Reviewing Common T2 Schedules

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By L.Kenway BComm CPB Retired

Published July 3, 2024 | Edited July 14, 2024

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Order to Review | Part I Tax Payable Calculation (includes example) | T2Sch1 | T2Sch2 | T2Sch3 | T2Sch4 | T2Sch6 | Difference Between ACL and ABIL | T2Sch7 | Free Tax Textbook

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Small Business Common T2 Schedules

For this article, I've compiled a list of common T2 schedules that may be applicable to an average small business in Canada. I'll show you how to review your T2 return which involves understanding the various schedules required to correctly calculate your income tax payable. Because it's complex, I'll also show you how Part I federal tax payable is calculated. Let's learn how your corporation is taxed.

Business Loan Reviewing Corporate Tax ReturnHow to review common T2 schedules

In What Order Do You Review Your T2 Schedules?

Preparing a T2 corporate income tax return can be complex, especially for a Canadian-Controlled Private Corporation (CCPC) with multiple income types and connections with other companies. That's why it's in your best interest to have your accountant prepare this return for you.

That said, it's always good to know how to review the T2 once prepared. It will give you a better idea of how your business is taxed. Before your accountant can prepare your return, you need to collect information to take to your accountant.

  • Ensure all year-end adjustments are made, including depreciation, inventory adjustments, and expense accruals. Check your engagement letter, as your accountant may do this for you.
  • Collect all financial statements and relevant documentation, such as the income statement, balance sheet, statement of cash flow, and statement of retained earnings. Don't forget to include your Aged A/R and A/P summaries.
  • Ensure all documentation to support the salary and dividends paid to the owner-manager are provided, including T4 slips for salary and T5 slips for dividends. If you can't find them, sign into your CRA My Account and download the information from there. It should all be online by the end of March.

Here’s a systematic step-by-step approach to help a small business person review their accountant prepared T2 return. Let's take a look at the most common T2 Schedules you'll find in your T2 return before you sign.

1. Look at Schedule 100 (Balance Sheet Information): The information on this schedule should match your company's balance sheet.

2. Look at Schedule 125 (Income Statement Information): The information on this schedule should match your company's income statement.

3. What's happening on Schedule 8 (Capital Cost Allowance):

  • This schedule calculates the Capital Cost Allowance (CCA) for depreciable property.
  • Check to ensure all your capital assets and dispositions were captured by the accountant. Did the accountant claim or not claim CCA this year?

More >> Learn about CCA and why you may not want to make a full CCA claim on your tax return every year.

4. How was Taxable Income calculated?:

  • Net Income for tax purposes is calculated on Schedule 1. This schedule reconciles the net income (loss) for accounting purposes with the net income (loss) for tax purposes. 
  • The tax program will have calculated Schedule 1 using information from Schedules 100 and 125. 
  • You should notice that the accounting net income was adjusted by adding or subtracting items that were not taxable or not deductible.

More >> Schedule 1

5. Do you have passive income?:

  •  Schedule 7 divides your corporate income into taxable "buckets" so that the tax payable can be calculated correctly.
  • If you don't have passive income (aggregate investment income - AII), then this schedule does not need to be completed.
  • Check to see if the aggregate investment income from your investments such as interest, dividends, and capital gains is what you expected it to be.
  • Check the SBD (small business deduction) calculations. Is the ABI (active business income) what you were expecting?

More >> Schedule 7

6. Review Schedule 50 (Shareholder Information): Verify the details of shareholders are reported correctly; particularly the owner/manager who may be an employee as well as a shareholder .

7. Did you dispose of any capital property in the year that attracted a capital gain or loss?:

Check Schedule 6 (Summary of Dispositions of Capital Property) to see that any capital gains and losses from the disposition of capital property have been reported and the information  is what you were expecting.

More >> Schedule 6

8. Schedule 3 (Dividends Received, Taxable Dividends Paid, and Part IV Tax) is where you report any dividends paid or received:

  • Check the details on dividends received and paid, including eligible, ineligible, and capital dividends reported. Is it what you were expecting?
  • This schedule calculates Part IV tax on dividends received from connected corporations.

