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Executive Summary

Investing today, whether for the short-term, long-term or in-retirement, can be complicated. An Advisor can guide you but there are many terms that investors should know in order to best understand the direction, recommendations and outcomes of their investments.

The following is a glossary of terms to help you understand some of the jargon and technical terms you have heard, and will likely hear again.  Please use it as a reference tool.

Investment Terms

1. Rate of Return: gain or loss of an investment expressed as a percentage of the invested capital and is calculated on an entire investment portfolio to determine performance. Planning your Rate of Return to match financial goals and your risk/reward profile is a necessary step to successful investment planning.
2. Asset Allocation is an investment strategy that balances Risk and Return by placing investments inside an investment portfolio into different Asset Classes like equities/stocks, fixed income, and cash. Each class has its own characteristics and can contribute more to the total as proportions increase. Asset allocation helps manage risks and rewards to meet your financial needs.
3. Equities is a broad term used to describe ‘stocks’ or shares of a company. Most owners of shares believe they own shares, but, in fact, they own the company. In the case of publicly traded companies people investing for retirement own a very small percentage of the company, but they are the owners.
4. Fixed Income is a category of investments that generate interest at a predictable, stable amount. Fixed income instruments inside a portfolio are often meant to be the safest investments. In the case of GICs, the balance is guaranteed by insurance and the interest payments typically have a very strong track record of occurring.
5. Cash and Cash-like instruments are highly liquid investments. These investments can take advantage of market opportunities, and accommodate short-term unexpected personal expenditures without forcing the sale of an investment at an inopportune time.
6. Capital Gains: Increase (or loss) in the value of a security at the time it is sold versus its cost when purchased. Since capital gains are taxed in Canada at a lower rate than interest income, depending on the province or territory, the highest marginal tax rate for capital gains is approximately 25%.
7. Interest Income: Payments made to the owner of capital for the use of that capital and is calculated by multiplying the capital amount by the interest rate being paid for a particular period of time. Example – a $10,000, one-year annual-pay GIC paying 1.5% generates $150 of interest income each year, and would be paid on the anniversary date.
8. Dividends: Payments made monthly, quarterly, semi-annually or annually to the “owner of record” of a share of a company. The dividend yield is calculated by dividing the expected dividend for the next year by the current share price.
9. Basis Points a single basis point is one-one hundredth (1/100^th) of a percentage point (1%) or 0.0001. Mathematically, a basis point is equal to one ten-thousandth.  Basis Points are used to express very small changes in numbers like percentages or the value of the Canadian dollar compared to the US dollar, for example.
10. Volatility: the reaction of an investment to changes in the overall market. In other words, if the market goes up by 10%, will the stock react more, less or the same. Volatility is called ‘Beta.’ An investment’s Beta expresses how it reacts relative to the market, meaning the stock market in total.
11. Diversification is a way to mitigate risk by placing investments in different kinds of investments (see Asset Allocation above) and by placing investments within an asset class in different industries, sectors, countries, etc. Diversification is a method used to manage risk by not having all of your eggs in one basket. If a country or an industry or a single company has a bad day, month or year your entire portfolio will have a measure of protection by being spread around.

The Bottom Line

We are here to help guide and advise you through the sometimes complicated world of finances and investments. To best understand our recommendations and their implications it is important for you to understand investment terminology. Keep this filed away as a tool for your reference or contact us for assistance or clarification anytime.

Investments can deliver a major source of income and tax implications for individuals.  Each major type of investment income is subject to special tax treatment.

Understanding how your investments are taxed is an important consideration for investment planning since after-tax yield is more important than gross returns.  The most common types of income most investors will receive are interest, dividends, and capital gains.

Inside a registered account, like an RRSP or TFSA, these earnings are not taxed.  The total withdrawal from an RRSP is subject to income tax, while TFSA withdrawals are not.  For investment income that is subject to tax when it is earned, the effective income tax rate can vary widely for an individual.

