In Canada, many small business owners don’t realize that they have some options in terms of the type of remuneration they can receive from their company. Each type of remuneration has its advantages as well as disadvantages. Due to the unique circumstances of each business there is never a right answer as to which type of remuneration is best. To you the owner, the type of remuneration you would like to receive depends on your short and long term goals as well as the type of financial freedoms that you require and your age. The following discussed how each type of remuneration can impact you.

 

For salaries, the advantages are:

1. You can contribute to an RRSP, and make future RRSP room as RRSP’s is calculated based on earned income

2. You are contributing to the Canada Pension Plan (CPP) and will be entitled to future benefits. Your CPP pension benefit is based on how much and for how long you contributed to the plan.

3. The salary or bonus paid out will be a tax deduction for the corporation.

 

For salaries, the disadvantages are:

1. There are reduced income splitting advantages for shareholders as remuneration paid to a spouse for example, is based on reasonability of wage tests.

2. Your salary is 100% taxable on your personal taxes, so depending on your overall salary, you could be causing a greater tax load on yourself.

3. More compliance paperwork as a payroll account will need to be setup with the Canada Revenue Agency. Also required is an annual filing of a T4 Summary and Slips from your company.

 

For dividends, you must first keep in mind that it is against the Alberta Corporations Act to declare dividends if that dividend will put your company’s retained earnings balance into a deficit. Therefore, if you are losing money in your company, then this option is out the window for you.

For dividends, the advantages are:

1. There are income splitting advantages for shareholders that hold another class of shares as remuneration paid to a spouse for example, will not be based on the reasonability of wage tests.

2. Your dividends may or may not be taxable on your personal taxes, so depending on your overall remuneration, you could be paying no tax at all on the dividends.

3. Even though you won’t be paying into the CPP plan, you can potentially save the employer contribution and invest it each year, potentially getting larger amounts of money long term than what a CPP plan can deliver to you at an old age.

4. There is less compliance paperwork. All that is required is a declaration of dividends through your corporate minutes as well as annual filing of a T5 Summary and Slips from your company.

5. By leaving profits in the company and not drawing them out you could essentially create a retirement plan using your company by paying yourself dividends each year after you retire. For this scenario to work best, you should only take equity out of your company’s accounts as you need it each year. Invest your excess savings in your company or a related company.

 

For dividends, the disadvantages are:

1.  You can only contribute to an RRSP up to your previously established limits, and you cannot make future RRSP room as RRSP’s is calculated based on earned income, and dividends are not considered earned income

2. You are not contributing to the Canada Pension Plan (CPP) and may not be entitled to future benefits. Your CPP pension benefit is based on how much and for how long you contributed to the plan. Under dividends, you may have no future benefit or a significantly reduced benefit (if you had salaries before taking the dividend route)

3. The dividend paid out will not be a tax deduction for the corporation, however, this can be offset with savings on your personal taxes due to the dividend tax credit.

4. You may no longer qualify for some other possible Personal Income Tax deductions and programs such as Child Care Expense Deductions and the Working Income Tax Benefit program.

 

 

Sometimes, the best answer lies with a mixture of both depending on your tax bracket and cash flows.  Also, your situation can also be affected by how big your corporation get. Right now, small companies get access to a Small Business Limit deduction for their corporate taxes. What this means is that net profits in the company up to $500,000 are taxed at a low corporate tax rate. As you surpass this income level,  this exemption phases out and you would start paying a high corporate tax rate. At this point you will also have access to another special type of dividend called eligible dividends. These types of dividends are taxed entirely different and are based on a special General Rate Income Pool. This will be discussed in detail in a later blog posting.

Therefore, the best tax advice you can get is from your accountant, depending on your situation. We encourage you to have a discussion with your tax professional, spouses, and family members using the above post as a tool.

 

If you would like more information on the above we would gladly be able to assist you with your needs.