More >> Schedule 3

9. Review Schedule 23 (Agreement Among Associated Corporations to Allocate the Business Limit):

  • You will only see this schedule if the corporation is connected with other companies.
  • This schedule shows the allocation of the SBD limit that must be shared between the companies.
  • If you have a Schedule 23, you may also have Schedules 4, 9, and 23 for Inter-Company Transactions. If there are any inter-company loans or transactions, ensure they are reported accurately.

10. Other Schedules as Required: Depending on the specifics of the corporation, other schedules may be required such as Schedule 31 for Investment Tax Credit, Schedule 21 for Federal and Provincial or Territorial Taxes Payable, etc..

11. Sign Return: Once you have reviewed the return for accuracy and completeness, sign the return so your accountant can e-file it on your behalf.

T2 Part I Tax Payable Calculation for a CCPC

This is to help you understand the importance of various sources of income a CCPC must track to calculate the correct amount of Part 1 tax payable. Public corporations are not affected by the Additional Refundable Tax (ART) or the Small Business Deduction (SBD).

More >> What is ABI?

    1. Calculate tax payable at the general corporate tax rate [Basic Part I Tax] @ 38% per ITA 123(1). Calculated on T2 Jacket.
    2. Deduct federal abatement for Provincial Tax @ 10% per ITA 124(1) [Income earned outside Canada is not eligible]. Calculated on Schedule 13.
    3. Deduct small business deduction 19% per ITA 125(1) [applicable if ABI under $500,000 limit; taxable ABI income eligible for SBD]. Calculated on Schedule 7.
    4. Deduct M&P deduction 13%  per ITA 125.1 [applicable if M&P income over SBD limit]. Calculated on Schedule 21.
    5. Deduct the general rate reduction 13% per ITA 123.4(2)[applicable if ABI over $500,000 limit - I.E. general rate reduction applies to active business income (ABI) not eligible for SBD;  taxable income not impacted by SBD or AII]. Calculated on Schedule 27.
    6. Add additional refundable tax (ART) on CCPC Aggregate Investment Income (AII) @ 10.67% per ITA 123.3 (applicable on investment income). Calculated on Schedule 7.
    7. Total Federal Part I Tax = #1 - #2 - #3 - #4 - #5 + #6

Example Using 2023 Rates:

A CCPC with a December 31st year-end, has active business income of $200,000 in 2023 all of which is earned in Canada and $50,000 aggregate investment income. It is associated with two other corporation. Its share of the annual SDB limit is $100,000. Determine the company’s federal tax payable for the year ending December 31, 2023.

Calculation by the different sections of the ITA:

  1. Basic Part I Tax = ($200,000 ABI + $50,000 AII) x 38% = $95,000
  2. Less: Federal Abatement = $250,000 x 10% = ($25,000)
  3. Less: SBD = $100,000 x 19% = ($19,000)
  4. Less: General Rate Deduction = ($200,000 ABI - $100,000 SBD) x 13% = ($13,000)
  5. Add: Additional Refund Tax (ART) = $50,000 x 10.67% = $5,335
  6. Total Federal Part I Tax Payable = $95,000 - $25,000 - $19,000 - $13,000 + $5,335 = $43,335

An alternative calculation is identifying by the different types of income:

  1.  Apply SBD on ABI = $100,000 x 9% = $9,000 where 9% = 38% -10% - 19%
  2. Apply General Corporate Rate on remaining ABI = ($200,000 - $100,000) x 15% = $15,000 where 15% = 38% - 10% - 13%
  3. Apply ART to AII = $50,000 x 38.67% = $19,335 where 38.67% = 38% - 10% + 10.67%
  4. Total Federal Part I Tax Payable = $9,000 + $15,000 + 19,335  = $43,335 where refundable portion is not immediately refunded but held in RDTOH for future dividend payouts

