Tax Planning Ideas

By: Glenn Ayrton

As a business owner, in the past you’ve probably been advised to pay yourself at least enough salary from your corporation to allow you to contribute the maximum amount to an RRSP.

There are potentially two flaws with this reasoning, at least for Canadian-Controlled Private Corporations (“CCPC”) with taxable income subject to the preferred corporate small business tax rate (Up to $500,000 @ 13.5% in BC).

First, if you need the cash, you actually pay more tax on the funds withdrawn as salary then as dividends. Second, if you don’t need the cash, you give up a significant tax deferral of about 30% by withdrawing the funds from the company and paying personal tax instead of simply leaving cash in the corporation to be taxed at a much lower small business corporate tax rate (13.5%).

Small business owners in BC will be better off if they pay themselves enough dividends each year to fund their current family lifestyle and retained any surplus funds inside the corporation, where the cash would be invested in a diversified portfolio. Building their wealth at the corporate level will leave them better off in retirement and from an estate perspective.

This strategy makes sense where pre-salary/bonus corporate taxable income is subject to the small business tax rate. The basic premise is that the amount the owner would have contributed to an RRSP is instead left inside the company and invested in the same manner as an RRSP. At retirement, instead of withdrawing funds from an RRSP or RRIF, the business owner would sell corporately-held investments and extract the after-tax proceeds as a taxable dividend.

Comparing investing in a corporation with investing in the tax sheltered environment of an RRSP, you would think that the RRSP would significantly outperform the unsheltered tax environment of the corporation primarily because income tax is not paid immediately on investment returns within the RRSP leaving more capital to be reinvested. However, the facts are that certain investments are subject to lower taxes and the RRSP “tax advantage” is reduced.

For example, it is important to remember that the traditional advantages associated with earning capital gains (only half of the gain is taxable) or Canadian portfolio dividends (eligible for the dividend tax credit) are completely lost when this type of investment income is earned inside an RRSP while these tax advantages are preserved when earned inside a corporation. In addition, when funds are withdrawn from an RRSP they are taxed as regular income while funds paid from a corporation are taxed at a preferred tax rate as taxable dividends.

Using Life Insurance As An Investment Income Shelter

To further maximize the benefit of retained corporate investment income, a business owner may consider using corporate-owned life insurance to shelter investment income from tax. Corporate retained earnings invested in an insurance contract could generate enhanced returns since investments that would have been exposed to tax, and in particular the business owners portfolio invested in highly- axed “fixed income” investments, can accumulate within the policy on a tax-free basis.

In retirement, there are ways of accessing this investment portfolio within the life insurance contract that can provide the business owner with a significant source of income. In addition, from an estate perspective, it is possible to extract some or all of the value of the life insurance proceeds from the company tax free. Life insurance is a tax efficient way of transferring wealth from one generation to the next. Further, the insurance contract could also provide a form of creditor protection that is not available through conventional investments.

In determining whether a surplus investment strategy rather than a salary/RRSP maximization approach is appropriate for our clients, we generally work with the client’s accountants and consider other factors including: a review of the current corporate structure, eligibility for the lifetime capital gains exemption, creditor protection issues, and income splitting opportunities.

I suggest that you to speak with your current financial advisor and accountant to determine if these strategies will be beneficial to your situation. I welcome any questions that you may have or if you require further clarification on these strategies.

Glenn Ayrton is registered as an Investment Advisor with Sora Group Wealth Advisors Inc. (SGWA), a member of the Canadian Investment Protection Fund. This information is general in nature and is intended for educational purposes only. This should not be considered personal investment advice or solicitation to buy or sell securities. For specific situations you should always consult a financial professional. The views expressed are those of the author and not necessarily those of SGWA.