Dividend or Salary Which one will be the best??
As an employee and shareholder of a Canadian-Controlled Private Corporation (CCPC), you have the flexibility of receiving your remuneration in the form of a salary, dividend, or a combination of both. The most tax-efficient type of remuneration for you and your corporation will be a determining factor in which one you choose. The tax treatment of salary and dividend income is different at both the corporate and individual level.
Salary
As you paid salary from your corporation here is how it impacts on your overall tax liability:
- It is considered as a tax-deductible expense and will lower the corporation’s taxable income.
- Salary subject to payroll taxes. CPP, EI, CIT are deducted at source and remitted to CRA. The gross salary amount is employment income and subject to your marginal tax rate.
- Your are eligible for non-refundable tax credits such as CPP/QPP as well as you are eligible to claim Canada employment amount.
- Salary also eases to get personal loan such as home mortgage loans from financial institutes as long as they are paid consistently.
- Salary is considered earned income for the purpose of RRSP contribution and pensionable earnings for the purpose of CPP pension at retirement. RRSP amount is deductible from all income including dividend income.
“Dividend income is not earned income but the salary is, and thus the combination should be used to have more tax savings”
Dividend
The main advantage of paying dividend is lower corporation tax rate. This is anywhere between 14% and 16% based on the province you are living in. Here are the tax implications of dividend:
- Unlike salary dividend is not an expense for a corporation. It is a kind of distribution of after-tax profit.
- Dividends are not subject to payroll deduction. It is taxed at individual level with a gross-up calculation and allowed to have dividend tax credit.
- Dividend income is not considered earned income; thus it does not create RRSP room. This is also not included in calculating CPP pensionable earning.
# 1 Strategy
Based on the advantage and disadvantage small business corporation may consider paying the owner-operator a combination of Salary and Dividend. Plan for salary or dividend in advance.
Paying salary to reach the maximum RRSP limit or 18% earned income will allow individual to reduce their taxable income even after receiving dividend income. It also allows to maximize CPP and EI premiums. As a result maximum CPP pensions during retirement can be ensured and also option to access EI benefit can be restored. Note that if an owner-operator or director of the corporation owns more than 40% of share, participating to EI becomes voluntary. The another advantage of paying salary is to become eligible for residential loan without much hassle.
Paying your Family member
Corporation tax rate is lower than the individual tax rate and thus most corporations pay dividend or salary to family member to reduce tax burdens.
As of 2018 rules to pay your family members has changed. The rules restricts paying dividend to family member who are not actively working in your corporation. If you are paying dividend to your family member they may be taxed at higher tax rate, they will not receive the dividend tax credit.
# 2 Tax Strategy
This rule does not apply if your spouse or children work for your business at least 20 hrs a week and paid a reasonable salary at market standard rate. Your family member can have less than 10% of company shares and paid dividend accordingly. They are also allowed to receive year-end bonus based on your corporation performance as an employee.
Do you need to register for GST?
Not all businesses are required to register for GST/HST. If what you sell or provide is GST/HST taxable, or zero-rated, you may register for GST/HST promptly! According to CRA rules you are not required to register for GST/HST before your sales reached by $30,000. Keep in mind that you usually have more expenses than revenues in these first months of operation.
If your taxable services/sales income does not exceed $400,000 for the last five consecutive quarter you may elect to use quick method GST/HST remittance rate. This will allow your business to remit less GST/HST to CRA then the regular remittance rate. This is particularly beneficial for those businesses that are not directly purchase inventory for sale. Most of the consulting business other than Financial consulting can have this advantage.
# 3 Tax Strategy
Register your business for GST/HST only when you cross the $30,000 threshold. Besides quick method remittance rate can save more for your business if you are eligible to use it.
Creating a holding Corporation
As your business grows and accumulates funds and other assets you may be better off registering another company as ‘holding corporation’. Holding corporation usually have less transaction and does not expose to various claims. Limited liability offered by corporate structure has also it’s own limitations from tax perspective. Moving fund from one corporation to another will not trigger any tax payments. Once the fund is in your holding corporation you may invest the fund as your personal own fund. However you have to pay tax some later period but by then you have bigger pool of capital to invest.
# 4 Tax Strategy
Accumulate your wealth not in the same corporation rather in a related corporation that have less transactions. This will help avoiding claims against the corporation. Moving fund to related corporation will not trigger tax payments.
Keep your business record straight
This could be a costly mistakes if your corporation failed to keep adequate business records, such as
– invoices
– receipts
– bank statements
– deposit slips
– agreements
– letters from CRA, WSIB, and others
Without guessing numbers your business can accurately claim all legitimate business expenses and will not miss any deductions.
It is always a good idea to keep a separate file with articles of incorporation, minutes book and other documents related to the foundation of the company.
As an owner-operator/director you need to keep track all your withdrawals and investment. Your out of pocket expenses paid by the corporation should be supported by adequate proof. Any money that you deposited to your business account considered as business income unless a record shows otherwise.
# 5 Tax Strategy
Separate all personal transaction from your business transactions. A good record keeping will allow deductions to be accurate and minimize the risk of CRA audits.