What You Need to Know

Interest Income

Interest income refers to the compensation an individual receives from making funds available to another party. Interest income is earned most commonly on fixed income securities, such as bonds and Guaranteed Income Certificates (GIC).  It is taxed at your marginal tax rate without any preferential tax treatment and is taxed annually whether or not it has been withdrawn from the investment.

Example:

An investor buys a 10-year GIC that has agreed to pay him 4% annually.  If the investor bought the GIC for $100, the contract stipulates that they will earn $4 of interest each year for the next 10 years.  The investor must report the $4 of interest income on their income tax return each of those 10 years.

Since interest income is reported as regular income, like employment income, it is the least favourable way to earn investment income if it is subject to income tax.  Typically, GICs offer relatively less risk than other investments to compensate for lower gross and after-tax returns.

Dividend Income

Dividend income is considered property income.  A dividend is generally a distribution of corporate profit that has been divided among the corporation’s shareholders.  The Canadian government gives preferential tax treatment to Canadian Controlled Public Corporations (CCPC) in the form of a dividend income gross up and Dividend Tax Credit (DTC).

Taxpayers who receive eligible dividends are subject to a 38% dividend income gross up, which is then offset by a federal DTC worth 15.02% of the total grossed up amount.

Example:

 A shareholder of a Canadian Controlled Public Corporation is paid a dividend of $100.  This income is an eligible dividend and is subject to the gross up and the DTC.  The dividend would be grossed up 38%, so the income is now considered to be $138.   The DTC would be 15.02% of $138, the grossed-up amount, equaling $20.73.  Therefore, the shareholder would report a dividend income of $138, but would have their federal taxes reduced by $20.73. 

The rationale for the gross up and DTC is related to the fact that dividends are paid in after-tax corporate earnings.  If there were no adjustments to the dividend, it would result in the dollars being double taxed.   This tax treatment makes dividends a more tax efficient way to receive income than interest income. Tax is payable when the dividends are paid out.

Different rules apply for dividends derived from non-Canadian and private corporations and can offer different tax treatment and advantages when professional tax expertise is employed.

Capital Gains

Capital gains are realized on equity investments (such as stocks) that appreciate.  For example, if an investor bought a stock at $6 per share and sold at $10 per share, they would have earned a capital gain of $4.  In Canada, only 50% of a capital gain is subject to income tax.  In this example only $2 of the gain would be taxed.  Another desirable trait of capital gains income is that tax is not due until the investment is sold or deemed to have been sold.  This provides the investor with a measure of control over the timing of taxes.  Whether or not they are the most tax efficient income depends on your province of residence and subsequent tax rates.

The Bottom Line

It is important to ensure that investors understand their tax situation and the implications that different types of investment income can have on future taxes.

Financial, retirement and income planning should include the anticipated tax obligations at both the federal and provincial level.  Ensuring an investor’s expert advisors understand overall objectives, risk tolerance and retirement timing can allow them to maximize after tax returns.

By: Michael Lutes CFP, CLU

Certified Financial Planner

Introduction

In Canada, the taxation of passive income earned by corporations has been a topic of interest and debate for many years.

The rules and regulations surrounding this income have evolved, impacting how businesses manage their investments and financial strategies.

In this blog post, we will delve into the essentials of Canadian corporate passive income, including what it is, how it is taxed, and strategies for optimizing your corporate investments.

What is passive income?

Passive income refers to the income earned by a corporation from investments in assets such as stocks, bonds, rental properties, and other passive sources. This income is distinct from active business income, which is generated from a corporation’s core business operations.

Common types of passive income include:

1. Dividend Income: Earnings received from investments in shares of other corporations.
2. Interest Income: Earnings from investments in bonds, GICs, or loans.
3. Rental Income: Income generated from leasing out real estate properties.
4. Capital Gains: Profits realized from the sale of investments, such as stocks or real estate.

How is passive income taxed?

Taxation of passive income is governed by the Canadian Income Tax Act. The key principle is that passive income is subject to a higher tax rate compared to active business income to discourage corporations from accumulating excessive passive investments.

