You’ve built up an investment portfolio inside your corporation and would like to maximize your returns. How can taxes factor into investment decisions? As always, tax calculations should be weighed against your overall goals of generating income and/or growth and the level of risk associated with the investment. For the sake of simplicity, let’s assume that we have three investment funds that are the same except for the type of income they pay out. One pays Canadian dividends, the second pays interest, and the third pays capital gains:
| Canadian dividends | Interest | Capital gains | |
| Investment income | $1,000 | $1,000 | $1,000* |
| Corporate tax | $383 | $502 | $251 |
| Net cash retained by your corporation | $617 | $498 | $749 |
All other things being equal, generating capital gains will attract the least amount of tax inside your corporation. Your company will pay 25.1% tax vs 50.2% on interest or 38.3% on dividends.
Personal withdrawals from your corporation
The table above only tells half the story. The other half occurs when you withdraw funds from your corporation as dividends. This is where things get a little more complex. Part of the tax paid by your corporation on its investment income is refundable when it pays a dividend out to you, the shareholder. Here’s what that looks like for our three types of income:
| Canadian dividends | Interest | Capital gains | |
| Investment income | $1,000 | $1,000 | $1,000 |
| Corporate tax | $383 | $502 | $251 |
| Corporate tax refund when the dividend noted below is paid to the shareholder | $383 | $307 | $153 |
| Net corporate tax | Nil | $195 | $98 |
| Dividend paid to shareholder subject to personal tax | $1,000 | $800 | $400 |
| Tax-free capital dividend paid to the shareholder | Nil | Nil | $500 |
The entire $383 of tax your corporation paid on its dividend income noted in the table above will be refunded when it pays the same dividend out to you. You would then pay personal tax on the dividend. For interest income, the corporate tax refund is $307 when your corporation pays you a dividend of $800. For capital gains, the corporate refund would be $153.
Why would the government bother with charging tax and then refunding it? They do not want there to be an advantage to using a corporation to generate investment income. If you could hold investment income in your corporation with no tax (or reduced tax), that would be an advantage.
There is, however, an advantage that is hard to create legislation to get rid of, and that has to do with timing. You have no control over when investment income is generated inside your investment portfolio, but you do have control over when your corporation pays a dividend to you. If you know your personal income will be lower than usual in a particular year, that might be a good time to pay a dividend. Depending on which tax bracket you fall into, a personal tax on dividends ranges from 0% to almost 50%. This translates into a significant savings opportunity when you time the payment correctly. Your McCay Duff LLP advisor can help you determine the best time to take a dividend in your circumstances.
Tax savings opportunity for withdrawing capital gain income
50% of capital gains are taxable. This is true for both corporations and individuals. When capital gains are generated inside your corporation, the 50% portion that is not taxable can be flowed out to you, the shareholder, through a capital dividend. Capital dividends are tax-free but require special election forms to be filed before the dividend is paid out. If you have generated significant capital gains inside your corporation, it’s a good idea to discuss your options with your McCay Duff LLP advisor as soon as possible. Future losses can erode the amount you can pay tax-free, so timeliness is essential here.
Contact McCay Duff LLP in Ottawa for advice and assistance with tax planning and preparation matters.
Contact the tax professionals at McCay Duff LLP in Ottawa to discuss how partnering with us can help save you time, anxiety, and money regarding your taxes. Our tax advisors provide expertise in all aspects of corporate tax, Canadian and U.S. personal tax and ensure compliance with tax laws while minimizing your tax obligations. To learn more about how McCay Duff LLP can assist you or your business, please get in touch with us online, telephone at 613-236-2367, or toll-free at 1-800-267-6551.
