Private Lending vs Corporate Investing
Private Lending vs Corporate Investing
Samuel earned $100,000 from his new lending business. After-tax benefit: $14,080. 86% lost to taxes. Here's how it happened and what the alternative looks like.
Client Profile: Samuel
Background
Profile
Tech founder, Montreal
Retained Earnings
$1,000,000
Decision
Started private lending (no advisors first)
Tech Company (OpCo)
Annual Profit
$500,000
SBD Status
At maximum limit
Business
Info systems for financial institutions
LendCo (NewCo)
Capital Deployed
$1,000,000
Year 1 Income
$100,000 (interest)
Employees
0 = Specified Investment Business
The Challenge
What Happened
Interest income = passive income
Impact
SBD grind-down on OpCo
$100k LendCo Earned Netted
~$14,080 after tax
Samuel Earned $100,000 from LendCo
Capital deployed. Risk taken. Work done.
After-tax benefit: $14,080
86% of earnings lost to taxes
At a Glance
Capital deployed$1,000,000
Year 1 income (both paths)$100,000
Path A (Lending) tax$146,920
Path B (Investing) tax$62,250
Year 1 difference$84,670 advantage to investing
10-year advantage$902,752 advantage to investing
The Logic Chain: Capital-Based Income to Tax Penalty
Capital-based business (interest, dividends, rent, royalties) with fewer than 6 employees
CRA qualifies as SIB → income is passive income
Affects related companies
All companies you control
OpCo pays the penalty
SBD grind-down on your tech company
OpCo Alone vs OpCo + LendCo
All the risk and work under LendCo. How much actually lands in your pocket?
OpCo Alone: $500k Profit
Full SBD. No passive income.
OpCo + LendCo: $600k Total
SBD grind-down. Passive income.
The Net Effect
$100,000 earned from LendCo (risk, work, capital tied up) nets only:
$14,080
more after tax ($453,080 − $439,000). 86% of the additional income is lost to taxes.
What If the $1M Was Simply Invested in a Fund?
Lending vs. investing the same capital. Option A keeps the lending business. Option B deploys the $1M in a corporate class fund.
Risk, Effort and Tax: Side by Side
| Lending | Investing | |
|---|---|---|
| Risk | Higher (defaults, concentration) | Lower (diversified) |
| Effort | Higher (sourcing, vetting, servicing) | Low (passive) |
| Tax | 86% drag on new income | Year 1 savings $84,670 vs lending |
Lending offers control and active involvement. The trade-off is risk, effort, and a significant tax drag.
Option A: Private Lending Business (No Employees)
| Tech company profit | $500,000 |
| Lending interest income | $100,000 |
| Total income | $600,000 |
| Tech company tax | $96,750 |
| Lending company tax | $50,170 |
| Total tax | $146,920 |
| After-tax cash | $453,080 |
What happens:
- CRA classifies lending as passive income (no employees = Specified Investment Business)
- Passive income triggers grind-down of Small Business Deduction
- Tech company loses half its tax break
- Extra cost: $35,750 permanently plus $50,170 on lending income
Option B: Corporate Class Investment
| Tech company profit | $500,000 |
| Investment growth (unrealized) | $100,000 |
| Taxable distribution (~0.5%) | $5,000 |
| Total income | $605,000 |
| Tech company tax | $61,000 |
| Investment tax | $1,250 |
| Total tax | $62,250 |
| After-tax cash | $542,750 |
What happens:
- Growth is mostly unrealized (no tax until sold)
- Minimal annual distributions (0.5% vs. 100% with lending)
- Tech company keeps full Small Business Deduction
- Year 1 savings vs. lending: $84,670
The 10-Year Picture
Lending
Year 1 tax$146,920
Year 10 tax$146,920
Total tax (10yr)$1,469,200
Fund value (Yr 10)~$2,000,000
Investing
Year 1 tax$62,250
Year 10 tax$82,537
Total tax (10yr)$725,373
Fund value (Yr 10)$2,158,925
Total Net Effect (Investing vs Lending)
Tax saved over 10 years: $743,827
Extra wealth built: $158,925
Combined advantage of investing vs new business: $902,752
Given this advantage, why put time, effort and capital into a lending business?
