There are no clear answers when it comes to remuneration. The ultimate goal is to allow you to take out funds from the corporation with minimal tax costs. However, the remuneration strategy is not straight forward and depends on individual circumstances. Finding the right remuneration strategy is best left in the hands of your trusted Chartered Accountant.
When it comes to the remuneration strategy, we take a multidimensional approach to ensure an optimal tax position:
The first step is to decide how much money you want to take out from the corporation
This is an important step as the ultimate tax deferral and saving can be achieved when cash-flow is retained in your corporation. When corporate funds are distributed as salary or dividends, tax will be assessed at personal level. With proper tax planning you can minimize or greatly reduce the personal tax liability. For example if you pay dividends during a period when you have little or no additional income (maybe upon retirement) you will be in a much lower tax bracket, therefore greatly reducing the overall tax paid on your remuneration.
There are limited tax planning opportunities if all funds earned by the corporation are distributed immediately to the individual. The reason for this is that the individual will pay tax at the top marginal personal rates (currently 39% in Alberta). This is not an intended result, since the same money can be received in years when you have no additional income and pay little or no personal tax on the same funds.
Who should receive the funds?
A proactive remuneration strategy is to pay some income to spouse, children or parents. The objective is to divest cash-flow to lower tax-bracket individuals and therefore reduce the overall tax bill for the family. There are many tax traps that need to be considered at the onset of the remuneration planning. For example there is a reasonableness test that should be met before paying any salaries to your spouse or children. What is a reasonable salary? It is the amount the corporation would pay to a non-related individual for the same services provided by your spouse or children.
What is the right mix for remuneration: dividends, salary, bonus, etc.?
The right mix of dividends and salary is the conundrum of tax integration. Under the Canadian tax system, there are two main forms of remuneration from a corporation to the owner: salary or dividends. Salary is deductible for the corporation whereas dividends are not. However, through the tax integration system, it should make no difference if the cash-flow is paid to the shareholder before or after corporate taxes. Dividends are taxed in the hands of individuals through a special mechanism (gross-up and dividend tax credit) that in theory should generate the same amount of tax, had the remuneration been paid as a salary.
However, the integration system is not perfect due to various provincial tax rates and the introduction of eligible and non-eligible dividends. Significant tax rate changes are expected over the next few years, and your trusted Chartered Accountant can make sure your remuneration strategy makes sense for your situation.
When should the remuneration be paid?
Due to the changing tax rates, it may be more beneficial to accelerate the payment of dividends in a given year. However, the net tax savings on tax integration should not be the only consideration. The following are some other factors to consider when planning the remuneration strategy:
- Impact of accelerated dividends payment over the personal tax installments
- Paying salaries / dividends to other family members
- Do you want to maximize the RRSP contribution limit?
- If the corporation has investment income, a dividend pay-out will trigger a refund of high corporate taxes paid on such income.
Your trusted Chartered Accountant provides remuneration strategy services to clients located in Calgary and area.