In the future when a dividend is paid out, they will receive a tax refund:

  1. Apply RDTOH to AII = $50,000 x 30.67% = ($15,335) where 30.67% = 38% - 10% + 10.67% - 8% [refundable when dividends are paid out of RDTOH]
  2. Adjusted Total Federal Tax Payable After Dividend = $9,000 + $15,000 + ($19,335 - $15,335) = $28,000 where the $15,335 refundable portion was not immediately refunded but held in RDTOH for future dividend payouts





Common T2 Schedules Used by Small Business Owners

Schedule 1 - Net Income

Schedule 1 is an integral schedule to the T2 income tax return in Canada for corporations. Its primary purpose is to reconcile the net income (or loss) for accounting purposes, as reported on the corporation's financial statements, with the net income (or loss) for tax purposes, which is required to calculate the corporation's taxable income according to the Income Tax Act.

This reconciliation is crucial because financial accounting rules and tax rules often have different objectives and standards, leading to disparities between accounting income and income calculated for tax purposes. Schedule 1 ensures that these differences are systematically addressed to arrive at the correct amount of income that should be taxed.

Here’s how Schedule 1 works:

1. Adjusting Accounting Income to Taxable Income:

  • The starting point for Schedule 1 is the net income before taxes from the corporation’s financial statements.
  • Various adjustments are then made to this figure to convert it from accounting income to taxable income.
  • The ending point is net income for tax purposes.

By the end of Schedule 1, the result is the corporation's net income for tax purposes, which then forms the basis for computing taxable income subject to further deductions, additions, and tax calculations as required by other parts of the T2 form.

2. Non-Deductible Items:

Certain expenses that are permitted under accounting rules are not allowed for tax purposes, so they need to be added back to net income. You'll find a complete list on lines 101 to 199 on the Schedule 1. Common examples include:

  • income tax expense,
  • CRA interest and penalties on taxes,
  • accounting depreciation,
  • loss on disposal of assets,
  • taxable capital gains (from Schedule 6),
  • non-deductible portion of club dues, meals and entertainment,
  • non-deductible auto expenses,
  • non deductible life insurance premiums, and
  • reserves for accounting purposes that are not allowed for tax purposes.


3. Tax Deductible Items Not in Accounting Income:

Some items are deductible for tax purposes but do not affect accounting income. These need to be subtracted from the accounting net income. You'll find a complete list on lines 401 to 499 on the Schedule 1. Examples include:


4. Other Adjustments:

There are additional adjustments that may pertain to different tax rules and incentives. For instance, adjustments for scientific research and experimental development (SR&ED) tax credits, various government incentives, or other specific tax treatments.

Common T2 Schedules

Schedule 2 - Charitable Donations and Gifts

Schedule 2, also known as the "Charitable Donations and Gifts" schedule, is a common T2 schedule for small businesses in Canada that make charitable donations. Its primary purpose is to keep track of all the donations and gifts your corporation made during the tax year. It figures out how much you are eligible to claim as deductions or tax credits.

Schedule 2 helps keep things clear and straightforward when it comes to donations by making sure corporations provide detailed documentation and reports. This way, everything stays transparent and follows Canadian tax rules about charitable contributions. You’ll need to include official receipts and information about who received the donations.

Here’s an overview of  Schedule 2:

  • Corporations that make charitable donations or gifts must detail these on Schedule 2. Entries include gifts to registered charities, Canadian amateur athletic associations, registered Canadian municipalities, and certain other qualified donees.
  • The schedule calculates the eligible amount of charitable donations and gifts that can be claimed. This involves determining the lesser of the actual donation amount or 75% of the corporation’s net income before donations.
  • If the corporation’s total donations exceed the maximum allowable amount for the current tax year, the excess amount can often be carried forward for up to five years. Part 6 of the Schedule 2 tracks these carry forward amounts for you so you can apply them to future tax returns.
  • The schedule calculates the federal tax credit for charitable donations.