Moreover, having too much passive income in any given year will reduce or eliminate a corporation’s access to the following year’s Small Business Deduction, the effect of which can be an additional approximately 15% income tax.

Strategies for managing passive income

To minimize passive income and avoid the potential loss of the Small Business Deduction, business owners should consider the following strategies:

1. Withdraw additional funds for investment in RRSP or TFSA accounts.
2. Use accumulated Capital Dividend Account (CRA) credit to withdraw funds tax-free and reduce potential for passive income.
3. Remove funds tax-free by having the corporation repay any outstanding shareholder loans.
4. Focus on capital gains-oriented investment. Unlike interest and dividend income which is earned regularly and taxed in the year it’s received; capital gains can be realized strategically and only 50% of capital gains are included in income.
5. Let your winners ride! In other words, if you have unrealized capital gains, you might consider hanging on to them until a future year when you may avoid a further reduction of your SBD. Or hang on and sell them in a year when you already have greater than $150,000 of passive income and have already eliminated the SBD anyway.
6. Spread out your gains. Instead of deferring capital gains to future years, sell your winners over two or more years to potentially avoid reducing your SBD.
7. Implement an Individual Pension Plan (IPP). An IPP is essentially a business owner’s very own defined benefit pension plan. The money contributed is eliminated from the calculation of passive income.
8. Buy permanent life insurance inside the corporation. The investment income is sheltered inside the policy as “cash value” and doesn’t count to the calculation of passive income. Furthermore, on death the entire death benefit can often be paid out to shareholders tax-free.
9. Donations from a corporation will reduce the funds that would otherwise be producing passive income. Further, if donating securities or funds with unrealized gains, there are additional benefits such as no tax payable and a credit to withdraw funds from corporation tax-free.

Conclusion

Understanding Canadian corporate passive investment income and its taxation is crucial for businessowners looking to optimize their financial planning strategies. By staying informed about the rules and employing effective tax planning strategies, businessowners can strike a balance between accumulating passive investments and managing their tax liabilities. Consulting with a qualified tax professional or financial advisor is often recommended to navigate the complexities of corporate taxation in Canada effectively.

By:  William Henriksen, CFP^®

Farmers play a vital role in our society, providing food and sustaining our communities. However, there comes a time when farmers may start thinking about selling their farm or retiring from the agricultural business. This exit requires careful planning and consideration to ensure a smooth and successful transition. According to a recent census, 60% of farmers are 55 or older, but only 13% of farmers have written succession plans in place!

In this blog post, we will explore the essential factors that farmers need to consider when they are contemplating selling or retiring from their farming operations, with a specific focus on the lifetime capital gains exemption.

1. Understanding the Lifetime Capital Gains Exemption: The lifetime capital gains exemption is a tax provision available to Canadian farmers and fishers. It allows them to claim a tax exemption on the capital gains realized from the sale of qualified farm or fishing property, up to a certain limit. Today, the exemption limit is $1 million. Understanding the details and requirements of this exemption is crucial for farmers considering selling their farm, as it can have a significant impact on their tax payable.
2. Eligibility and Qualified Farm Property: To benefit from the lifetime capital gains exemption, farmers must ensure that their property meets the criteria of qualified farm property. Qualified farm property typically includes land, buildings, and equipment used primarily in a farming business. Farmers should review the specific requirements outlined by the Canada Revenue Agency (CRA) and consult with tax professionals to confirm their eligibility and ensure compliance with the exemption rules. I’ve included the current requirements at the end of this blog.
3. Tax Planning and Optimization: Farmers considering the sale of their farm should engage in thorough tax planning to optimize the use of the lifetime capital gains exemption. This involves assessing the potential capital gains, considering the available exemption limit, and strategizing to minimize tax liabilities. Working with experienced tax advisors or accountants can help farmers navigate the complex tax rules, identify opportunities for tax minimization, structure the sale in a manner that maximizes the benefit of the exemption and ensures maximum long term wealth preservation.
4. Timing the Sale: The timing of the sale can have a significant impact on the utilization of the lifetime capital gains exemption. Farmers should carefully consider their tax situation, personal circumstances, and market conditions when determining the optimal time to sell. Changes in tax laws or regulations may affect the availability or value of the exemption, so staying informed and seeking professional advice is crucial.
5. Transition and Succession Planning: Farmers looking to retire and sell their farm must also consider the implications of the lifetime capital gains exemption for succession planning. If the goal is to transfer the farm to the next generation, structuring the sale in a way that allows for the use of the exemption by both parties can be advantageous. This may involve strategies such as share transfers, leasing arrangements, or implementing a gradual transition plan. Working closely with legal and financial professionals can help ensure a smooth transition while optimizing the tax benefits.
6. Professional Guidance: Given the complexities of tax laws and regulations, it is essential for farmers to seek professional guidance when considering the lifetime capital gains exemption. Engaging with tax advisors, accountants, and lawyers experienced in agricultural taxation can provide valuable insights and ensure compliance with the CRA’s requirements. These professionals can also assist in developing a comprehensive tax strategy that aligns with the farmers’ overall retirement and financial goals.

