Generally, interest income earned in a corporation is taxed at 45.67% as it is considered passive income. Passive income is a return on invested capital in which there is little or no activity required to produce the return. This type of interest is added to the aggregate investment income pool for determining the amount of Refundable Dividend Tax On Hand (RDTOH) available. In some instances, interest income can be taxed at the active business income rate of 13.5% (for BC Canadian Controlled Private Corporations on the first $500,000). In order for this tax treatment to apply, the interest income must be considered to be incidental income. Incidental investment income is investment income that is earned as a result of the ordinary operations of the business. Incidental income is not added to aggregate investment income and not subject to RDTOH. Two examples of incidental income:

1. The corporation earns interest income on its operating chequing account. This is considered incidental income as the company is not purposely putting money aside to earn interest income. Rather the money is accumulated to cover short-term operating costs.
2. The corporation earns interest income on investments in which the company’s main purpose of holding the investment is to segregate customer deposits that it has received from regular operating funds. Since the investment is held primarily for the purpose of generating income from its active business (i.e. securing future sales through customer deposits), the interest income earned from the investments would be considered active business income.

Therefore, in determining the tax treatment of interest income, it must first be determined why the interest income is being earned. Is the purpose of the investment to earn interest income or is the interest income a result of an activity required for the business.

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Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.