This is the seventh article in a year-long progressive series, ‘The Path to Business Ownership,’ which reviews the pros and cons of various types of business structures. This installment continues with the discussion started in parts 4, 5 and 6, around the exploration of corporations and some of the important aspects to consider.
As a shareholder in a corporation, there are two basic means in which your company can remunerate you: paying you a salary or issuing you a dividend. The tax consequences of each remuneration method are quite different and need to be understood before deciding which method to use, or whether to use a combination of the two.
At first blush, you would probably conclude that remuneration by salary is the best option. This very well could be, but there are benefits to a dividend as well.
Salaries to shareholders who are not active in the company have to be reasonable in comparison to their efforts and contribution to the company. An unreasonable salary could have serious tax implications if challenged later by the CRA. However, dividends are not subject to this reasonableness restriction (at least at the time of writing) giving the company more freedom in what they pay their shareholders.
Perhaps the company had also generated passive taxable income in the past from investment or rental income. In this situation, the company would have paid tax at the highest tax rate, but upon paying out a dividend, it will be eligible to recover some of this high rate tax.
Sometimes a business ceases its active operations but is holding a significant amount of assets (i.e. cash and investments). In this situation, it would be difficult to pay out a reasonable salary given the activities of the company are completely passive. In this case, paying a dividend is a viable means of remunerating the owner.
Remuneration strategies can often be complex, and at times, result in possible double taxation should a salary to an inactive shareholder be deemed unreasonable by the CRA. It is always best to discuss such strategies with your accountant or reach out to me at BDO, to discuss which strategy is right for you.
Jonathon (Tug) McGraw, BCOMM, CPA, CA
BDO Canada LLP
Jonathan can be reached at: email@example.com