Common T2 Schedules

Schedule 3 - Dividends Received, Taxable Dividends Paid, and part IV Tax Calculations

Schedule 3, also known as the "Dividends Received, Taxable Dividends Paid, and Part IV Tax Calculations" schedule. This common T2 schedule's main purpose is to report dividends that a corporation receives and pays out, and to calculate any associated Part IV tax.

This schedule helps you (1) accurately report dividend income and payments, (2) calculate any Part IV tax liabilities, (3) ensure compliance with tax rules on inter-corporate dividends, and (4) facilitate dividend refunds where applicable. The objective of this schedule is to ensure the tax system fairly accounts for income derived from, and paid out as, corporate dividends, maintaining the integrity of the tax system and preventing undue tax advantages or burdens.

Relationship with Schedule 1 (Reconciliation of Net Income for Tax Purposes):

  • Dividends received that are reported in Schedule 3 need to be integrated into Schedule 1. For example, dividends from Canadian corporations that are not subject to Part IV tax or those subject to preferential treatments must be added to the net income for tax purposes in Schedule 1.
  • If Part IV tax applies, the amount of taxable dividends and the corresponding refundable tax under subsection 129(3) must be considered in the adjustments made within Schedule 1.

Relationship with T2 Jacket:

  • The dividends received and detailed in Schedule 3 need to be accurately reflected in the corresponding lines of the T2 jacket. For example, line 320 on the T2 jacket reflects dividends received from taxable Canadian corporations.
  • The Part IV tax calculated on Schedule 3 is reported on line 712 of the T2 jacket. This integrates the refundable tax aspects into the overall tax calculation.
  • Refundable Dividend Tax on Hand (RDTOH) information from Schedule 3 impacts the RDTOH reported on Schedule 3, line 450 of the T2 jacket, and potentially line 360 if there is a dividend refund claim.

Here’s a detailed breakdown of Schedule 3:

1. Reporting Dividends Received: Under Section 112 of the ITA, corporations must report any taxable dividends they receive from other corporations. The section 112 deduction allows the Canada Revenue Agency (CRA) to track inter-corporate dividend flows and ensures that these amounts are considered when determining tax liability.

2. Reporting Taxable Dividends Paid: Corporations that pay taxable dividends to their shareholders must report these dividends on Schedule 3. This information is needed for the CRA to verify shareholders' reported income and to ensure appropriate tax treatment of these payments.

3. Part IV Tax Calculation: Part IV tax applies to certain types of dividends received by a corporation. Specifically, it can apply to dividends from non-connected corporations. Schedule 3 helps determine if Part IV tax applies, based on the relationship between the dividend-paying and dividend-receiving corporations and other specific factors set out under the Income Tax Act.

More >> Section 112 and main purpose of Refundable Part IV Tax

4. Integration with Dividend Refunds: Schedule 3 also aids in determining if the corporation is eligible for a dividend refund. When corporations pay enough taxable dividends to their shareholders, they may be entitled to a refund of Part IV tax paid on dividends received. This ensures the integration principle, preventing double taxation within corporate groups. The amounts reported on Schedule 3 feed into the calculations for the corporation’s "Dividend Refund Account", affecting the amounts of tax refunds on dividends that can be claimed.

More >> What is the RDTOH and how does it work?

Common T2 Schedules

Schedule 4 - Corporation Loss Continuity and Application

Schedule 4 is another common T2 schedule. It is titled "Corporation Loss Continuity and Application." Its primary purpose is to help corporations track and properly apply various types of losses incurred during different tax years. This ensures that losses are carried forward or back as permitted by tax legislation, thus optimizing the corporation's tax position.

Corporations use Schedule 4 to track different types of losses, such as non-capital losses, net capital losses, and restricted farm losses, among others. This historical tracking is necessary for determining the amounts available for carryforward or carryback. 

This common T2 schedule is a tool for corporations to manage their losses effectively. It allows for accurate tracking, proper application of various types of tax losses, and ensures compliance with Canadian tax regulations. This can lead to significant tax savings and better financial planning for the corporation.