Hopefully by exposing more farmers to articles like this one, we start seeing the percentage of farmers with written succession plans trending higher year over year. If you’re a farmer or if you know a farmer, share this with them and encourage them to seek professional guidance so that they can optimize their retirement planning and ensure a smooth transition to the next phase of their lives.

Below are the current requirements to meet the criteria of qualified farm property for the purpose of the lifetime capital gains exemption:

1. Farming Activity: The property must be used primarily in a farming business, meaning that it is actively involved in agricultural production. This includes activities such as cultivating land, raising livestock, growing crops, or producing aquaculture or other agricultural products.
2. Ownership: The property must be owned by an individual or a partnership of individuals. Corporations or trusts generally do not qualify for the lifetime capital gains exemption on farm property.
3. Duration of Ownership: The property must have been owned and used in a farming business for at least 24 months before the disposition (sale) occurs. However, in some cases, the CRA allows for a shorter ownership period if there were circumstances beyond the farmer’s control that prevented meeting the 24-month requirement.
4. Nature of the Property: The property must meet specific nature criteria to qualify as qualified farm property. The following requirements generally apply:
   • Buildings and Structures: Buildings and structures, such as barns, storage sheds, or silos, that are used primarily in the farming business can qualify as part of the qualified farm property.
   • Shares of a Family Farm Corporation: Shares of a family farm corporation can be considered qualified farm property if certain conditions are met, including that the majority of the assets of the corporation are qualified farm property and that the shares are owned by individuals who meet specific eligibility criteria.
5. Farming Income Test: The farming income test requires that farming income, either alone or in combination with farming income of a spouse or common-law partner, exceed other income (excluding taxable capital gains) in at least two out of the last five years. This ensures that the lifetime capital gains exemption is primarily available to farmers and not individuals who may own farm property but do not actively engage in farming activities.

If you are a farmer, and you are contemplating selling or retiring from your farming operations, or if you would like to set up a succession plan, click HERE to book an appointment with us today!

A capital gain can be defined as an increase in the value of an asset (stocks, shares, etc.) from its original cost price.

There are two forms of capital gain:

Realized capital gain: You have a realized gain when you sell an asset for a higher price than you bought it.

Unrealized capital gain: This occurs when there is an increment in the value of your asset, but you haven’t sold it.

Therefore, you only ‘realize’ a capital gain once you sell that particular asset that has increased in value. However, you must know that a realized capital gain isn’t just yours to possess, and the government takes a cut from it by way of tax.

How is Capital Gain Taxed in Canada?

Capital gain gets taxed at a rate of 50% in Canada. Once you realize a capital gain, you’ll need to add 50% of the capital gain to your revenue. This means the portion of extra tax you pay will differ depending on how much you’re earning and what other sources of earnings you possess.

