Payment Mechanism
The most tax-efficient personal withdrawal mechanism is a hybrid approach between Salary and Dividends depending on individual circumstances.
Here are a few options to consider:
Payment Mechanism
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Paying dividends can be advantageous as they may be subject to lower tax rates, especially if they are eligible dividends.
However, consider the impact on personal tax brackets, the need for cash flow, and potential loss of certain benefits tied to employment income (e.g. Employment Insurance).
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Paying a salary can provide personal tax deductions, such as contributions to the Canada Pension Plan (CPP) and Registered Retirement Savings Plan (RRSP).
Salary can also help establish employment income history for various purposes, including obtaining mortgages or credit.
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A combination of salary and dividends may provide a balanced approach, taking into account both personal tax savings and cash flow requirements.
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Determining the appropriate salary for a Canadian resident who owns a corporation depends the individual's specific circumstances, the nature of their business, and tax considerations.
Here are a few points to consider:
Reasonableness of Salary: The salary paid to the individual should be reasonable for the services they provide to the corporation. The Canada Revenue Agency (CRA) expects that salaries should be comparable to what would be paid to an arm's length employee performing similar duties in a similar industry.
Tax Efficiency: The salary level can affect both personal taxes and corporate taxes. A higher salary means a higher personal tax liability but may allow the corporation to claim a higher deduction for salary expenses. On the other hand, a lower salary reduces personal taxes but limits the deduction for salary expenses.
Tax Integration: Canada's tax system aims to achieve tax integration, where the combined personal and corporate taxes paid on business income are roughly equivalent to the tax that would be paid if the income was earned directly by the individual. This means that the total taxes paid, including both personal and corporate taxes, should be considered when determining the most tax-efficient salary.
Other Factors: The individual's overall income, eligibility for tax credits and deductions, retirement plans, and long-term financial goals should also be taken into account.
It's important to note that tax laws and regulations are subject to change, and individual circumstances vary.
Consulting with a tax professional or accountant is recommended to determine the optimal salary and personal withdrawal strategy based on specific circumstances and goals.
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Eligible and non-eligible dividends are different types of dividends that Canadian residents may receive from certain Canadian corporations.
Eligible Dividends: Eligible dividends are dividends paid by Canadian corporations to an individual that is also Canadian that have met specific criteria set by the Canada Revenue Agency (CRA).
These dividends are generally paid out of the corporation's income that has been subject to corporate income tax at the regular corporate tax rates that don’t receive the small business deduction.
Eligible dividends are generally more tax-efficient for individual investors, as they benefit from a higher gross-up rate and a lower dividend tax rate.
When individuals receive eligible dividends, they are entitled to a higher dividend tax credit, which helps reduce the overall tax liability on the dividend income.
Non-Eligible Dividends: Non-eligible dividends, also known as "ordinary dividends" or "other than eligible dividends," are dividends paid by private Canadian corporations that do not meet the specific criteria for eligible dividends.
These dividends may include dividends paid out of the corporation's income that has been taxed at lower tax rates, such as the small business tax rate.
Non-eligible dividends have a lower gross-up rate and a higher dividend tax rate compared to eligible dividends.
When individuals receive non-eligible dividends, they are entitled to a lower dividend tax credit, resulting in a relatively higher tax liability on the dividend income.
Foreign Dividends: Foreign dividends are dividends that are distributed to a Canadian shareholder from a company that isn’t Canadian.
These dividends are taxed without the dividend tax credit. This is because the company that issued the dividend did not pay taxes to the Canadian government.
A credit for the foreign dividends taxed can be applied. This is known as a withholding tax, varying from country to country, depending on where your foreign dividends are from.
Inter-Corporate Dividends: Intercorporate Dividends can be either eligible or non-eligible, depending if they are received by a Canadian corporation that qualifies (or not) for the lower tax rate.
These are dividends received from one corporation to another within a corporate group, for example, a shareholder may have an operating company and a holding company which holds the shares of the operating company, learn more about this in the Business structure content.
In summary, the main difference between eligible and non-eligible dividends lies in how they are taxed and the associated tax rates. Eligible dividends generally offer more tax advantages to individual investors due to their higher gross-up rate and lower tax rate, along with a higher dividend tax credit.
It is recommended to consult with a tax professional or refer to the official guidelines from the Canada Revenue Agency (CRA) for accurate and up-to-date information regarding dividend taxation in Canada.
Types Of Income
Most are unaware of the different types of incomes that exist, and that each are taxed differently! Here is a list of the most common:
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Income earned through employment, including salaries, wages, bonuses, tips, and commissions.
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Income earned by self-employed individuals, including freelancers, contractors, and business owners.
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Income earned from operating a business, including sales revenue, fees, and profits.
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Profit earned from the sale of capital assets, such as real estate, stocks, or business assets.
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Eligible Dividends: Dividends received from taxable Canadian corporations that qualify for a lower tax rate
Non-Eligible Dividends: Dividends received from taxable Canadian corporations that do not qualify for the lower tax rate
Foreign Dividends: Dividends received from foreign corporations
Inter-corporate Dividends: Dividends received from one corporation to another within a corporate group
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Income generated from renting out property or real estate.
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Income earned from interest on loans, savings accounts, or fixed-income investments.
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Other types of income generated from passive sources, such as rental income, royalties, or capital gains.
Active versus Passive Income
Active and passive income streams are taxed differently, it’s important to understand the distinction.
In summary, passive income is generated from investments or activities where you are not actively involved, while active income is earned through employment, self-employment, or business activities where you actively participate and provide services.
Understanding the distinction between passive and active income is important because they are taxed differently, have varying tax implications, and may be subject to different rules and regulations.