Here’s a detailed look at the various loss components of Schedule 4:

  • Non-Capital Losses: Includes business losses, property rental losses, and allowable business investment losses (ABIL). These can generally be carried back three years or forward up to twenty years.
  • Net Capital Losses: Pertains to capital transactions such as the sale of investments or property (other than inventory). These losses can only be applied against capital gains and can be carried back three years or forward indefinitely.
  • Restricted Farm Losses and Other Specified Losses: These are specific losses that have different rules and limitations for carry forward and carry back and must be tracked according to the applicable provisions.

Application of Losses

  • Schedule 4 is used to record how the corporation is applying these losses against income in the current tax year or carrying them back to a previous year. This application can reduce taxable income, thereby lowering the corporation’s tax liability.
  • Corporations can choose whether or not to deduct an available loss from income in any order in a taxation year. It is usually best to deduct the oldest available loss first to minimize the amount of loss carry forwards that expire.


Use Schedule 4 for Tax Planning

Schedule 4 allows corporations to plan their tax strategies better, reducing tax liability over multiple years. By optimizing the timing and method of applying losses, corporations can improve their financial stability and cash flow management.

Common T2 Schedules

Schedule 6 - Summary of Dispositions of Capital Property

A common T2 schedule is Schedule 6. It is used for reporting dispositions of capital property under Section 54 of the ITA. Its primary purpose is to provide a detailed summary of all capital properties disposed of by the corporation during the tax year. It calculates the capital gains or capital losses from these dispositions. Capital gains receive favourable tax treatment.

Corporations must report each disposition of capital property, which can include shares, bonds, land, buildings, and other capital assets. This means you have to enter in details about the transaction(s). Tracking investments using a program like Quicken® makes it easy to enter investment related data required for this form. Your T5008 statement is also useful when preparing this schedule.

Relationship with Schedule 1 (Reconciliation of Net Income for Tax Purposes):

  • The capital gains (losses) calculated in Schedule 6 must be included in Schedule 1. Specifically, the taxable capital gains (after applying the inclusion rate, 50% before June 25, 2024, 66.67% after June 24, 2024) are added to the accounting income in Schedule 1. This ensures the gains are properly reflected in the corporation's net income for tax purposes.
  • Any allowable capital losses from Schedule 6 may be used to offset capital gains, which would also influence the amounts reported in Schedule 1.

Relationship with T2 Jacket:

  • The details from Schedule 6 feed into the pertinent sections of the T2 jacket. For example, line 135 on the T2 jacket captures net capital gains (or line 197 for capital gains from dispositions of securities).
  • Note: the net income (loss) for tax purposes calculated in Schedule 1 (which includes adjustments for capital gains/losses from Schedule 6) affects the amount reported on line 300 of the T2 jacket.

Here's a breakdown on what data to enter so the gain or loss can be calculated:

  • Enter the proceeds of disposition (POD) received from each sale. It could also be the result of proceeds from an insurance claim due to an expropriation, damaged or stolen property.
  • Record the adjusted cost base (ACB) of each disposed property, which represents the original cost plus any adjustments (such as additional costs incurred after the property was acquired). The ACB of the property can be (1) the actual cost, (2) a deemed cost, or (3) the V-day (valuation day) value of the property. Circumstances determine which value is used.
  • Include any expenses directly related to the sale of the property, such as legal fees, commissions, repair costs, land transfer taxes, and other reasonable selling expenses.

Calculating Capital Gains or Losses For Each Type Of Property:

  • POD
  • - ACB
  • + or - Adjustments
  • = Net capital gain or net capital loss
  • x Inclusion Tax Rate 50% (66.67% after June 25, 2024)
  • = TCG (taxable capital gains) or ACL (allowable capital loss)


The TCG portion of these gains is included in the corporation’s income for tax purposes. If applicable, Schedule 6 can also be used in conjunction with other schedules to apply net capital losses carried forward from previous years to offset current year capital gains.