The only way you can have a capital gain without being taxed on it by the government is if your investments are registered in tax-sheltered plans like Registered Retirement Savings Plan (RRSP), Registered Retirement Plan (RPP) or Registered Education Savings Plan (RESP).

Apart from these plans, your capital gain will be taxed. You must know how to calculate said capital gain tax.

How To Calculate Capital Gain Tax?

Before effectively calculating your capital gain tax, you must know some significant amounts. They are:

Adjusted Cost Base (ACB): The price of an investment, including any costs related to obtaining the capital property.

Dividends of Disposition: This refers to the amount you have profited by selling your capital asset. This is the amount gotten when you deduct any outlay or expense you may have incurred by selling.

Expenses Required to Sell:  These are any outlays you may have to make when selling your capital property.

Capital gain subject to tax = Selling price – the Adjusted Cost Base

Bottom Line

Ultimately, you possess a capital gain when you sell a capital asset for a higher amount than the total of its ACB and the outlays and expenses incurred to trade the property.

The view about high-net-worth people is they probably have too much and don’t bother about taxes. This couldn’t be farther from the truth. HNW people are just like everyday people. They bleed cash like every other regular Canadian. High net worth people are also entitled to tax benefits on their money just like every other Canadian. As a high-net-worth individual who moves financial assets from one place to the other, it is important to maximize whatever tax benefit is available to you to save funds. In this article, we will discuss key tax matters and best practices that you must be wary of when dealing with friends and family. These three matters include: property gifts, having a secondary residence, and personal loans to friends and families.

1. Tax Implications of Real Estate Property Gifts

Real estate is becoming increasingly expensive in Canada. If you have the privilege of owning some real estate properties and thinking of gifting them to your loved ones, there are things you must consider.

Capital Gains Attribution – This is one thing you should be wary of when gifting a real estate property in Canada. For a better understanding, let us look at this example: If you gift a property to your spouse and they decide to sell to a third party, any capital gain or loss on the value of the property will be charged back to you. In other words, any profit or loss made on a property you gifted to your loved one will be attributed as yours and taxed accordingly. This is known as Tax-free rollover. It is an automatic tax charge on income from a property gifted to a spouse. To avoid this, you must apply to opt-out of the automatic tax-free rollover. When you apply, it means that you will have to report any accrued gains on the property and your spouse will also report any future gains on the property. The exception to this is when the property is gifted to a minor. You are not allowed to opt-out when you gift the property to a minor.

Income Attribution – Income attribution in Canada has to do with income from real estate properties. This occurs especially when you gift a property to your underaged family member. It could be your child, or a nephew or niece. If the child is under 18, any income on the property will accrue to you and will be taxed. This means that you will carry the tax burden of the income on the property gifted until such minor clocks 18 years of age. The income referred to in this type of attribution means rental income. It is different from capital gains attribution.  Income attribution also applies to spousal gifting of property or a common-law spouse. Any income accrued on the property will accrue to you and will be taxed accordingly. In all of this, it does not matter if you spend out of the profit or not; if it is a gift coming from you to your spouse or an underaged loved one and it will be assumed that the income is going to you.

Double Taxation on Transfer of Real Estate Property – Double taxation on real estate property gifts may occur when you transfer your property to a family member for less than the fair market value of such property. For a better understanding, let us use an example where you sell a real estate property to your son at a value of $20,000 as against the fair market value which is $350,000. In this type of situation, it will be deemed that you made a proceed of $350,000 on the property. Your capital gains, in this case, will be $320,000 ($350,000 – $20,000). Half of the $320,000 will be subject to tax. If your son goes ahead to sell the property for the fair market value of $350,000, you will be taxed on this sale again. This then amounts to double taxation.  Another example of when double taxation can occur is when you sell your property to a loved one at a value more than the fair market value. For example, if the property is valued at $300,000 and you sell it to your sister at $350,000, it will be deemed that you made a proceed of $350,000 on the property and taxed accordingly, but it will be deemed that the property cost your sister $300,000. If your sister decides to sell the property in future, you will be taxed again. Fortunately, there is a way out. The reason for the double taxation in the scenarios painted above is that the property was sold for a value. However, if you transfer the property for no consideration at all, it will be deemed that it was sold at a fair market value. The beneficiary will have a fair market cost base which will allow you to avoid double taxation.

