Tax efficient way of withdrawing money from your business
Starting up a new corporation involves a great deal of investment and expense on the part of any shareholder. Owner-operators will very often have to forego deriving any income as they attempt to work their corporation into a profitable position. When the time finally comes that the corporation is successful enough to allow its owners to make a living from its operations, two questions then arise.
The first question is: does the owner-operator need the money? Surplus funds can – and very often should – be re-invested into the corporation – acquisitions of new assets, capital equipment, new innovations (copyrights, trademarks, or patents), or intangibles. Allocating additional resources toward improving the quality of life in the workplace setting for yourself and your employees might also be desirable – growth can be internal as well as external.
With that question answered, the next question is: what is the best way for an owner-operator to withdraw funds from the corporation?
Many owner-operators are also employees of the corporation – they draw a pre-determined wage or stipend from the corporation, and remit the requisite deductions to the CRA on a monthly or quarterly basis, along with the deductions paid on behalf of the other, arm’s-length employees. This approach can also be used to pay relatives who work for the organizations – spouses, parents, siblings, and children, as appropriate. However, these non-arm’s-length employees should be paid salaries commensurate with their duties, at reasonable rates – in other words, what an arm’s-length employee would expect to receive for performing the same duties. Otherwise, such a payroll expense would likely not be considered valid by the CRA. Only the owner-operator is allowed some latitude in setting their own salary, given the unique responsibilities and obligations that come with the position.
Essentially this shifts the burden of taxation from the corporation to the individual – as the corporate income is reduced by the amount of the payroll expense, and the personal income is increased by the amount of the gross employment income. It should be noted that employees – including the owner-operator – will have to remit withholdings to the CRA on a monthly or quarterly basis. All employees need to have CPP deducted from their gross pay, and the employer is bound to remit an equal amount to the CRA from their own funds (i.e. as an additional expense on top of the salary) – this is often called a wage burden. This includes the owner-operator. In addition, it is highly recommended that the owner-operator deduct their expected personal tax owing from the gross salary and remit them (along with the CPP payments) to the CRA, so as to prevent a very large payable from being incurred when the personal tax return is prepared. Usually an owner-operator or any employees not operating at arm’s-length will not have to deduct or remit employment insurance (EI) premiums as part of their salary.
Dividends are distributions from a corporation’s retained earnings – net profits after taxes. Therefore they have already been taxed and this is reflected in the dividend tax credit given to those who receive dividend income. However, the dividend tax credit is reduced if the dividends are non-eligible – as most dividends from Canadian-controlled private corporations are. Because most CCPCs are taxed at lower rates than public corporations (due to the small business deduction on corporate taxes), this difference is made up in the dividends distributed to the shareholders by this lower tax credit.
However, certain dividends paid by the corporation may be eligible for the higher dividend tax credit. These come in two categories. If the CCPC receives eligible dividends (usually paid on investments in public corporations), then it can pay out eligible dividends in kind, up to the same amount; for example, if $10,000 in eligible dividends are received during a tax year, then $10,000 in eligible dividends can be paid out to the shareholder(s). In addition, of the corporation has active business income that is taxed at the general rate, then these earnings can be paid out as eligible dividends.
Remember that on the personal side, the actual amount of the dividends must be grossed-up (increased) to arrive at the taxable income, despite tax credits reducing the amount of tax payable. Be very cautious of this consideration, because it can impact the income level which determines eligibility for payments from many government-run programs such as the CPP and OAS.
Although these rules are complicated, especially to the layperson, their objective is to achieve an integrated tax system – which provides for an individual to pay the same amount of taxes whether they earn their income on a personal level or through a corporation. Since corporations, as noted above, already pay taxes on their earnings, this needs to be reflected on the dividends issued by these corporations to their shareholders. At the moment, the burden of taxation is lower for a CCPC earning less than the small business tax rate threshold ($500,000) and paying out ineligible dividends than it is for a larger corporation earning income taxes at the general corporate rate and paying out eligible dividends.
Dividends can also be distributed to family members who are shareholders, which is beneficial since – unlike salaries – there is no test of reasonableness on such a transaction. However, children who are under the age of 18 who receive dividends from a CCPC are automatically taxed at the highest rate with even the standard personal income tax exemption waived. However, the federal government has identified this strategy as providing an unfair advantage to people with higher incomes, and it may be subject to review in a future budget. Therefore, if a long-term strategy is needed, it may be wise to pursue other avenues.
The objective for the owner-operator of a Canadian-controlled private corporation (CCPC) is to maximize tax efficiency – to ensure that the taxes payable to the CRA on behalf of the corporation and the shareholder, taken together, are as low as possible. This is best achieved through a careful and conscientious mix of salary and dividends. We can provide you with the experience and expertise needed to determine which mix best suits your specific and individualized needs.
Hard ACB into Cash
If you own a corporation that you purchased from someone else, there is a consideration that does not exist for owner-operators who founded their corporation. The amount paid for the acquired shares is called the hard adjusted cost base. However, accessing this funding will require a holding company.
Repayment of Outstanding Shareholder Loans
Shareholder loans are, as the term implies, funds (or resources in kind) loaned to the corporation on behalf of its shareholder(s). A corporation should always end each fiscal year owing money to its shareholder(s) – if the shareholder(s) have an outstanding “loan” from the corporation without a legal instrument (requiring interest to be paid at fair market value) allowing for It, then according to the Income Tax Act this amount is to be considered personal income for the shareholder(s) in question, and is taxed accordingly. Therefore, it is extremely important that the shareholder not take money out of the corporation without accounting for it – in the form of a salary (T4), dividends (T5), or a financial instrument (loan agreement or similar). However, there is an exception to this, which entails the corporation repaying its loan balance to shareholder(s). Money that any shareholder has loaned to corporation can be repaid in full, usually without tax consequences – allowing the shareholder to draw a large sum of money from the corporation without needing to claim it as income. This allows shareholders who have invested a great deal of their own resources into the success of their corporation to reap the rewards once it is finally generating its own income and a positive cash flow.
Hard ACB into Cash
All corporations have capital dividend accounts. This account represents the non-taxable portion of all capital gains which have been realized on the disposition of capital assets. Capital dividends can be distributed to shareholders as a non-taxable dividend.
It should be noted that any cumulative capital gains will be reversed by any cumulative capital losses that are incurred concurrently or subsequently. However, capital dividends which have already been distributed cannot be retroactively reversed. Therefore, if a capital gain is incurred through the disposition of capital assets, the capital dividend should be paid out as soon as the gain is realized.
Again, the arcane rules of the CRA can make it difficult for everyone except professionals who are up-to-date on the most recent rules and are experienced with the complicated calculations needed to make sure the capital dividend balances are accurate and correct.
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