As a business owner, you are in the enviable position of being able to receive a salary, a dividend or some combination thereof.
Although tax considerations weigh heavily in this decision there are other qualitative and quantitative factors to consider before deciding on what form your remuneration should take.
Advantages of a Salary
- Corporations working in certain fields such as Scientific Research and Experimental Development (SR&ED) and design activities are eligible for tax credits based on salaries paid to employees, including the owner, engaged in these activities.
- Salary is considered earned income for RRSP purposes and can increase your contribution room while dividends do not.
- If you receive a salary, it may be worthwhile for your company to set up an Individual Pension Plan (IPP). An IPP can be more advantageous than an RRSP.
- By paying a salary, you and you and your company contribute to the Canadian Pension Plan (CPP) contributions on your behalf, or if you live in Quebec, the Quebec Pension Plan (QPP).
- Salaries are generally not restricted when corporations have financial debt covenants or are in financial distress.
- Personal financing is easier to obtain. Financial institutions prefer a steady and predictable inflow of income being reported.
Disadvantages of a Salary
- Paying a salary requires more administrative work. If it does not already have one, the corporation must open a payroll account with the Canada Revenue Agency and Revenu Quebec (for Quebec employers), report salaries paid and remit payroll taxes withheld throughout the year.
- There is an added cost for the corporation as payroll taxes withheld include amounts which represent the employer’s contributions.
- The amount you receive is net of withholding tax and thus there is less disposable cash during the year.
Advantages of a Dividend
- Dividends provide a better cash flow as the resulting personal taxes are only payable, either quarterly or when your personal tax return is due.
- The corporation is not required to open a payroll account and the administrative burden is simpler. All that is required is to report the dividend paid on a T5 and RL-3 tax slip due February 28 of the following year.
- Dividends are considered investment income when reported on your personal tax return. If you incur personal investments which generate losses, you can deduct investment expenses incurred personally against dividend income received from your company.
Disadvantages of a Dividend
- Certain personal expenses, such as child care expenses, are deductible in the personal tax return of the lower income spouse based on earned income. If you only receive dividends, your earned income is zero for the year and consequently, you obtain no benefit from those expenses.
- Dividend payments in excess of retained earnings may violate business corporation act under which the corporation was formed and creditors can sue the directors for debts owing if the corporation becomes insolvent because dividends were paid.
Which should I take?
The ultimate decision depends on your personal and business situation.
Younger business owners should focus on taking salary as that will allow them to build up RRSP contribution room to contribute to as well as pay into the CPP or QPP pension plans.
Growth of RRSP plans are tax-deferred until you start withdrawing funds. The more lead-time you have to contribute, the more potential there is for your plan to grow in size and provide a larger income for you at retirement.
As you and your business mature, you may want to look a dividend as a way to increase your personal income as well as streamline your corporate finances.
We’re Here to Help
Would you like to know which options would be the most fiscally advantageous you’re your business? Do not hesitate to contact a member of our Tax department to discuss your particular situation.