What Are Your Alternatives? With all the taxes mentioned above, it is advisable that real estate properties should not be transferred for a lower amount from the fair market value. But if you want to transfer your property to your loved ones without any consideration to find a way around Capital gains attribution and income attribution, you can consider any of the following:

• You can gift your loved one the cash they need to acquire the money at a fair market value. That way, you will not be taxed on capital gains or income from the property.
• The other option you have is to lend your loved one the money required to purchase the property at a fair market value. However, you must ensure that they pay a prescribed interest rate on the loan. – The full loan must be repaid on or before the 30th of January the following year and it must include the interest income in your tax return.

2. Best Practice Personal Loans to Friends & Family

Being a high-net-worth individual may mean that people come to you from time to time to get loans. It is a privilege to be able to help others, but you must ensure you do it with your eyes wide open so as not to regret it later. For one, the reason most people turn to private loans from friends and family is that banks have rejected them, and they believe they will get flexible terms. This makes lending money to friends and family a risky venture.

Here are some best practices to guide you on what you need to protect yourself:

Choose Wisely – People have different reasons for needing a loan without a thought as to how they will repay the loan. Some reasons are more worth it than others. Therefore, it is important to know the reason for the loan before giving it. The reason for the loan will probably tell you what you need to know about the person. They may be your friends and family but it is your money, and the final decision is yours. Here are some genuine reasons you can consider lending money:

• A start-up business or an existing one. Investing in a business could yield returns afterwards.
• Down payment for a new home. You can consider helping in this regard.
• Medical needs. This is another genuine reason for which you can lend money.
• Divorce and legal problems are also genuine reasons someone may want to borrow money.
• If the person just relocated, you could consider lending him/her some money.

It is also important that every detail of the loan should be discussed. Being a friend or family is not enough. There should be a repayment plan and an agreed interest rate. All these terms should be clear and should be in writing if possible or there should be a witness to the discussion.

Have A Plan – It is important to have a plan with the person you are lending money to. Some of the things to be discussed include:

The Type of Credit Arrangement – It is very important to be clear whether it is a loan, or you are co-signing on a loan already borrowed. Both are risky but co-signing may be riskier because you are placing liability on yourself to repay if the person defaults. This may affect your credit score. Meanwhile, a loan coming from you bears a lighter risk because if the person does not pay it back, you must be prepared for that eventuality. Be clear on the difference and make sure you make the best decision.

Be Clear on Interest Rate – This is a tricky subject for friends and family who want to enter into a loan agreement. On the one hand, you as a lender will want to make sure you give a favourable interest rate, especially with the risk involved. The borrower, on the other hand will be expectant that you give an interest rate that will be favourable to him or no interest rate at all, considering the relationship between you two. Whatever the case may be, it is important that you are clear on this condition. You can give a lower interest rate than banks but high enough to ensure you make money from the transaction rather than your money just lying in the bank.

Get It Documented – This is an important step that could make or mar your relationship with the borrower. Money can be a tricky issue which can give room for recriminations. To avoid this, it is important to get everything discussed, especially the terms agreed upon by both parties’ documents. The amount, interest rate, repayment dates, and the penalty for late repayment. There are free online resources that provide templates you can use for the contract to be signed by both parties. This makes them facts and legally binding on both parties regardless of the relationship between you two.

Payment Arrangement – The payment agreement is an important part of the contract. It is important to agree on when and how the loan will be paid. All these should be written in clear terms in the contract drawn up. Loaning money to family and friends can be tricky. It is important to adhere to the tips mentioned to preserve your relationship with the person.

