Simply withdrawing cash from your business’s bank account will likely result in a significant tax bill. So the question then becomes: how do you take money out of your business in a tax-efficient manner?
Remunerate yourself and family members
If family members work in the business, a reasonable salary (or wages) can be paid to them. This is especially beneficial if family members have little or no other sources of income. Generally speaking, a “reasonable” salary in this instance would be one that approximates what would be paid to an unrelated third party for the same work activities.
Pay a taxable dividend
Dividends can be used to distribute money from the corporation to both you and your family members. It will be critical to consider both the tax on split income (TOSI) rules and the corporate attribution rules before any distribution is made.
Optimize your salary versus dividend mix
It is common for owner-managers (of Canadian controlled private corporations) to pay themselves a combination of both salary and dividends. Various factors can influence the owner and increase the complexity of the issue.
- Drawing dividends alone will not provide you with earned income for purposes of your RRSP contribution.
- On the corporate side, you will want to consider the impact of any relevant payroll taxes, as well as any remittance requirements and filing obligations that may arise.
- Lastly, your corporation’s ability to claim scientific research and experimental development credits may be impacted by remuneration decisions, although this has become much less of a concern due to a beneficial federal tax change made in 2019.
Convert “hard ACB” into cash
If you purchased your business from someone else, it is possible that the shares you acquired have “hard” adjusted cost base (ACB), which can become relevant when planning to withdraw cash from your business. Essentially, “hard ACB” is a tax term that represents the amount that you paid for the shares when you purchased them, and it can potentially be converted into cash (or debt that can be repaid later) using a holding company.
There are some very punitive rules in the Income Tax Act relating to converting the hard ACB of your shares into cash to be aware of.
Repay that shareholder loan
To help finance the start-up or growth of your business, you may have loaned funds to your company in the form of a shareholder loan. Any amount that you receive in settlement of your shareholder loan will be a tax-free distribution, similar to a return of capital.
Pay a capital dividend
In simple terms, the capital dividend account (CDA) is a notional balance that most commonly represents the non-taxable portion of any capital gains that a private corporation has realized on the disposition of capital assets. A positive balance in a corporation’s CDA can be distributed to Canadian resident shareholders as a tax-free dividend.
That said, calculating the CDA can be complex. As well, specific filing requirements must be met when paying a capital dividend.
Taking the time to properly plan how you’re going to withdraw money from your business will ensure that you’ll pay the minimum amount of tax necessary. Each option above can land you in complex rules so please consult your advisor before finalizing your plan. There are numerous potential avenues to explore, and many factors to consider, when selecting the most tax-beneficial plan for your unique situation.
Scott Conner is an experienced tax practitioner and practical problem solver at BDO. As a partner specializing in Canadian income tax, Scott has particular specialties in private companies, planning for estates, trusts, and complex transactions. Scott works closely with his clients to understand their specific needs and adjust strategies accordingly. Scott and his team take a proactive, hands-on approach. They closely follow existing and proposed legislation to determine how it will affect individual financial goals, and provide ongoing guidance.