How does the specified corporate income rule limit the small business deduction when my client bills a related private corporation?
For 2026, specified corporate income gets the 9% small business rate only to the extent the customer corporation assigns business limit under s.125(3.2). It's income from serving a private corporation your client, a shareholder or a non arm's length person holds an interest in, unless all or substantially all of your client's business income is from arm's length customers.
When is income specified corporate income?
The definition in subsection 125(7) has three parts that must all be met, plus two carve outs. Paragraph 125(1)(a) then pulls this income out of ordinary active business income and lets it back in only as specified corporate income laws-lois.justice.gc.ca.
| Test | What s.125(7) says | What it catches in practice |
|---|---|---|
| Customer | Active business income from providing services or property to a private corporation, directly or indirectly, in any manner whatever | Management fees, consulting, staffing, equipment or goods sold to a related company |
| Interest | At any time in the year, your client, one of its shareholders, or a person not dealing at arm's length with either holds a direct or indirect interest in the customer | Spouse's company, parent's company, a company your client's shareholder owns a few shares of |
| Outside customers | Not caught if all or substantially all of your client's active business income is from arm's length persons (other than that customer) or arm's length partnerships | A business whose related company is a small sideline customer |
| Farm and fish carve out | Specified farming or fishing income is excluded | Sales of farm products or fish catches to an arm's length corporation |
| Associated customer carve out | Subsection 125(10) excludes income from an associated corporation, unless the payer deducts it against its own specified partnership, specified corporate or s.129(6) income | Most fees between associated companies, which already share one limit |
The definition sets no minimum ownership percentage, so a small direct or indirect interest held by your client's spouse is enough to trigger it. It applies to tax years that began after March 21, 2016, the Budget 2016 start date canada.ca. The budget explained the target: using a second corporation to multiply access to the small business deduction
budget.canada.ca.
The Act doesn't define "all or substantially all". The CRA's published position is that "substantially all" in the Income Tax Act means 90% or more canada.ca, so treat 90% of active business income from arm's length customers as the working line.
How much of it gets the 9% rate?
Specified corporate income is the lesser of two amounts: the income caught by the tests above, capped at the business limit that the private corporation customer assigns under subsection 125(3.2), and an amount the Minister determines to be reasonable in the circumstances laws-lois.justice.gc.ca. With no assignment, the answer is nil and the income is taxed at the 15% general federal rate instead of 9%.
Subsection 125(3.2) lets a CCPC assign all or any portion of its business limit to the corporation that served it, if four conditions are met laws-lois.justice.gc.ca:
| Condition | What to check |
|---|---|
| Direct supply | The recipient earned the income from providing services or property directly to the assignor |
| Year ends | The assignor's tax year ends in the recipient's tax year |
| Cap | The amount assigned is no more than A minus B: A is that income, B is the part of it the assignor deducts in computing its own specified partnership or specified corporate income |
| Forms | Both corporations file the prescribed form with their T2 returns |
The assignment isn't free. Subsection 125(3.1) reduces the assignor's own business limit by every dollar it assigns laws-lois.justice.gc.ca. In effect the two corporations share one $500,000 limit, the same result as if they were associated. Budget 2016 described it as the customer assigning its unused business limit
budget.canada.ca. The recipient still needs room in its own business limit too, because the deduction is 19% of the least of line 400, line 405, line 410 and line 428
canada.ca.
Worked example: a $200,000 assignment saves a spouse's management company $12,000
Dr. Lee owns all the shares of Dentalco. Her spouse owns all the shares of Serviceco, which isn't associated with Dentalco. Both have calendar year ends. In 2026 Dentalco earns $600,000 of active business income before paying Serviceco a $300,000 management fee, and Serviceco's only income is that fee. Dr. Lee doesn't deal at arm's length with her spouse, Serviceco's shareholder, and none of Serviceco's income is from arm's length customers, so the whole $300,000 is caught.
| Step | Arithmetic | Result |
|---|---|---|
| Dentalco active business income after the fee | $600,000 minus $300,000 | $300,000 |
| Dentalco unused business limit | $500,000 minus $300,000 | $200,000 |
| Most Dentalco can assign (A minus B) | $300,000 minus $0 | $300,000 |
| Dentalco assigns its unused limit | $200,000 | |
| Serviceco specified corporate income | Lesser of $300,000 and $200,000 | $200,000 |
| Serviceco federal tax | $200,000 × 9% + $100,000 × 15% | $33,000 |
| Dentalco federal tax | $300,000 × 9% | $27,000 |
| Group federal tax | $33,000 + $27,000 | $60,000 |
Without the assignment, Serviceco pays $300,000 × 15%, or $45,000, and the group pays $72,000. With it, the group pays $60,000: 9% on $500,000 and 15% on the last $100,000, exactly one business limit. Before 2016, Serviceco would have used its own $500,000 limit on the full fee and paid $27,000, which is the doubled limit the rule shut down.