Illustrative only. Assumptions: 8% annual return, 0.5% taxable distributions, Quebec tax rates 2026. Source: Internal analysis.
Already started a capital-based business?
Calculate your actual tax cost vs. the investment alternative.
Review My StructureWhy This Happens: The Passive Income Grind-Down
The Rule
For every $1 of passive income over $50,000, you lose $5 of Small Business Deduction room.
Samuel's situation:
Passive income: $100,000
Threshold: $50,000
Over threshold: $50,000
SBD reduction: $50,000 × 5 = $250,000
Translation: OpCo gets the low rate (12.2%) on only $250k instead of $500k. The other $250k is taxed at 26.5%. Extra cost: 14.3% × $250k = $35,750 per year, every year.
Why 86% of $100k Disappears
LendCo pays ~$50k tax on $100k income. OpCo pays an extra ~$36k due to the grind-down. Total extra tax: ~$86k. Net benefit: $100k − $86k = $14,080.
This example is illustrative only. Assumptions: Quebec tax rates 2026. Source: Internal analysis.
The Escape Hatch: 6+ Employees
The Only Way to Make Lending "Active"
Employ more than 5 full-time employees in the lending company. Then interest income becomes "active business income," no passive income grind-down, and both companies share the $500k SBD limit.
The trade-off: To save $73,720/year in taxes, you need 6+ full-time, arm's-length employees with legitimate business justification. If 6 employees cost $60k each ($360k total), the math doesn't work. The employees must be genuinely required for the business.
Risk and Liquidity Comparison
Lending Business
- Liquidity: low (capital tied up 1–5 years)
- Credit risk: high (borrower defaults)
- Operational burden: high
- Tax efficiency: poor (without 6+ employees)
- Control: high
Corporate Class Investment
- Liquidity: high (sell anytime)
- Risk: market volatility
- Operational burden: none
- Tax efficiency: excellent
- Control: low (passive)
If You Have Already Started: Options and Constraints
Several strategies exist to reduce the tax burden, but each has limits.
Bonus Down
Pay salary from OpCo to reduce profit below the grind-down limit. Constraint: you accelerate personal tax instead of deferring. You pay now rather than later.
Recharacterizing (Service Fees)
Charge origination or admin fees instead of interest. CRA is strict; you typically still need 6+ employees for "active" treatment.
MIC or IPP
Mortgage Investment Corporation or Individual Pension Plan. Can help, but complex to set up. MIC needs 20+ shareholders; IPP has age and contribution rules.
The Real Question (For You)
Do you want to build a lending business, or do you want to deploy capital tax-efficiently?
If you've already started a capital-based business (like Samuel):
- Calculate your actual tax cost vs. the investment alternative
- Evaluate whether hiring 6+ employees makes business sense
- Consider if the operational benefits justify the tax penalty
- Explore restructuring options with your CPA
If you're considering a capital-based business:
- Build a lending/real estate business → Plan for 6+ employees from day one, or accept the tax cost
- Deploy capital efficiently → Corporate class funds (or similar structures) are simpler and more tax-efficient
Don't start a lending or real estate business just because you have cash to invest. The tax penalty is significant unless you're committed to building a real operation with 6+ employees.
Key Takeaways
- Capital-based businesses trigger passive income rules if you have fewer than 6 employees (the rule is "more than 5")
- Passive income affects your operating company's tax rate through the grind-down penalty
- Tax-efficient investing often beats business expansion for deploying retained earnings
- The grind-down is permanent: $35,750/year extra tax on OpCo, every year
- If you have already started: calculate the cost and explore restructuring options
- Before launching new ventures: model the tax impact with your CPA first
Want to see your own numbers?
Request a structure review: [email protected] | (514) 575-6123
Review My StructureAssumptions used: Quebec tax rates 2026 (SME 12.2%, General 26.5%, Passive 50.17%). Investment return: 8% annually. Taxable distributions: 0.5% annually. All earnings retained in corporations. OpCo qualifies for Quebec SME rate (5,500+ remunerated hours). Fidelity Global Innovators Class is rated high risk. Past returns do not guarantee future performance.
This is educational content, not advice. Work with your CPA, lawyer, and licensed advisor. Mutual funds through WhiteHaven Securities Inc. Insurance through iAssure Inc.