • Businesses holding excess cash, real estate, or investments inside the corporation.

  • Entrepreneurs looking to build long-term wealth inside their business but penalized for it.

3. Dividend Tax vs. Salary Tax Trap

What Happens?

  • Business owners typically pay themselves through dividends or salary.

  • Dividends are taxed at up to 47.74% in Ontario, making them costly.

  • Salaries require payroll taxes (CPP, EI) that increase costs.

Tax Impact:

  • The combined corporate + personal tax on dividends often exceeds 55%.

  • No RRSP room is created with dividends, making it harder to build personal wealth.

Who’s Affected?

  • Small business owners who take dividends instead of salary.

  • Those unaware of tax-efficient pay structures to optimize their income.

4. Capital Gains Inclusion Rate Increase (Upcoming Change)

What’s Changing?

  • Currently, 50% of capital gains are taxable.

  • The government is considering raising this to 66.7% or even 75%

Tax Impact:

  • Selling shares of your business could result in higher capital gains tax.

  • The Lifetime Capital Gains Exemption (LCGE) (which allows up to $1.25M tax-free gains on business sales in 2024) may lose some of its value.

Who’s Affected?

  • Business owners planning to sell their business.

  • Entrepreneurs looking to use an estate freeze or family trust to pass wealth efficiently.

5. Triple Tax on Business Wealth Transfer

What’s Changing?

When moving wealth from a corporation to family members, businesses face a triple tax hit:

1️⃣ Corporate tax on business income.

2️⃣ Dividend tax when extracting funds.

3️⃣ Estate tax (potential capital gains or deemed disposition) when passing wealth on death.

Tax Impact:

  • Some businesses see over 55% of their wealth lost to tax before reaching the next generation.

  • Selling a business to family can be taxed more heavily than selling to an outsider (although recent Bill C-208 changes have helped).

Who’s Affected?

  • Family-run businesses planning succession.

  • Entrepreneurs with significant retained earnings or investment holdings inside their company.

Final Thoughts: How to Beat the Grind Down

  • Use an Estate Freeze to transfer business growth to family or a trust while locking in today’s tax rates.

  • Utilize a Capital Dividend Account (CDA) to extract tax-free money from the company.

  • Reinvest passive income into active businesses (real estate, lending within the business, etc.) to avoid passive income grind-down rules.

  • Consider corporate-owned life insurance to grow wealth tax-efficiently inside the corporation.

  • Split income legally through family members in a tax-efficient manner.

Conclusion: The Small Business Grind Down is Real—But Can Be Managed

Ontario small businesses face hidden tax traps as they grow. The loss of SBD, passive income penalties, rising dividend taxes, and triple taxation make it harder to keep wealth in the business.

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