3. Tax Implications for Secondary Residences

It is not uncommon for high-net-worth individuals to have an additional shelter as part of their assets. it could be a vacation home or an investment. The fact remains that it is your asset and will be referred to as a secondary residence. Usually, a residence that is being habited is regarded as a primary residence. The CRA requires that you report a sale of your primary residence to qualify for the Principal Residence Exemption (PRE). The CRA will analyze your data before granting you a PRE. Details that are assessed include the duration you have been living in the said residence, your real estate investments, and your sources of income. All of these will help them determine if the building is truly your primary place of residence. This exemption does not apply to your secondary residence.

To save yourself some cash on taxes, if you have a secondary residence and you have a spouse or a common-law partner, you can designate the secondary residence to your spouse for all the years you own and use it as a primary residence which qualifies it for capital gains tax exemption when it is sold. Fortunately, the Canada Revenue Agency (CRA) does not prescribe how long you must live in a house for it to become your primary residence. It only says that you must habit the residence for a short period which makes it open to interpretation. Residences outside Canada can also be designated as a primary residence if the designate has inhabited the home in the year in which the PRE is being applied for. If you fail to take advantage of this, your secondary residence will be subject to capital gains tax for the years it was not designated to an inhabitant.

When designating, there are exceptions you need to take note of. The first is that only one property per year and per family can be designated as a primary residence. A family member in this context means your spouse or common-law partner and your children that are under 18. Another exception is that any residence that is above 1.2 acres in size will not qualify for PRE except if you are able to prove that the excess land is required for the use and enjoyment of the residence. This means that the excess land will be subject to capital gains tax.

For a maximum tax advantage, you should designate the residence with the highest average capital gains per year. You can also contact a tax expert for proper guidance.

Bottom Line

Although it seems like a lot to digest, that is why you have an advisor. Reach out with any questions in any of the above areas if you feel in over your head.

Book an appointment with us today! – CLICK HERE

Executive Summary

There are numerous ways to take money from corporate earnings while keeping your tax bill to a minimum. Often, business owners opt to receive a portion of corporate earnings through a salary. While others opt to extract profits using a mix between salary and dividends.

Finding the optimal combination to maximize your tax savings depends on many factors including (but not limited to) your cash flow needs, income level, payroll taxes on salary, or the corporation’s income level.

Understanding the tax treatment of payments is important as you want to ensure that the maximum amount of funds is left to be invested back into the corporation.

Earning Options

Paid-Up Capital: If you funded your corporation with a large sum of capital, you may be able to extract funds tax-free by reducing the corporation’s paid-up capital; essentially this is the amount of capital contributed in exchange for shares. Typically, you are allowed to pay shareholders any amount less than the corporation’s paid-up capital without tax consequences.

Repay Shareholder Loans: Another option to receive corporate funds is to repay shareholder loans. If you loaned funds to your own corporation, you are entitled to receive any amount of repayment of the loan tax-free. You may also arrange to have the corporation pay you interest on the loan. Taxation of the interest income is about equivalent to the taxes deducted if the corporation paid you a salary.

Passive income: Investment income earned inside your corporation is classified as ‘passive income’ as it is not generated by direct business operations. The combined tax rates are over 50%, depending on your province of residence, on the taxable portion of earnings. In the case of interest, that is the entire earned amount. For capital gains, half of the gain is subject to the combined tax rate and for dividends the rate is 33.33%. All three of these rates are higher than the highest marginal rate for individuals. Subjecting passive income to higher tax rates within a corporation can lend some benefits like:

• Building your nest-egg inside the business to fund future expansions
• Cover short-comings during difficult periods
• Facilitate borrowing

However, the largest risk with this option lies in losing the capital gains exemption on the sale of shares of a ‘qualified small business corporation.’ As the invested assets build over time, and operating assets decline in value thanks to depreciation, the asset mix could be lopsided. To have the capital gains be exempt, the ‘passive’ invested assets cannot exceed 10% of the fair market value of the corporations’ assets.