Dentalco could assign up to $300,000, but every dollar above $200,000 comes off its own limit and costs it the same 6 points that Serviceco saves. Assign the unused amount and stop there.
Where does each corporation report the assignment on its T2?
The recipient computes specified corporate income on Schedule 7, Part 7, and the assignor reports the assignment on page 4 of its own return canada.ca. The current form is the 2025 version of T2SCH7
canada.ca.
| Corporation | Where | What goes there |
|---|---|---|
| Recipient (Serviceco) | Schedule 7, Part 7, column EE (line 600) | Business number of the customer corporation |
| Recipient | Column FF (line 610), total line 615 | Income caught by the specified corporate income tests, from that customer |
| Recipient | Column GG (line 620), total line 625 | Business limit that customer assigned |
| Recipient | Part 6, amounts AA and CC | Line 615 comes out at AA, line 625 goes back in at CC, and amount DD goes to T2 line 400 |
| Assignor (Dentalco) | T2 page 4 | Amount assigned and the recipient's business number |
| Assignor | Line 428 | Reduced business limit on line 426 minus the amount assigned |
Schedule 7's note to column GG repeats the cap: the assigned amount can't exceed the income from services or property provided directly to the assignor, less any part the assignor deducts against its own ineligible income. The same note tells the recipient to leave specified farming or fishing income, and associated corporation income covered by subsection 125(10), out of column FF. For the rest of the schedule, see our Schedule 7 walkthrough.
Five ways the rule catches files you didn't plan for
A customer that isn't a CCPC. The rule catches income from any private corporation, but only a CCPC can assign business limit under subsection 125(3.2) laws-lois.justice.gc.ca. If the related customer is a private corporation that isn't a CCPC, nothing can be assigned and the caught income gets the general rate.
Mismatched year ends. The assignor's tax year has to end in the recipient's tax year laws-lois.justice.gc.ca. If Serviceco's year ends June 30, 2026, the assignment comes from Dentalco's year ending December 31, 2025, the one that ends inside Serviceco's year.
Routing through a third party. Subsection 125(9) applies where your client serves a person or partnership that holds an interest in the related company, and one of the reasons was to avoid the rule. Then none of that income counts under paragraph 125(1)(a) at all, so no assignment can rescue it laws-lois.justice.gc.ca.
An interest held for part of the year. The test applies if the interest exists at any time in the year, so a related shareholder who sells out of the customer partway through the year still taints the whole year's income from it laws-lois.justice.gc.ca.
Partnerships run on a parallel rule. Income a corporation earns serving a partnership its shareholder belongs to falls under the specified partnership income rules instead, with its own assignment under subsection 125(8). Our page on professional corporations covers that version, and the base rate and grinds are on our small business deduction 2026 page.
Sources
Does the rule apply when the two corporations are associated?
Usually not. Subsection 125(10) excludes income from an associated corporation unless that corporation deducts the payment against its own specified partnership, specified corporate or s.129(6) income laws-lois.justice.gc.ca. Associated corporations already share one $500,000 limit through the Schedule 23 agreement, covered on our associated corporations page.
Can the customer assign more than its unused limit?
Yes, up to the A minus B cap, but subsection 125(3.1) takes every assigned dollar off its own business limit laws-lois.justice.gc.ca. Assigning more than it has spare just moves the 9% rate from one corporation to the other.
What share of arm's length income gets my client out of the rule?
All or substantially all of its active business income, which the CRA reads as 90% or more canada.ca. The related customer's revenue doesn't count toward the arm's length share, and neither does revenue from a partnership in which a non arm's length person holds an interest
laws-lois.justice.gc.ca.
Does the CRA have to accept the assignment as filed?
No. Specified corporate income is the lesser of the assigned amount calculation and an amount the Minister determines to be reasonable in the circumstances, so the CRA can reduce it laws-lois.justice.gc.ca. Fees that look inflated for the services actually provided are the obvious target.
General information for the tax year shown, not advice for a specific client. Confirm the facts before you file or remit.