Passive income is income that is derived from the ownership of capital property or assets that generate income without excessive effort on the part of the stakeholder. Most of the time, passive income is considered taxable income in Canada. Sources of income where you actively have to work is considered “active business income”.
Passive Income Canada – Investments
One of the most common methods of earning passive income is through the ownership of financial investments. Low-risk investments like Guaranteed Investment Certificates (GICs) and personal savings accounts are typically low-yield sources of passive income where the owner earns small amounts of interest proportionate to the amount of money invested. Moderate-risk investments like dividends from shares of a corporation are also passive income. All passive income earned through investments that are part of a non-registered investment plan or portfolio are considered to be taxable income in Canada.
Registered plans like Tax-Free Savings Accounts (TFSAs) or Registered Retirement Savings Plans (RRSPs) may fully or temporarily shield investment earnings from inclusion in the income of the Canadian taxpayer. TFSAs allow investors to accrue tax-free earnings, so long as the taxpayer’s TFSA contribution limit is not exceeded. By contrast, RRSPs earn taxable passive income while allowing the taxpayer’s annual RRSP contributions to be fully deducted from the taxpayer’s taxable income for the tax year in which the contribution was made. The contributions and accumulated interest are then taxed at the marginal rate of the taxpayer upon their withdrawal.
Passive Income Canada – Rental Properties
Income earned through the leasing of a rental property is another prevalent method of generating passive income. While rental income is considered taxable income in Canada, passive income from a rental property allows taxpayers to deduct many expenses associated with the earning of the rental income. These deductions include most repairs, most energy costs (if the landlord is the payor), and even the interest portion of the taxpayer’s mortgage payment.
It is possible for rental income to be considered active business, but the vast majority of the time it is passive. Please give us a call if you would like to know more.
Passive Income Canada – Online
Online platforms have become an increasingly popular method of earning passive income in Canada. Earning money online can be done independently through one’s own website or through partnership with affiliates.
For example, a YouTube creator may generate passive income through the profit-sharing of the advertising revenue generated from the video. This is typically proportionate to the viewership garnered by the video. He or she may also generate income by establishing independent affiliation with other companies. If, for example, the YouTube creator is a product reviewer and hyperlinks products from their affiliates in the description boxes below their videos, any resulting sales from viewers who clicked the product hyperlinks result in royalties for the YouTube creator. A creator may still be earning significant amounts passive income from videos years after the initial release of their videos, as people continuing to view the videos and purchase the products will continue to generate income for the creator.
This is just one example of how web-based passive income can supplement taxpayer income or, in some cases, become the primary source of a taxpayer’s income.
Passive Income Canada – Corporations
It is likely that an income source’s characterization as either “active” or “passive” for income tax purposes is most important in the corporate context. Many corporations own shares in other corporations simply as a means to generate passive income. This presents issues for tax policymakers who want to incentivize economic growth through tax incentives for small businesses, but who are also concerned with issues of neutrality and fairness.
Canadian-Controlled Private Corporations (CCPCs), are able to access the Small Business Deduction on “active business income” (up to a maximum of $500,000 annually and pursuant to other eligibility criteria). However, the CRA does not allow CCPCs to apply the Small Business Deduction to reduce their income tax payable on income earned through investments, as investment income does not qualify as “active business income”. By not allowing passive investment income to be deducted under the Small Business Deduction, the Canadian government dissuades individuals who have controlling interests in corporations from transposing their personal investment portfolios from their personal asset pool into their corporation’s in order to garner the Small Business Deduction and pay less tax on their investment earnings.
With the exception of inter-corporate dividends, passive income earned by CCPCs (or any corporation in Canada) is ineligible for deductions and consequently fully taxable at the corporation’s combined provincial and federal tax rate. This is frequently higher than the marginal tax rate payable by the individual which reduces the desirability of incorporating one’s investment portfolio.
Now, CCPCs also have to be careful not to trigger potential consequences that may stem from the new rules regarding passive income and the small business deduction limit.
The difference between passive income, and active income can have a huge difference in the amount of taxes you end up paying. If you want to know how to turn your passive income into active income, call us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.