Lifetime Capital Gains Exemption (LCGE): For 2021, the LCGE limit per person is $892,218 and is indexed to inflation. This means a married couple who both own shares and can both utilize the exemption could shelter $1.784 million from taxes. Farms and fishing operations that qualify have the individual limit of $1 million per person, allowing a couple to shelter a maximum amount of $2 million. Depending on your goals, a short-term increase in tax and the professional fees associated to establishing the appropriate corporate structure could save you significant amounts of tax in the long run.

Maximizing Capital Dividend Payments: When you have a capital gain, the untaxed portion (one half of the gain) is added to its capital dividend account. The corporation can pay any amount from this account to your client without attracting personal tax. Although this is likely your best option, you must ensure that you make the appropriate tax deductions and remember to file the directors’ resolutions with the CRA.

Bottom Line

Every corporation is going to present varying degrees of needs. When it comes to determining how to pay yourself, be sure to be well informed before making any final decisions. Of course, consulting with a financial expert, like myself, can prove helpful. I encourage you to get in touch with any questions or concerns or to simply learn more.

Book an appointment to discuss how you can get money from your Corporation – Book Here

Capital Gains tax occurs when you sell capital property for more than you paid for it. In Canada, you are only taxed on 50% of your capital gain. For example, if you bought an investment for $25,000 and sold it for $75,000 you would have a capital gain of $50,000.  You would then be taxed on 50% of the gain. In this instance, you would pay tax on $25,000.  In Canada, there are some legitimate ways to avoid paying this tax: Tax shelters, Lifetime Capital Gains Exemption, Capital Losses, Deferring, and Charitable Giving. *

What You Need to Know

1.   Tax Shelters

RRSPs and TFSAs are investment vehicles that are available to Canadians that allow investments to be bought and sold with no immediate tax implications:

• RRSPs – Registered Retirement Savings Plans are popular tax sheltering accounts.  Investments in these accounts grow tax free and you are not subject to capital gains on profits.  When you withdraw your funds, you will be taxed at your marginal tax rate.
• TFSAs – Tax Free Savings Accounts are like RRSPs in that they allow investments to grow tax free and you are not subject to capital gains tax on the profits you make. The key difference between TFSAs and RRSPs is that TFSAs hold after tax dollars. This means you can withdraw from the account without incurring tax penalties.

2.   Lifetime Capital Gains Exemption

The Lifetime Capital Gains Exemption is available to some small business owners in Canada. It is allowing them to avoid capital gains when they sell shares of their business, a farming property, or fishing property. The CRA determines the exemption amount annually.  The Lifetime Capital Gains Exemption amount is cumulative over your lifetime and can be used until the entire amount has been applied.

3.   Offset Capital Losses

Generally, if you have had an allowable capital loss for the year, you can use it offset any capital gain tax you have owing. This can reduce or eliminate the taxes you will owe. There are a few considerations for employing this strategy:

• Losses have to a real loss in the eyes of the CRA. Superficial losses will not be allowed to offset gains.
• You can carry your losses forward or backward to apply them to different tax years. Losses can be carried back 3 years and carried forward indefinitely. This means you can accumulate losses that can be used to offset gains in future years.

4.   Defer Your Earnings

A possible strategy is to defer your earnings on the sale of an asset because you only will owe tax on the earnings that you have received.  For example, if you sell a property for $200,000 you could ask the buyer to stagger their payments over 4 years. Then you would receive $50,000 a year. This would allow you to spread out your capital gain tax.

This strategy is known as the Capital Gain Reserve.  There are a few things you need to keep in mind before using this strategy:

• The Capital Gains Reserve can be claimed up to 5 years.
• There is a 20% inclusion rate for each year. This means you must include at least 20% of the proceeds in your income each year for up to 5 years.
• There are some instances that the 5-year period can be extended to 10 years.

5.   Charity

Consider donating shares of property to charities instead of cash. This method allows you to make a charitable donation, receive a tax credit based on the donation, and avoid tax on any profit. Win-win!

* Avoiding or deferring Capital Gain Taxes should always be done with the guidance of a professional financial advisor and accountant to ensure all CRA guidelines are being carefully followed.

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