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Feb 09, 2022
Retaining income

4 tax-time tips for business owners to keep more of their hard-earned dollars

Knowing these tax basics can support effective conversations with your financial advisor – and better financial outcomes for your business.

As a business owner, you likely already know that good tax management can help you retain more business income. At the same time, all those tax regulations can feel a little overwhelming.

“The good news is, you don’t need to be a tax expert,” says Robert Bradburn, an AVP at CWB Wealth Management. “Getting a good handle on a few fundamentals can help to guide better conversations with your financial advisor so they can do the heavy lifting for you – and you can keep more of your hard-earned dollars.” 

Focusing on Canadian Controlled Private Corporations (CCPC’s), Bradburn says the following are four things business owners should have on their radar at tax time when it comes to retaining more income. 

 

1. How much your company earns will impact its tax rate

This may seem obvious, but small businesses in Canada aren’t subject to graduated tax rates the way individuals are. The general (federal + provincial) tax rate for active business income ranges from 23% (Alberta) to 31% (PEI). However, businesses get a reduced tax rate on the first $500,000 of taxable income ($600,000 in Saskatchewan) thanks to the Small Business Deduction (SBD). This first $500,000 (or $600,000) is known as the business limit

Why is this important? Because the tax rate applied to business income will impact the tax rate applied to you personally, as you pay yourself either eligible or non-eligible dividends from the company.  

Take the simplified example below, which shows how $10,000 of business income in Alberta is taxed depending on whether it received the SBD or not.   

 

  SBD Income   General Income 
 Earned by corporation  10,000   10,000  
 (Foreign taxes)  -  -
 (Part I tax - non-refundable)  (900)
(1,500)
 Part I tax - refundable -
 
 (Part IV tax) -
-
 (Provincial/territorial corporate tax) (200)  (800) 
 Dividend refund -
-
 Available for distribution  8,900  7,700 

Source: Alberta, 2022 Tax Facts and Tables. Tax Templates Inc.

 

2. Your investments can affect your corporate tax rate

The business limit is reduced by $5 for every $1 of adjusted aggregate investment income (also known as AAii) earned over $50,000 within your company or associated companies. AAii is the net sum income from property, taxable capital gains (passive assets), taxable dividends, interest and foreign investment income.  

Let’s take, say, an investment portfolio of $2.5M in your holding company with stocks, bonds and GIC’s. In this scenario, generating 5% taxable income would reduce your business limit by $375,000. The Small Business Deduction would only apply to the first $125,000 of active business income. Fortunately, certain investments, such as those held within insurance policies, do not claw back your access to generous tax rates applied via the Small Business Deduction.

The example below shows the relationship between AAii and the business limit. We’ve also done the math for the above scenario with the $2.5M investment portfolio.

 

 

Adjusted Aggregate Investment Income  Business Limit Reduction   Business Limit 
25,000

500,000 

50,000 
  500,000 

75,000
125,000
375,000
100,000 
250,000
250,000  
125,000 375,000 
125,000 
150,000 500,000

Source: Taxtips.ca

$2.5Mil portfolio earning 5% = $125,000 AAii income
($125,000 - $50,000) x 5 = $375,000 SBD reduction
$500,000 - $375,000 = $125,000 SBD

 

3. High tax rates are applied to corporate investments

Aside from losing access to your SBD from having too much AAii, what your company invests in can create even more pain at tax time. Bond coupon payments, GIC interest, dividends from non-Canadian companies and even interest from savings accounts are all taxed at rates of over 50% in every province except for Alberta (46.67%). 

In places like the Yukon, Saskatchewan, PEI, Nunavut, the Northwest Territories and Manitoba, the tax rate applied on these investments within your corporation is actually higher than the highest personal marginal tax rate.

 

What’s this mean? Well, you’d be better off earning that income in your personal hands even if you had very high taxable income. 

