The SBD "Grind" & Your Corporate Portfolio

Executive Summary

If you're an incorporated business owner with surplus cash invested in your corporation, you need to understand the SBD "grind." Here's what you should know:

• What it is: A tax mechanism that reduces your small business deduction when passive investment income exceeds $50,000
• Why it matters: It can increase your corporate tax rate from ~12-15% (small business rate) to ~26-27% (general rate) on active business income
• The math: For every $1 of passive income above $50,000, you lose $5 of small business deduction
• Who it affects: Canadian-controlled private corporations (CCPCs) earning active business income and holding passive investments
• What to do: Work with your CPA to understand your exposure, then design your investment portfolio to manage the grind while still growing wealth

This article explains the mechanics, provides examples, and outlines strategies to consider with your professional team.

Mindset: Thinking Like a Dynasty

Before diving into the technical details, let's step back and think about this from a dynasty-first perspective.

The SBD grind isn't necessarily a reason to avoid corporate investing. Instead, it's a constraint to understand and work within. Your goal isn't to eliminate all passive income:that would mean leaving corporate cash idle, which loses ground to inflation and represents a different kind of cost.

Instead, think about:

1. Tax drag over decades: A 1-2% difference in tax drag compounds significantly over 20-30 years. Understanding the grind helps you make informed decisions about portfolio structure.

2. Total wealth optimization: Sometimes accepting some grind is worth it if the after-tax returns still exceed alternatives. The key is making this decision consciously, not accidentally.

3. Coordination across accounts: Your corporate portfolio is one piece of a larger puzzle that includes personal accounts (RRSP, TFSA, non-registered), insurance, and estate structures. The grind is one factor among many.

4. Long-term flexibility: Tax rules change. Structures that work today may need adjustment tomorrow. Building a portfolio with awareness of the grind gives you options to adapt.

The mindset shift: from "how do I avoid the grind entirely?" to "how do I optimize total wealth while managing the grind's impact?"

Mechanics: How the SBD Grind Works

The Basic Rule

The Small Business Deduction (SBD) allows Canadian-controlled private corporations to pay a reduced tax rate (typically 12-15% depending on province) on the first $500,000 of active business income. This is a significant tax advantage.

However, this preferential rate is reduced (or "ground down") when the corporation earns passive investment income. Specifically:

• Threshold: When passive investment income exceeds $50,000 in a taxation year
• Reduction: For every $1 of passive income above $50,000, the small business deduction is reduced by $5
• Maximum impact: The small business deduction is fully eliminated when passive income reaches $150,000

What Counts as Passive Investment Income?

For SBD grind purposes, passive investment income includes:

• Interest income from corporate investments (GICs, bonds, savings accounts)
• Rental income (with some exceptions for active real estate businesses)
• Dividend income from portfolio investments (but not dividends from connected corporations in some cases)
• Capital gains (but only 50% of capital gains count toward the grind calculation)
• Royalties and other passive income sources

Important note: Only 50% of capital gains count toward the grind calculation, which is why capital gains are often favored in corporate portfolios. This is one reason corporate-class funds can be valuable:they convert taxable income to capital gains.

The Calculation

Here's how the grind works in practice:

Note: The following example is illustrative only and not a substitute for professional advice. Actual calculations will depend on your specific corporate structure, province, tax rates, and circumstances.

Example Corporation:

• Active business income: $400,000
• Passive investment income: $80,000
• Small business limit (base): $500,000

Step 1: Calculate the reduction

• Passive income above threshold: $80,000 - $50,000 = $30,000
• Reduction amount: $30,000 × $5 = $150,000

Step 2: Calculate the reduced small business limit

• Reduced limit: $500,000 - $150,000 = $350,000

Step 3: Apply tax rates

• First $350,000 of active income: taxed at small business rate (~12-15%)
• Remaining $50,000 of active income: taxed at general rate (~26-27%)

Provincial Variations

The small business deduction limit and rates vary by province:

• Québec: $500,000 limit, ~12% small business rate, ~26.5% general rate
• Ontario: $500,000 limit, ~12.2% small business rate, ~26.5% general rate

The grind mechanism works the same way across provinces, but the actual tax impact depends on your province's rates.

How to Apply: Owner Playbook

Step 1: Understand Your Current Exposure

Work with your CPA to calculate:

1. Current passive income: What did your corporation earn from investments last year?
2. Projected passive income: Based on your current portfolio, what might you earn this year?
3. Active business income: How much active business income do you expect?
4. Grind impact: If passive income exceeds $50,000, how much small business deduction would you lose?

This gives you a baseline understanding of where you stand.

Step 2: Evaluate Portfolio Structure

Review your current corporate investment portfolio:

• What income types are you generating? (Interest, dividends, capital gains)
• What's your current yield? (Total investment income as a percentage of portfolio value)
• Are you using corporate-class funds? (These can convert interest and dividends to capital gains)
• What's your time horizon? (Longer horizons favor capital gains strategies)

Step 3: Consider Strategic Adjustments

Based on your exposure and goals, consider these approaches with your advisor and CPA:

Option A: Manage Income, Not Avoid It

• Focus on capital gains (only 50% counts toward grind)
• Use corporate-class funds to convert interest/dividends to capital gains
• Defer income realization where possible
• Accept some grind if after-tax returns still exceed alternatives

Option B: Reduce Passive Income

• Shift some investments to personal accounts (RRSP, TFSA) if appropriate
• Use insurance products (permanent life insurance) that can grow tax-sheltered
• Consider paying dividends to personal accounts for reinvestment (understanding RDTOH & GRIP implications)
• Keep more cash in operating account (though this has opportunity cost)

Option C: Hybrid Approach

• Maintain a base level of passive income (below $50,000 if possible)
• Structure portfolio to favor capital gains for growth
• Use personal accounts and insurance for additional tax-sheltered growth
• Coordinate across all accounts for total wealth optimization

Step 4: Monitor and Adjust

Tax rules and your circumstances change. Review annually with your team:

• Has passive income changed significantly?
• Have tax rules changed?
• Has your business income changed?
• Are there new strategies or products to consider?

