Private Canadian Corporations and Taxes – Scenarios

Yesterday’s article explained the basics of the taxation of private Canadian corporations. Today, we’ll go through a couple of scenarios to see the tax implications of withdrawing money from the corporation.

Scenario 1: Say that Jim from Newfoundland had a private incorporated business that made $10k/yr. Jim also makes $65k/yr in his regular job.

If the money was kept as a sole proprietorship, Jim would have to pay 38% on his business income.

If held in a corporation, he would only have to pay 16.0% on the business income. However, if he wanted to withdraw the money for personal use, there would be additional tax on his personal income tax.

  • If the $10k business income is distributed to Jim via salary, the corporation would get a tax deduction, but the income would be added to Jim’s existing $65k job income. This would result in net tax of 38% on business income.
  • If the $10k is distributed to Jim via dividends, the money would be distributed to Jim with corporate after tax dollars, but Jim would get the dividend tax credit for private Canadian corporations (25% gross up). The personal dividend would be taxed 24.58%, but that’s after the money has already been taxed 16% via the corporation. This scenario would actually result in net tax of 41.58% on the business income.

Scenario 2: Say that Jim’s business income has grown to $65k/yr but decides to quit his day job to pursue growing his business full time. Jim needs to withdraw $30k/yr to cover his personal expenses.

  • If the business was held as a sole proprietorship the $65k/yr would be taxed at an average rate of 30.30%.
  • If the small business was under a corporation, and only $30k was withdrawn as salary, $35k of the business income would be taxed 16%, and $30k of the salary would be taxed 21.61% including CPP/EI. The net taxation on the annual income would be: 18.5%
  • What if the money was withdrawn as dividends? In that case, the whole $65k would face the 16% corporate tax, with the $30k personal dividend facing 4.35% in tax. The net taxation on the annual income would be: $11706/$65000= ~18%

Conclusions

As you can see from the scenarios above, whether you withdraw from your corporation in the form of salary or dividends, it works out to be approximately the same taxation.

If going with the private corporation full time, it may be preferred to take a salary as it will provide RRSP contribution room. In terms of taxation, the biggest benefit of holding a private corporation is for the tax deferral and the capital gains exemption if the company is sold.

Please note that i’m not an accountant or tax professional. Use the information above at your own risk.

I've Completed My Million Dollar Journey. Let Me Guide You Through Yours!

Sign up below to get a copy of our free eBook: Can I Retire Yet?

Posted in

FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
Subscribe
Notify of

This site uses Akismet to reduce spam. Learn how your comment data is processed.

24 Comments
Newest
Oldest
Inline Feedbacks
View all comments
Chuck
12 years ago

Amit, you should also check with your accountant / lawyer to ensure that your business won’t be considered a PSB (personal services business). If the CRA deems you so, you have less deductions available to you and end up paying more tax than if you remained self-employed.

Melinda
12 years ago

Hi FT,

I believe awhile back you had a link to a John Chow blog post about setting up your blog as a corporation. According to John Chow, an individual with no other income can withdraw about $33k per person ($33k for himself & $33k for his wife per year) tax free as dividends per year and have the corporation being taxed at about 15%. Maybe you might want to write another blog entry following up on John Chow’s blog entry on the topic.

Amit
12 years ago

If I have a partnership with my spouse, and I do all the work (no other employees) and hence split the income between my wife and myself, will CRA cause any issues? The partnership income may reach upto ~200K/yr while my wife does have a regular job of $30K – effectively making her income at the end of the year as $130K while mine as $100K. Will there be any benefit in incorporating? We have two kids under 6.

Can anyone suggest a good accountant that they use in either Vancouver or in Calgary?

Sarlock
12 years ago

You’re not really going to save much in the end from the tax man with funds you are pulling out of the corporation, either as salaries or dividends. Dividends enjoy a bit of a break, but salary allows RRSP contribution room and CPP contributions.

The biggest advantage of a corporation is being able to flow expenses through and pay them with pre-tax dollars. The larger your business is, the easier it is to flow more and more expenses through that you would normally have to pay with after-tax dollars and easily justify them in the eyes of CRA as being legitimate business expenses. The real advantages start to occur in the $100k-$500k revenue range. Below that and whatever you manage to save will just get eaten up with added corporate fees (accounting, legal, etc).

Chuck
12 years ago

My thought with my own business was to transfer retained earnings (cash) from one corp to another one that generates a fairly steady income stream. I was figuring that would help the business grow to the 750k threshold and I could sell it in whole or piecemeal if I got bored of it in retirement.

blaze
12 years ago

I suppose, though, really your best bet is just to try to grow your business to be worth $750K.

blaze
12 years ago

OK, that’s sounds likely.

What about scenario 2, then, retaining earnings in your corp until you get enough to purchase a business when you then sell all the shares for your $750K capital gains exemption?

Only at the time of sale, does 90% of the assets have to be engaged in active business.

And if you only do this once (just before you cash out) in the entire lifetime of your corp.. that’s hardly habitual, and I’m sure you can manage the optics to make it appear as if you were ‘intending’ on running it as a real business.

The advantage to this is that you only pay corp tax on your retained earnings and some transactional fees for buying the business in the middle (which I suppose, can be large or smaller depending on how well you negotiate).

Does this make sense?

Chuck
12 years ago

Blaze, flipping a property as a business is not a capital gain, in the eyes of the CRA it may be construed as active business income.

Just to draw your attention to CRA IT-218. http://www.cra-arc.gc.ca/E/pub/tp/it218r/it218r-e.html It discusses whether the sale of property is a capital gain, or business income

Drawing your attention to two sections the CRA can treat habitual property flipping as business income.

5. A taxpayer’s intention at the time of purchase of real estate is relevant in determining whether a gain on its sale will be treated as business income or as a capital gain. It is possible for a taxpayer to have an alternate or secondary intention, at the time of acquiring real estate, of reselling it at a profit if the main or primary intention is thwarted. If this secondary intention is carried out any gain realized on the sale usually will be taxed as business income.

6. The more closely a taxpayer’s business or occupation (e.g. a builder, a real estate agent) is related to real estate transactions, the more likely it is that any gain realized by the taxpayer from such a transaction will be considered to be business income rather than a capital gain (see 3(f) and (j) above).

For example, my university tax prof used to talk about the hard luck farmer who would buy properties, discover they’d be marginal for farming but he’d “find” tonnes of gravel on the property and sell them for a large (capital) gain. The CRA caught him because he was expensing geological survey reports.

blaze
12 years ago

I guess the other approach is to retain earnings, and then when you get close to 750K, buy a business with your retained earnings, and then keep it for 24 months, and then sell the whole thing tax exempt.

blaze
12 years ago

By flipping several times, I think it’s like roughly 5 times. Maybe the tax rate would be 7% instead of 9%, depending on your province.

If I tried to do this as a real estate person sole propietor, I’d have to pay 50% of my marginal rate on each flip, which would mean there’d be up to a 20% tax rate on each flip. Which means I’d have to flip 6 and a bit times.

Which, in the scheme of things, probably isn’t a big deal. What’s one more flip if you’ve done it 5 times already?