Capital gains are taxed at half these amounts and dividends from Canadian companies are hit with a 38.33% rate. This is also higher than the highest personal rate for eligible dividends in Alberta, BC, Manitoba, New Brunswick, the Northwest Territories, Nunavut, PEI, Saskatchewan and the Yukon.

Don’t fret though! It’s not all bad news, because here’s the kickera lot of the tax applied to your corporate investment earnings is actually refundable.

 

And here’s the catch: to receive the tax refund, you must pay out the income to shareholders through a dividend. This dividend will then be taxed in the shareholders’ personal hands. Something else to keep in mind is that if you’re not taking money out of the company, you’re not getting that refundable tax and your investments will compound with a major drag. It’s like putting a block of wood under your gas pedal. Sure, you might reach your destination, but it’ll take a long time to get up to speed.

So, this bring us to a question: is it better to earn investment income in your corporation or in your own personal name? Before answering that, we need to discuss a fun little topic known as integration. 


4. Integration and tax deferral – personal tax isn’t applied until the money comes out of the corporation

The high-level idea behind integration is that the total tax applied to a dollar, by the time it reaches your personal bank account, should be the same regardless of whether it was earned under your personal name or your corporation. That said, integration isn’t perfect, and it rarely works out this way. 

Generally for any income in 2022, compared to the highest personal levels there will be a slightly greater overall tax burden to earning in the corporation and paying out as a dividend than taking a salary or bonus. 

For example, for general business income where the SBD has been applied, a business owner taking non-eligible dividends would be taxed higher than if those dollars were paid out directly through salary. Only the Northwest Territories and Saskatchewan apply lower overall taxes to business owners in this instance. Furthermore, if you consider there are no RRSP or CPP contributions associated with dividend remuneration, salary starts to look more attractive than a dividend payout from a tax saving perspective. 

Now, regardless of the remuneration outcomes, the greatest benefit for shareholders is the tax deferral that companies see before taking income out of the company. Since active business income is taxed in the corporation at a much lower rate than personal income, just leaving money in the company allows for greater capital growth through compounding. With this in mind, a business owner may be better off investing excess profits within the company, even with the heavy tax applied to passive investment income. 

In the example below, we use tax rates in Alberta to show a massive tax deferral for business owners leaving money in the company to grow in an investment portfolio rather than taking it out to invest in their own name. 

That’s because integration doesn’t have the chance to work until money is paid out from the company: the deferral of tax is only possible because only corporate tax has been applied. Personal tax isn’t applied until the money comes out of the corporation. This means the deferred tax will remain in the company to grow year after year.  

 

   SBD Income  General Income
Earned by individual 10,000 10,000 
(Tax payable by individual) (4,800)   (4,800) 
Net amount to the individual 5,200 5,200 
     
Earned by corporation 10,000   10,000 
(Part I tax - non-refundable) (900)  (1,500)
(Provincial/territorial corporate tax) (200)  (800)
Available for distribution    8,900  7,700 
(Tax payable by individual)   (3,765)  (2,682) 
Net amount to the individual  5,135  5,018 
     
Tax savings (cost) using corporation  (65)   (182) 
Tax deferral advantage (cost)  3,700   2,500 

Source: Alberta, 2022 Tax Facts and Tables. Tax Templates Inc.

Bringing it all together 

Well, we’ve learned a few things about what impacts your tax rate (how much your company earns and your investments – especially those corporate investments!) and that integration doesn’t kick in until money is paid out from the company, leaving the deferred tax in the company to grow.

 

Ultimately the best tax strategies for you will depend on your own unique personal and business circumstances. And that’s where the experts come in! Many CWB Wealth Management advisors have deep knowledge of tax strategy and would be happy to help you with any tax-related questions. Wishing you an effective and painless (as possible) tax season!  

 

This blog is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB Group takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB Group or any other person as to its accuracy, completeness or correctness. CWB Group reserves the right at any time and without notice to change, amend or cease publication of the information. Click here to view the full disclaimer.