The TCG is entered on line 113 of Schedule 1.

Example 1: Disposition of a Building and Associated Land

Scenario:
A corporation sells a building and the land it is on for total proceeds of $1,000,000. The original purchase price (adjusted cost base or ACB) of the building and land was $700,000, and the corporation incurred $50,000 in related selling expenses (e.g., legal fees, real estate commissions). For simplicity, there was no depreciation taken on the building. Land is not a depreciable assets. Assume the sale was before June 25, 2024.

Calculation:

  • Proceeds of Disposition (POD): $1,000,000
  • - Adjusted Cost Base (ACB): $700,000
  • - Selling Expenses: $50,000
  • = Net Capital Gain: $250,000
  • x 50% inclusion tax rate
  • = Taxable Capital Gain (TCG) $125,000

The corporation has realized a TCG of $125,000 from the disposition of the building and land.

Example 2: Disposition of Shares in a Publicly Traded Company

Scenario:
A corporation sells 1,000 shares of a publicly traded company that is not connected to it for proceeds of $70,000. The adjusted cost base of these shares was $100,000, and the corporation incurred $1,000 in brokerage fees. Assume the sale was after June 25, 2024.

Calculation:

  • Proceeds of Disposition (POD): $70,000
  • - Adjusted Cost Base (ACB): $100,000
  • - Selling Expenses: $1,000
  • = Net Capital Loss: $31,000
  • x 66.67% inclusion tax rate
  • = Taxable Capital Loss (ACL) $20,668 rounded

The corporation has realized an ACL of $20,668 from the disposition of the shares.

The ITA allows the ACL to be applied against the TCG therefore the net (adjusted) taxable capital gains carried forward to Schedule 1 would be $104,332 ($125,000 - $20,668). If the ACL had been greater than the TCG, a net capital loss (NCL) would have been created and could be applied in future years.

Difference Between ACL and ABIL

Allowable Capital Loss (ACL)

An ACL represents 50% of the capital loss incurred on the sale of capital property, such as shares in a publicly traded company, land, or buildings.

ACLs can be used to offset taxable capital gains (TCG) but cannot be deducted against other types of income. Unused ACL can be carried back for three years or carried forward indefinitely to apply against future capital gains.

ACL Example -  A corporation sells shares of a publicly traded company for a loss. Assume a capital loss of $10,000 x 50% inclusion tax rate = $5,000 ACL

The $5,000 ACL can offset TCG but not other types of income.



Allowable Business Investment Loss (ABIL)

An ABIL is a special type of capital loss arising from a disposition of certain types of properties, such as shares* or debts of a small business corporation. *This happens if you sell your incorporated business (i.e. the shares) as opposed to selling the assets of the business for a loss creating a business investment loss (BIL).

ABIL can be deducted against any type of income, not just capital gains. This makes ABIL more flexible and beneficial compared to ACL.

Like ACL, ABIL can be carried back three years. However, it can only be carried forward up to ten years. After ten years, any remaining ABIL converts into a net capital loss that can be carried forward indefinitely but can only be applied against capital gains.

ABIL Example -  A corporation writes off an uncollectible loan made to a small business corporation. They have documented their attempts at collection to prove it is an uncollectible debt. Assume a business investment loss (BIL) of $10,000 x 50% inclusion tax rate = $5,000 ABIL

The $5,000 ABIL can offset not just capital gains but any taxable income, such as business income or rental income.

KEY TAKEAWAYS

  • ACL offsets only taxable capital gains and can be carried forward indefinitely.
  • ABIL is more flexible, offsetting both taxable gains and other income types, and has a different carry-forward period.


Common T2 Schedules

Schedule 7 - Aggregate Investment Income and Income Eligible for the Small Business Deduction

The next common T2 schedule we will examine in this article is Schedule 7. The primary purpose of Schedule 7 is to separate and keep track of a Canadian Controlled Private Corporation’s (CCPC) income into Active Business Income (ABI) and Aggregate Investment Income (AII). This separation is crucial because different tax treatments apply to these types of income.

