Owners of Canadian Controlled Private Corporations (“CCPC”) have more choices than employees in terms of how to get compensated. The easiest method is through salaries and bonuses. Like all other salaried Canadians, the owner will have to pay taxes on their personal income at graduated income tax brackets.
Another method to extract monies out of a CCPC is through the payment of dividends since the owner is also a shareholder of the company. To obtain a dividend, the CCPC must first pay corporate income tax on its income (since it is a distinct legal entity from the owner), and upon the payment of the dividend, the owner must account for the dividend using the Income Tax Act (Canada)’s dividend gross-up and credit mechanism and then pay personal income tax at graduated rates.
In theory, the total tax paid by the owner whether it is in the form of salary or dividends should be exactly the same. This is what tax experts call the ‘theory of integration’. The theory of integration worked so long as the corporate tax rate paid was set at a certain level. In practice, however, provincial governments have gradually reduced the level of provincial corporate tax over the past decades in order to attract businesses. The theory of integration fell apart under these conditions and an arbitrage opportunity began to emerge favoring the payment of remuneration through dividends rather than salary.
As a result, accountants and other tax consultants began a process of counseling their clients to shift away from salaries to rely exclusively on dividends as the primary method of extracting funds needed for daily living -‐ out of their CCPCs.
The theory of integration was virtually fixed on January 1, 2014, when measures adopted in the Federal Budget for 2013 came into force. The federal government increased the taxation of non-‐eligible dividends (that is, the dividends paid by CCPCs on corporate income that had been taxed at the lower small business deduction rate) to level the playing field between salaried compensation and dividends.
The table below shows how this arbitrage opportunity virtually disappeared in Canada:
|Province||2013 Dividend Advantage or (Disadvantage)||2014 Dividend Advantage or (Disadvantage)|
|Prince Edward Island||(0.18%)||(1.95%)|
The conclusion to be drawn from this Table is that unless one lives in Nova Scotia, there is no real tax advantage to taking compensation out of a company via dividends anymore. This is particularly true when one uses a Personal Pension Plan to further reduce the overall corporate taxes paid thanks to the many tax deductions available to sponsors of pension plans.
In light of the new tax rules that penalize passive investments within CCPCs, advisors must understand how pension legislation can become a powerful tool to deal with wealth succession, business succession, and tax optimization within a corporate environment.Learn more about the ppp101 course