Worked Example: The Impact Over Time

Note: This example is illustrative only and not a substitute for professional advice. Actual results will vary based on your specific circumstances, tax rates, investment returns, and other factors. Always consult with your CPA and financial advisor before making decisions.

Let's look at a concrete example to illustrate the grind's impact.

Assumptions

This example uses the following assumptions:

• Province: Québec
• Small business tax rate: 12%
• General corporate tax rate: 26.5%
• Corporate tax rate on interest income: 50.17%
• Corporate tax rate on capital gains: ~25% (50% inclusion rate × ~50% passive rate)
• Active business income: $400,000 per year (consistent)
• Investment portfolio: $1,000,000 initial value
• Returns are consistent over time (actual returns will vary)
• Tax rates and rules remain constant (actual rates may change)

Scenario

Corporation Details:

• Active business income: $400,000 per year
• Corporate surplus: $1,000,000 to invest
• Province: Québec
• Small business rate: 12%
• General rate: 26.5%

Portfolio Option A: Interest-Heavy Portfolio

• Portfolio: $1,000,000 in GICs and bonds
• Yield: 4% = $40,000 interest income per year
• Passive income: $40,000 (below $50,000 threshold)
• Grind impact: $0
• Active income tax: $400,000 × 12% = $48,000
• Investment income tax: $40,000 × 50.17% (corporate rate on interest) = $20,068
• Total corporate tax: $68,068

Portfolio Option B: Higher-Yield Portfolio

• Portfolio: $1,000,000 generating 6% = $60,000 income
• Passive income: $60,000 (above $50,000 threshold)
• Grind calculation: ($60,000 - $50,000) × $5 = $50,000 reduction
• Reduced small business limit: $500,000 - $50,000 = $450,000
• Active income tax:
  • First $400,000 × 12% = $48,000 (all active income still in small business range)
  • Investment income tax: $60,000 × 50.17% = $30,102
• Total corporate tax: $78,102
• Additional tax vs. Option A: $10,034 per year

Portfolio Option C: Capital Gains Focus

• Portfolio: $1,000,000 in growth-oriented investments
• Realized capital gains: $60,000 per year (6% return)
• Passive income for grind: $60,000 × 50% = $30,000 (only half counts)
• Grind impact: $0 (below $50,000 threshold)
• Active income tax: $400,000 × 12% = $48,000
• Investment income tax: $60,000 × 50% (inclusion rate) × 50.17% = $15,051
• Total corporate tax: $63,051
• Savings vs. Option B: $15,051 per year

The Long-Term Impact

Over 20 years, assuming the portfolio grows and generates consistent returns:

• Option A (low yield, no grind): After-tax value depends on reinvestment and growth
• Option B (higher yield, some grind): Additional $10,000+ per year in tax drag
• Option C (capital gains focus): Lower tax drag, potentially higher after-tax wealth

The key insight: Structure matters as much as yield. A 4% capital gains portfolio may outperform a 6% interest portfolio after taxes.

Important Reminder: This example is illustrative only. Your actual results will depend on your specific corporate structure, province, tax rates, investment returns, and other factors. Always work with your CPA and financial advisor to understand how these concepts apply to your situation.

Decision Checklist

Use this checklist to assess whether the SBD grind is relevant to your situation:

Corporate Structure:

• [ ] Is your corporation a Canadian-controlled private corporation (CCPC)?
• [ ] Does your corporation earn active business income?
• [ ] Does your corporation have surplus cash invested (or available to invest)?

Current Passive Income:

• [ ] Do you know your corporation's passive investment income from last year?
• [ ] Is it above $50,000, or likely to exceed $50,000?
• [ ] Have you calculated the potential grind impact?

Portfolio Review:

• [ ] Have you reviewed your corporate portfolio's income composition?
• [ ] Do you understand what income types you're generating (interest, dividends, capital gains)?
• [ ] Have you considered corporate-class funds or other tax-efficient structures?

Professional Coordination:

• [ ] Have you discussed the grind with your CPA?
• [ ] Have you reviewed your investment strategy with your advisor?
• [ ] Do you have a plan to monitor and adjust as circumstances change?

If you checked most items: The SBD grind is likely relevant to your situation, and you should work with your professional team to understand your exposure and optimize your strategy.

Fact-Check & Sources

Official Government Resources

• Canada Revenue Agency (CRA): Small Business Deduction
• CRA: Passive Investment Income Rules
• Revenu Québec: Small Business Deduction (French)

Tax Legislation

• Income Tax Act, Section 125: Small Business Deduction
• Income Tax Act, Section 125(5.1): Reduction of small business deduction for passive investment income

Related Articles

• RDTOH & GRIP for Owner-Managed Corporations - Understanding refundable tax mechanisms
• CDA 101: The Capital Dividend Account Explained - Tax-sheltering strategies for corporations
• Corporate Investing Services - How we help incorporated owners structure portfolios