It is used to calculate the Aggregate Investment Income (AII) and the Refundable Portion of Part I Tax. This schedule is critical for corporations that earn income from investments, separate from their active business income (ABI). Understanding how Schedule 7 works is important for corporations to ensure compliance with tax regulations to claim the small business deduction (SBD) properly. 

More >> ABI Exclusions

Key Objectives of Schedule 7:

  1. Determination of Active Business Income (ABI): ABI qualifies for the Small Business Deduction (SBD), which lowers the federal tax rate on the first $500,000 (subject to phase-out based on taxable capital) of ABI for CCPCs.
  2. Determination of Aggregate Investment Income (AII): AII is generally taxed at higher rates compared to ABI. It includes income such as taxable capital gains, interest, dividends received from non-connected corporations, and rental income. It helps in calculation of refundable taxes, such as Refundable Dividend Tax on Hand (RDTOH).
  3. Determination of ABI Available for Small Business Deduction (SBD)
  4. Identifying any business limits.

Relationship with Schedule 1 (Reconciliation of Net Income for Tax Purposes):

While Schedule 1 is used to reconcile accounting net income to net income for tax purposes, it takes into account adjustments that affect both active and passive income.

Relationship with T2 Jacket:

The T2 jacket is the main form for corporate income tax returns, which ties together various schedules to provide a summary of your corporation’s taxable income and taxes payable. Key lines related to Schedule 7 include:

  • Net Income/Loss: This is derived from Schedule 1 and includes all income, including ABI and AII.
  • Taxable Income: After adjustments and deductions, the net income translates to taxable income in the T2 jacket.
  • Tax Payable Calculation: This incorporates the ABI eligible for the SBD, affecting the overall tax payable.
  • Small Business Deduction (SBD): Part of Schedule 7 calculations (ABI) is used in determining this deduction.


Specific Link to T2 Jacket:

  • Line DD of Part 6 of Schedule 7 flows through to line 400 of the T2 jacket. Line 400 reflects income eligible for the SBD which would include ABI but exclude AII. 

How to Complete Schedule 7 Line-by-Line

I sometimes find this schedule difficult to calculate. The tax program does not automatically complete this schedule. It requires you to input some numbers. You need to know the rules. I always worry that if you do something wrong here, your SBD calculation is affected.  So I'll assume others besides myself may have the same difficulty with this Schedule and do a complete walk through of it.

Let's use the Part I Tax Payable example at the start of this chat to complete a Schedule 7:

Step 1: Calculate ABI:

  • Line 400 - ABI from all sources = $200,000
  • Line 405 - Base Amount is the same as line 400 unless any adjustments are needed $200,000
  • Line 410 - Specified Partnership Income - $0 in our example

Step 2: Determine income eligible for SBD:

  • Line 425 - ABI Eligible for SBD - Enter the lower of Line 405 or the allocated SDB Limit. In our example our SBD was allocated $100,000 as there are two connected companies that share the SBD = Enter $100,000

Step 3: Determine AII:

  • Line 430 - AII = $50,000 in our example

Step 4: Calculate effective business limit for SBD:

  • Line 445 - Base amount for the business limit - enter the standard amount before any reductions = $500,000
  • Line 450 - Income Prior to Dividends - Enter the taxable amount before applying the SBD = $250,000 [Total ABI + AII]
  • Line 460 - AII reduction - If AII exceeds $50,000, there’s a reduction of the business limit. Here AII is exactly $50,000.
    - Reduction formula: (Adjusted AII - $50,000) / 5
    - Since Adjusted AII is exactly $50,000, no reduction is needed. Enter $0
  • Line 465 - Gross reduction amount - Combine any reductions applicable (e.g., Line 460 and other potential reductions). Enter $0
  • Line 470 - Net Business Limit (NBL) - Standard business limit from line 445 $500,000 minus Gross reduction amount from line 465 $0 = Enter $500,000