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Active income, refers to income generated from activities in which you actively participate and perform services.
It is income earned through employment, self-employment, running a business, or providing services directly to clients or customers.
Examples include salaries and wages from a job, self-employment income, profits from a business you actively run, or income earned as a professional in a specific field.
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Passive income refers to income generated from activities in which you are not actively involved on a regular basis. Examples include interest from savings accounts, dividends from investments, rental income from real estate properties, or income from certain business activities you are not actively working or providing services. Corporate investment income is taxed as passive income at flat rates that vary by province and territory. There are no graduated tax rates for corporate investment income. The corporate tax rate on investment income is usually higher than the highest personal marginal tax rate and exceeds 50% in many provinces.
Types Of Taxes
There are three factors to that determine when taxes must be paid:
View Into The Types Of Taxes And Which Business They Relate To:
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A tax imposed on individuals, corporations, and other entities based on their income or profits earned within a specific tax year.
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A federal tax levied on the supply of most goods and services in Canada.
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A combined federal and provincial sales tax applied in provinces that have harmonized their sales tax with the GST.
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A tax levied by certain provinces on the purchase or lease of goods and services within those provinces.
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A tax imposed on the profits earned by corporations operating in Canada. (Same as Income tax).
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A tax on the profits realized from the sale of certain assets when the sale price exceeds the purchase price.
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Contributions made by employers and employees to fund social programs such as employment insurance (EI) and pension plans.
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A tax levied on the value of real estate properties assessed by municipal governments.
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A tax imposed on specific goods and services, such as alcohol, tobacco, and certain luxury items.
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Taxes levied on goods entering or leaving the country.
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A tax imposed on the transfer of assets from a deceased person to their beneficiaries.
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A tax imposed on the transfer of assets from one person to another without receiving fair market value in return.
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Excise taxes imposed on specific goods like alcohol, tobacco, cannabis, and certain fuels.
Double Clicking On Tax Structures Through Individual Versus Corporate Accounts:
Individual
Individual income taxes are progressive, meaning the amount of income made, active or passive, puts the individual in a higher marginal tax bracket. Only eligible and non-eligible dividends are taxed at different rates, but are still progressive based on the overall individual income.
Corporate
Corporate income taxes are not progressive, all active income are subject to the small business deduction or normal corporate tax rate, all other income streams fall within the “investment” tax which is taxed at ~50%. Only eligible and non-eligible dividends are taxed at different rates. Notional accounts exist which provide dividend tax-free schemes and tax refunds.
It's important to note that tax laws and regulations can change, and specific details may vary depending on the province or territory in Canada. Seeking advice from a tax professional is recommended to ensure accurate information.
In Canada, capital gains realized by a corporation are taxed differently from capital gains realized by individuals. Here's an overview of how capital gains are taxed in Canada for corporations:
Deep Dive Into Capital Gains tax:
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Corporations include 50% of the capital gains in their taxable income. This means that only 50% of the actual capital gain is subject to taxation.
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The taxable portion of the capital gain is taxed at the applicable investment tax rates, these rates vary based on the province or territory where the corporation operates.
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Corporations can use capital losses to offset capital gains. If a corporation incurs a capital loss in a taxation year, it can be carried back and applied against any capital gains in the three previous taxation years or carried forward to offset capital gains in future years.
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When a corporation realizes a capital gain, a portion of that gain may be added to the corporation's capital dividend account. Amounts in the CDA can be distributed to shareholders as tax-free capital dividends.
Corporate
Individual
In short, Capital gains are a more tax-efficient form of income, as only 50% is taxable (taxable capital gain) and taxed at the passive income tax rate. A portion of the tax is also refundable and added to the RDTOH account. The non-taxable half of the capital gain is added to the capital dividend account (CDA).
It's important to note that tax rules and rates can change, and specific circumstances may have different implications for the taxation of capital gains for corporations. It is advisable to consult with a tax professional or refer to the official guidelines from the Canada Revenue Agency (CRA) for the most accurate and up-to-date information regarding the taxation of capital gains for corporations in Canada.
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Other Types Of Taxable Income
When you EARN (Factor 1)
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Income earned through employment, including salaries, wages, bonuses, tips, and commissions.
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Income earned by self-employed individuals, including freelancers, contractors, and business owners.
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Income generated from renting out property or real estate.
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Income earned from investments, such as interest, dividends, capital gains, and mutual funds.
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Income received from pensions, RRSPs, RRIFs, and annuities.
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Income earned from operating a business, including sales revenue, fees, and profits.
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Income earned by partners in a partnership based on their share of the partnership's profits.
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Income received from the use of intellectual property or artistic works.
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Income earned from foreign sources, including employment, investments, and business activities abroad.
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Certain social benefits, such as EI benefits and CPP benefits, which may be taxable.
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Payments received as alimony or child support, which may be considered taxable income.
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Certain types of scholarships, fellowships, and grants that may be taxable.
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Profit earned from the sale of capital assets, such as real estate, stocks, or business assets.
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Dividends received from taxable Canadian corporations that qualify for a lower tax rate.
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Dividends received from taxable Canadian corporations that do not qualify for the lower tax rate.
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Income earned from interest on loans, savings accounts, or fixed-income investments.
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Dividends received from foreign corporations.
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Dividends received from one corporation to another within a corporate group.
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Other types of income generated from passive sources, such as rental income, royalties, or capital gains.
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Various types of income that may be taxable, including gambling winnings, prizes, and certain types of awards.
The applicability of taxable income types may vary based on specific circumstances and individual tax laws. Consulting with a tax professional or referring to the Canada Revenue Agency (CRA) guidelines is recommended for accurate and up-to-date information regarding taxable incomes in Canada.