If you have excess cash within your corporation that you do not need for the daily operations of the business, you can put it into a corporate investment account or into a personal investment account.
Investing cash within a corporation allows for a deferral of the personal income tax that would be due if the cash was withdrawn personally. In Ontario, the personal income tax deferral can be up to 48%. Additionally, leaving cash in the corporation allows for the investment of a larger sum of money. For example:
- Net income before tax – $100,000
- Corporate income tax (Federal + Ontario rate 26.5%) – $26,500
- Net after-tax income available to invest within the corporation – $73,500
- Dividend paid to individual shareholder – $73,500
- Personal income tax (Federal + Ontario top personal tax rate 48%) – $35,280
- Net after-tax income available to invest personally – $38,220
There are several factors you need to consider when deciding whether to invest at the corporate or personal level.
Firstly, the impact of investment income on the corporation’s ability to claim the small business deduction (SBD). The SBD allows for the first $500,000 of corporate profit to be taxed at the small business corporate income tax rate of 12.2% (Federal + Ontario), instead of the general corporate income tax rate of 26.5% (Federal + Ontario).
If a Canadian-controlled private corporation (CCPC) earns more than $50,000 of adjusted aggregate investment income (AAII), the $500,000 limit is reduced, and if AAII is $150,000 or more in the prior year, the full SBD is eliminated. This may not be an issue if your corporation is currently not eligible for the SBD due to other factors.
If your corporation already has an investment account, you will want to verify if the corporation has a capital dividend account (CDA) balance or refundable dividend tax on hand (RDTOH) balance. A CDA balance allows the corporation to pay out tax-free dividends to the shareholders personally, while the RDTOH balance allows for a corporate refund of previously paid corporate income tax based on the amount of taxable dividends paid to shareholders. Consulting with a tax advisor will ensure that these balances are effectively utilized to minimize the overall combined corporate and personal tax rate.
The personal income tax rate on the taxable dividend income paid to you can be managed if the cash is paid out over time and not in one lump sum. This allows you to utilize the lower personal graduated income tax rates.
If you have contribution room on your registered retirement savings plan (RRSP), you may want to take out the excess cash from your corporation and offset the personal income tax on the dividend received from your corporation by contributing to your RRSP. Your RRSP investment income grows tax-free until withdrawn in your retirement years, and you will be subject to your personal income tax rate at that time, which could be lower, depending on the level of your other income sources.
Furthermore, you may want to consider withdrawing the cash from your corporation to contribute to your tax-free savings account (TFSA). The personal income tax you pay now on the taxable dividend received from your corporation can be offset over time the longer you leave the cash to grow tax-free in the TFSA.
If you need the cash for personal reasons then you will have no choice but to take it out from the corporation. In this case, you want to consider withdrawing the cash over multiple tax years to take advantage of the lower personal graduated income tax rates, so as not to pay the highest tax rate on a lump sum withdrawal.
Another consideration if leaving the excess cash in your corporation is whether you want to sell your business in the future. If the answer is yes, you can look into setting up an investment holding corporation and moving the excess cash tax-free into it. This can help you qualify for the lifetime capital gains exemption if you were to sell the shares of your operating corporation. The lifetime capital gains exemption allows an individual to receive a tax-free capital gain of up to $913,630 on the sale of a qualified small business corporation. This represents tax savings of approximately $244,487 per individual. There are several criteria that must be met in order to qualify for the lifetime capital gains exemption. Additionally, there are various corporate structures that can be utilized when setting up an operating and/or investment holding corporation, which will depend on your particular situation.
As every situation is different and circumstances change over time, it is important that you meet with your tax advisor on a regular basis to address these and other tax planning issues.
If you have any questions or are looking for tax planning opportunities, do not hesitate to connect with us.