Step 5:  Summary

  • Line 475 - Business Limit Allocated - Enter the allocated business limit (based on Part 4, Line 470) = $500,000
  • Line 480 - Eligible Amount for SBD - Enter the lower of (Line 475) or (Line 425) = $100,000

Step 6: Review

  • Optimal entries ensure the ABI eligible for the SBD deduction is properly identified and calculated. Confirm that the tax software aligns with the amounts entered to ensure no deduction errors occur.
  • By filling in the above amounts accurately, Schedule 7 will correctly calculate the Small Business Deduction, ensuring the tax program determines the federal tax payable properly. 

Calculating the Refundable Portion of Part I Tax

Le't look at how to calculate the refundable portion of Part I tax.

  • The actual calculation for the refundable portion of Part I tax and the RDTOH calculation is done on the T2 jacket.
  • Schedule 7 helps determine the portion of Part I tax that is refundable because of investment income. This is known as the refundable dividend tax on hand (RDTOH). 
  • The RDTOH mechanism ensures that investment income within a corporation is not taxed more heavily than if it were earned by an individual directly. This is achieved by refunding a portion of the tax when the corporation pays dividends to its shareholders
  1. Income Calculation: Report your different types of investment income on Schedule 7. This includes Canadian and foreign dividend income, interest income, rental income, and net taxable capital gains.
  2. Non-Deductible Expenses: Deduct any non-deductible expenses related to earning the investment income to arrive at the net investment income.
  3. Part I Tax Calculation: Determine the total amount of Part I tax related to the AII by applying the appropriate tax rates to the net investment income.
  4. Refundable Portion: Calculate the refundable portion of the Part I tax, which is generally a percentage of the AII. For example, a standard rate is 30.67% of AII up to a maximum threshold, representing the RDTOH account. I explained the derivation of 30.67% at the start of this chat.
  5. Dividend Refunds: When the corporation pays taxable dividends, it can claim a dividend refund from the RDTOH account, thereby reducing the overall tax burden on investment income. The dividend refund is calculated as the lesser of the balance in the RDTOH account or a specified percentage of the taxable dividends paid.

Common T2 Schedules

Schedule 11 - Transactions with Shareholders, Officers or Employees

Schedule 11 is used to report transactions that a corporation has had with its shareholders, officers, or employees during the tax year. This is an informational schedule only.

The transactions include:

  • Payments the corporation made or amounts credited to the account of shareholders, officers, or employees, which were not part of their remuneration or reimbursement of expenses.
  • Loans or indebtedness to shareholders, officers, or employees, or persons connected with a shareholder, which were not repaid by the end of the taxation year.
  • Assets the corporation sold to or purchased from shareholders, officers, or employees, including those for which an election was made under section 85.

This schedule excludes the reporting remuneration or reimbursement of expenses.

If there is a Due to Shareholder account on your balance sheet, as opposed to a Due From Shareholder account, this usually represents monies shareholders have contributed to the corporation with "after tax" dollars. Generally this is classified as a capital contribution.

These capital contributions can be withdrawn as a "return of capital" with no tax implications so does not need to be reported on Schedule 11. 

However, it is really important to have documentation in place to prove the amounts withdrawn are return of capital not taxable income.

Want to Learn More About Tax For Free?

While researching the material for this chat, I came across a free Intermediate Canadian Tax textbook created by undergraduate tax students at Kwantlen Polytechnic University (“KPU”) in British Columbia. It's awesome. 

I like it because it "teaches" by answering questions you probably have. Each question answered is concise, usually followed with examples. At the end of most articles, you'll find an interactive quiz on the material so you can see if you got the concept.

The textbook was created in the Spring of 2020 so beware that it will not be up-to-date on recent tax changes such as the 2022 introduction of Substantive CCPCs or the latest 2024 change to the inclusion rate for capital gains.

Check it out. They also have an introductory tax textbook! I wish I could have learned tax in a fun way such as this when I was taking courses.

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