Salary and dividends: Integrative cash flow planning between private corporations and personal taxes

What does your business decision on whether to pay salary versus dividends say? In deciding the right mix, there is more to consider than just taxes.

Due to the integration principle of the Canadian tax system, the taxes paid on salaries and dividends from active business income earned within a Canadian-controlled private corporation (CCPC) are approximately the same. Where they differ is in the timing of when taxes are paid. But how do withdrawal strategies for investments held within your corporation impact your personal marginal tax rate in any given year?

Types of dividends

When you issue dividends from a CCPC, they will be classified as eligible or non-eligible dividends, depending on the corporate income pools from which the dividends are paid.

Non-eligible dividends are dividends that are generally paid out from a CCPC’s income that is within the limits of the small business deduction. In 2019, this limit is $500,000. In contrast, eligible dividends are dividends that are generally paid out from a CCPC’s full rate taxable income, or active business income in excess of the small business deduction.

A CCPC’s income derived from investments in public company shares are generally considered eligible dividends (commonly referred to as portfolio dividends). Those eligible dividends are subject to a refundable Part IV tax of 38.33 per cent. The CCPC is eligible for a corporate tax refund of that Part IV tax, known as a dividend refund, when those dividends are paid out to the shareholder. Other investment income earned within a CCPC, such as interest, will generally result in the payment of non-eligible dividends when that income is distributed to the shareholder. When dividends flow out of a corporation to the individual shareholder, personal taxes are paid on the grossed-up dividends, and the personal credit helps prevent double-taxation.

Non-taxable dividends – What's this phenomenon?

It is often said that there are dividend thresholds in which you don’t have to pay personal taxes: for example, in Ontario, approximately, $51,800 for eligible dividends and $30,700 for non-eligible dividends. The caveat is that this would be the only income you would be claiming on your personal tax return. Realistically, many business owners withdraw more than that and may be receiving other sources of income outside of the corporation such as rental income. Once you add other income, you would be paying taxes at your marginal tax rate.

Salaries – Paying tax upfront

Salaries, along with the associated source deductions such as the employer’s portion of Canada Pension Plan (CPP) contributions, are expenses to the corporation and reduce corporate taxes owing. The employee’s portion of those source deductions, including income tax and the employee’s portion of CPP contributions, are remitted to the Canada Revenue Agency (CRA) by the corporation on the employee’s behalf. You may end up not paying any more personal taxes when you file your return if adequate taxes have been withheld and remitted by the corporation. Unlike an all-dividend approach, salaries generate CPP benefits and RRSP contribution room. If you have a spouse earning lower income in any given year, and you earn other income outside of your corporation, you may want to use any available RRSP contribution room. You would be able to realize the personal tax break now to reinvest savings towards other goals.

The best corporate withdrawal strategies require integrative cash flow planning and a discussion amongst professionals regarding opportunities and pitfalls at the corporate and personal level. To determine the right option or mix, we should ask: was the tax filing reflective of an integrative cash flow strategy and does it meet the hierarchy of the client’s many objectives?

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Disclaimer

This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.

 

About the Author

Maricel Ramos

Maricel Ramos , CPA, CGA, CFP, RRC, is a financial consultant with Investors Group Financial Services in Toronto.