The Passive Income Rule for Canadian Corporations

By Shea Sanche, CFP® · Last reviewed: October 2026

Many owners first hear about this rule after the corporate investment account has grown. The business has not changed. The investment income has.

This article is educational. It sets out the federal rule in plain numbers, with one example in dollars. Your accountant confirms your corporation's figures.

The rule in three numbers

Number	What it means
$500,000	The business limit. A Canadian-controlled private corporation gets the federal small business rate on up to $500,000 of active business income. The federal rate is 9% with the small business deduction and 15% without it.
$50,000	The passive income line. When the corporation and its associated corporations together earn more than $50,000 of passive investment income in a year, the business limit starts to shrink.
$150,000	Where the limit is gone. The federal business limit is reduced by $5 for every $1 of passive income over $50,000. At $150,000, it is gone.

The tax term for this income is adjusted aggregate investment income, or AAII. The reduction is worked out as (business limit ÷ $500,000) × 5 × (AAII − $50,000).

One timing point. The reduction is measured on investment income from tax years that ended in the prior calendar year. Last year's investment income sets this year's limit.

What counts toward the $50,000

Not all investment income counts the same way.

Interest and most foreign income count in full. They are also fully taxable in the corporation at high rates.
Capital gains count at half. The inclusion rate is 50%, so half of a gain is taxable. The taxable half of a realized gain on investments counts as investment income in the year it is realized.
Growth that has not been realized does not count yet. A gain is taxed when it is realized, not while it builds.
Dividends from portfolio investments generally count as well.

A proposed increase in the capital gains inclusion rate to two-thirds was cancelled in March 2025 and never took effect.

Profit from the business itself is active business income. It is not part of this figure. Your accountant calculates the figure, and it is not always the same as the income shown on your investment statements.

A worked example, in dollars

Take a Canadian-controlled private corporation with $500,000 or more of active business income. Its investments produced $80,000 of passive income in the prior year.

Passive investment income	$80,000
The passive income line	$50,000
Over the line	$30,000
Federal business limit removed, at $5 for every $1 over	$150,000
Federal rate on that $150,000 of business income	15%, not 9%
The difference in federal rate	6 percentage points
More federal tax, before provincial tax	$9,000 a year

The same arithmetic at other levels of passive income:

Passive income	Over the line	Limit removed	Limit left
$50,000	$0	$0	$500,000
$80,000	$30,000	$150,000	$350,000
$100,000	$50,000	$250,000	$250,000
$150,000	$100,000	$500,000	$0

The reduction costs tax only on active business income above the limit that is left. In the example, the limit falls from $500,000 to $350,000. A corporation with $350,000 or less of active business income still has the small business rate on all of it. That is why the same $80,000 can mean $9,000 more federal tax for one corporation and none for another.

This is an illustration, not your corporation's figures. Your accountant confirms those.

A holding company does not move the line

Associated corporations are counted together. If you control an operating company and a holding company, the passive income of both is added up before the line is applied.

So moving investments into a holding company you control does not by itself avoid the rule. There can be good reasons to use one. This is not one of them. We cover that in Investing Through a Holding Company in Canada.

Your province may differ

Everything above is federal. Each province sets its own small business rate and its own rules. Ontario, for example, does not apply the federal passive income reduction to its own small business rate.

The provincial effect depends on your province. Your accountant has that figure.

What can be planned

The rule does not say to stop investing inside the corporation. It says the kind of investment income matters, and so does the timing. Interest and most foreign income count in full every year. Growth that stays in the portfolio does not count until a gain is realized, and a large realized gain in one year can reduce the business limit for the next.

A low-distribution portfolio is built to pay out less along the way, so less investment income lands on the return each year. It does not remove tax. It is built so the tax is planned. More on that in How to Invest Retained Earnings in Your Corporation.

What your accountant does, and what we do

Your accountant is in charge of the corporation's tax. They calculate the passive income figure, apply it across your associated corporations, prepare the return and advise on how you are paid. Nothing in this article replaces that.

Our part is the investment account. We build corporate portfolios to be low-distribution, so passive income is planned for, not discovered at filing. The timing of gains is part of the plan, and the plan is set with your accountant. With your permission, we coordinate directly with your accountant. Nothing is ever paid between us and your accountant, in either direction.

Common Questions

Short answers to the questions owners ask.

What is the passive income rule for corporations in Canada?

A Canadian-controlled private corporation gets the federal small business rate on up to $500,000 of active business income. When the corporation and its associated corporations earn more than $50,000 of passive investment income in a year, that limit is reduced by $5 for every $1 over $50,000, and it is gone at $150,000. It is measured on the prior year's investment income, and the provincial effect depends on your province.

How much tax does it cost to go over $50,000 of passive income?

It depends on how far over the line you are and how much active business income the corporation earns. As an illustration, $80,000 of passive income is $30,000 over the line, which removes $150,000 of the federal limit. For a corporation with $500,000 or more of active business income, that is 6 percentage points more federal tax on $150,000, or $9,000 a year, before provincial tax.

Do capital gains count as passive income in a corporation?

The taxable half of a realized gain on investments does. The capital gains inclusion rate is 50%, so half of a gain is taxable, and that half counts as investment income in the year the gain is realized. Growth that has not been realized does not count yet.

Does a holding company avoid the passive income rule?

Not by itself. Associated corporations are counted together, so passive income earned in a holding company you control is added to the operating company's when the federal business limit is measured. Your accountant confirms which of your corporations are associated.

Is the passive income rule the same in every province?

No. The rule described here is federal. Ontario, for example, does not apply the federal passive income reduction to its own small business rate. The provincial effect depends on your province.

Start with the number

The Corporate Tax Efficiency Test is by request, and free for owners who qualify. It names the problem in dollars. To see how we invest corporate money, read Insight Corporate Wealth.

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This article is general education for Canadian business owners. It is not tax, legal or investment advice, and it does not replace your accountant. The tax figures are federal and were checked against Canada.ca on October 7, 2026. Tax rules change, and the provincial effect depends on your province. All investments involve risk, including the possible loss of principal. Your accountant confirms your corporation's figures.

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