What the 12.2% rate is actually for
The small business deduction gives a Canadian-controlled private corporation a combined Ontario rate of roughly 12.2% on its first $500,000 of active business income; above that, the general rate is about 26.5%. Against a top personal rate of 53.53%, retaining a dollar in the corporation defers about 41 cents of tax. That deferral is the entire economic case for most consultant corporations, which means it only works if you can genuinely leave money inside. A consultant who bills 160,000 dollars and spends 160,000 dollars gets integration, not magic.
Two conditions sit under all of it. First, the corporation must not be a personal services business: a PSB loses the small business deduction entirely and pays about 44.5%, and one-main-client consultants should read our honest treatment of that risk on the incorporation page before planning anything. Second, the $500,000 limit is shared between associated corporations, so if your spouse runs a corporation and the association rules connect them, there is one limit between you, not two.
Salary, dividends, or the boring blend
For a corporation whose only employee is its shareholder, compensation is a design choice made during the year, not a box filled in at filing time. The mechanics differ more than the totals do:
| Consideration | Salary | Dividends |
|---|---|---|
| Corporate deduction | Yes, reduces corporate tax | No, paid from after-tax profit |
| RRSP room | Builds it, 18% of earned income | Builds none |
| CPP | Both portions paid, pension accrues | No contributions, no accrual |
| Paperwork | Payroll account, monthly remittances, T4 | Directors resolution, T5 once a year |
| Mortgage applications | Lenders read a T4 easily | Usually two years of statements |
| Timing | Fixed through the year | Can be placed in the right year |
Integration keeps the pure tax difference modest, so the decision usually turns on the other columns: whether you want RRSP room and CPP accrual, whether a mortgage renewal is coming, how much administrative cadence you will actually maintain. Most of our one-person clients land on a blend, salary to a deliberate target and dividends for the rest, revisited each year inside Tax Planning & Advisory rather than copied forward.
Retained earnings are a deferral account, not a vault
Money left at 12.2% eventually gets invested, and investment income inside a corporation is taxed at high rates with only a partial refund when dividends are later paid out. The corporation is a deferral vehicle, not a tax-free account, and it comes with a tripwire: once passive investment income passes $50,000 in a year, the federal small business limit shrinks by five dollars for every extra dollar, disappearing at $150,000. Ontario chose not to mirror that grind, which softens the damage but does not remove it.
Planning here is allocation: how much stays corporate and invested, how much comes out annually to fill RRSP and TFSA room, and which investments belong on which side of the wall. For consultants saving aggressively through their thirties and forties, the grind math starts mattering earlier than most expect, and it is cheaper to design for it than to reassess around it.
Bench years are cheap-dividend years
Contract gaps are miserable for cash flow and excellent for tax. A year with four unbilled months lands you in a lower personal bracket, which is exactly when a planned dividend comes out at the lowest cost, when capital gains in the corporate portfolio can be realized against a smaller grind, and when instalments deserve an immediate recalculation instead of quiet overpayment. The same logic runs in reverse: in a stacked year with two overlapping contracts, we hold distributions down and let the corporation absorb the spike at 12.2%.
This is why we treat planning as a standing calendar, not an annual event: a compensation review before year-end, an instalment reset after every filing, and a phone call the week a contract ends, because that week, not April, is when the plan changes.
Source: CRA — Corporation tax rates.
