Planning for the Creeping Tax Liability in your Corporation

In January, I wrote a post titled RRSPs and Corporations – Your Silent Creeping Tax Liability. The blog noted that whether you are currently working, near retirement or in retirement, you and/or your corporation have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation.

I followed up in April, with a post on some potential planning to address the creeping RRSP liability. Today, I discuss some planning and considerations to reduce the creeping corporate tax liability you may be accruing.

Corporate Tax Attributes

Many corporations have built up corporate tax attributes that can be accessed prior to retirement or in retirement that can reduce the tax liability related to you and/or your corporation. I discuss these below.

Shareholder Loans

Repayment of shareholder loans owing to you and other shareholders is the most tax efficient way to remove funds from your corporation on a tax-free basis.

Capital Dividend Account

If your corporation has a capital dividend account ("CDA") balance, paying out capital dividends is a great way to remove funds on a tax-free basis and reduce your ultimate corporate tax liability (Non-resident shareholders are subject to withholding tax on capital dividends). See this blog post I wrote for all the details of a capital dividend account. 

For some unknown reason, many corporations do not pay out tax-free capital dividends from their CDA on timely basis. Since this account is a "moment in time" account, this can prove very costly if you incur capital losses. For example, if your corporation had previous capital gains and the CDA balance is say $100,000 today, but the corporation incurs capital losses of say $60,000 tomorrow, the CDA account will be reduced by $30,000 to $70,000. Thus, your corporation will have forgone $30,000 in tax-free dividends if the capital dividend had been paid before the capital losses were incurred. 

Due to the poor stock markets this year, you may be triggering capital losses as part of the corporation's investment and/or tax planning. Discuss paying out a capital dividend with your investment advisor and accountant before triggering any capital losses this year. 

Refundable Dividend Taxes On Hand

Your corporation may have balances in the following two notional accounts: Eligible Refundable Dividend Tax on Hand (ERDTOH) and Non-Eligible Refundable Dividend Tax on Hand (NERDTOH). These accounts are the successor accounts of what was formerly known as Refundable Dividend Tax On Hand (RDTOH). These accounts are essentially prior years corporate taxes paid that are refundable when the corporations pays dividends to the shareholders. The accounts act as a mechanism to ensure that you and your corporation are not double taxed. 

While your corporation needs to pay a taxable dividend to trigger refunds from these accounts (the rules are confusing, speak to your accountant), the government essentially pays your corporation a refund somewhat equivalent to the personal tax you owe on the dividend, so you net out much better than if you paid a taxable dividend with no refundable tax.

Return of Capital

If your corporation has “hard” paid-up-capital (“PUC”) for money you previously paid to purchase corporate shares from treasury, you should be able to return most of the PUC tax-free.

Income Splitting

Payment of Wages

If you have family members who work in the business and are not paid a salary or are paid a very low salary, consider paying them a “reasonable salary”. I say reasonable, as the CRA requires a salary to family members to be reasonable to be deductible.

Tax on Split Income Rules

The Tax on Split Income Rules (“TOSI”) rules are very complicated and far beyond today’s brief discussion. However, in general, TOSI will not apply on amounts paid to a business owner’s spouse or common-law partner, who are inactive in the business, so long as the business owner has reached age 65 during the year. This will be the case where the amount would have been excluded from TOSI had it been received by the business owner directly, by virtue of the fact that they would have otherwise met another exclusion. So, an inactive spouse whose shares were subject to TOSI before the business owner turned 65, will in most cases, now be able to receive dividends on their shares without the TOSI rules applying. It may also be possible to reorganize the company when the business owner turns 65 to provide shares to the inactive spouse.

Tax Reorganizations/Tax Planning

If you have a successful corporation (especially an active corporation), your accountant or tax lawyer may have one or two reorganization/tax plan ideas to consider that could possibly lower your creeping tax liability. The Federal budget in April this year contains proposals to limit a couple of these planning ideas, so you should speak to your accountant to review whether there are any planning opportunities still available that may work for you and your corporation(s).

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Should your Investment Income be Earned in a Corporation

Many people often ask should they own their investments in a corporation to avoid and/or defer income taxes. Although there may be reasons to utilize a corporation for liability purposes or to save on U.S. estate taxes if you own U.S. securities, there are currently no income tax savings or benefits to utilizing a corporation to earn investment income.

The overriding principle of taxation in Canada is that an individual should be indifferent between earning investment income through a corporation and earning that same income personally. This concept is known as integration. To achieve integration on investment income, Canada imposes a refundable tax on Canadian controlled private corporations that earn investment income.

If investment income earned in a corporation was subject to an income tax rate that was lower than the highest marginal personal income tax rate, it would be possible to have an indefinite deferral of income tax so long as the after-corporate tax funds were left in the corporation.

In order to ensure taxpayers do not defer income tax on investment income by using a corporation, the Income Tax Act imposes an income tax rate that is essentially the same as the highest marginal personal income tax rate. Thus, an investment corporation in Ontario would currently pay 46.41% on all its investment income earned, which by coincidence is the exact same rate as the highest personal marginal income tax rate in Ontario. In order to ensure that double tax is not incurred, when corporate funds are distributed out to an individual by a dividend, the high rate of corporate income tax is partially refunded.  This refundable tax prevents the corporation from having more after-tax dollars available to reinvest than the individual would have had if he or she had earned the money personally.

This may be more than you want to know, but the way the refundable tax system works is as such: the 46.41% corporate income tax rate is split into two components, the income tax component which is 19.74% and the refundable tax component which is 26.67%. The refundable component goes into a notional account called the Refundable Tax On Hand (“RDTOH”) account. Where a corporation has paid refundable tax, it will receive a refund of this tax when it pays a dividend to its shareholder(s) who will then pay the personal tax on the dividends. The corporation receives a $1 refund for every $3 in dividends it pays to a shareholder.

It is probably best to think of the refundable taxes as a prepayment of the eventual personal taxes to be paid on the investment income. Below is a model of how the investment income integration system works (this is theoretical not actual; see below for a discussion of the realities of integration in Ontario). As demonstrated by the examples, theoretically where investment income is earned through a corporation there should be no deferral of tax and no tax savings where the individual shareholder pays tax on the dividends at the highest marginal tax rate.

Integration model	Interest	Eligible Dividend	Other Than Eligible Dividend
A:
Investment income earned personally	100.00	100.00	100.00
Personal tax (2011)	46.41	28.19	32.57
Net cash for investment	53.59	71.81	67.43
B:
Investment income earned in a corporation	100.00	100.00	100.00
Corporate tax	20.00	-	-
	80.00	100.00	100.00
Refundable tax	26.67	33.00	33.00
Net cash for investment	53.33	67.00	67.00
Corporation declares dividend to shareholder and recovers $1 of refundable tax for every $3 of dividends paid to the shareholder(s)
Dividend refund	26.67	33.00	33.00
Cash to pay dividend	80.00	100.00	100.00
Personal tax to shareholder on dividend	26.41	28.19	32.57
Net cash for personal investment	53.59	71.81	67.43

In reality, integration is not perfect. For example, in Ontario there is a ½ point of absolute income tax benefit to use a corporation when earning interest income, a ¼ point of savings if earning capital gains and no tax savings when earning dividends; however, based on the professional fees and administration, one would almost never use a corporation for such a small benefit.

The refundable income tax system is a somewhat nefarious concept; hopefully I have provided some insight into the concept above and not confused you further. However, the key take-away point is; there is no income tax benefit to incorporate your investment income.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.