Tax-efficient solutions for withdrawing funds from your business

You’ve worked hard to build your business into a profitable one. During its start-up years, you may have given up on paying yourself a salary and reinvested it in your business to help it grow. Today, it is possible that it is well established and that you are ready to take a share of the profits. You may want to increase your personal cash flow to improve your standard of living or meet your family financial obligations. Maybe you’re more concerned about maintaining your company’s “small business corporation” status with a view to one day obtaining the capital gains exemption.

Remuneration of your family members and yourself

Owners operating a business generally pay themselves a salary, the same way an employee is paid. If family members work for the company, they may also receive a reasonable wage (or salary), i.e. approximately equal to that which would be paid to an unrelated third party for the same activities. This can be particularly beneficial if family members have little or no other source of income.

entitled to a deduction for wages (or salary) paid in determining its taxable income, but only if the amounts are reasonable.

Note that there is an exception for salary (or bonuses) paid to owner-operators. Under this exception, the Canada Revenue Agency (CRA) will generally not question the amount of salary (or bonuses) paid by a Canadian-controlled private corporation (CCPC) to an owner-operator resident in Canada who actively participates in the day-to-day activities of the SPCC. The CRA’s position provides more flexibility with respect to owner-operator compensation decisions.

Payment of a taxable dividend

Dividends can be used to distribute funds from your company to you and your family members. Your spouse, your children and you must however hold shares in the company directly or indirectly, through a trust or a holding company.

Corporate income attribution rules – Transfers or loans made to make the income taxable in the hands of another family member may result in a higher tax bill for the individual making the transfer or the loan, unless certain conditions are met. Planning will help avoid the application of punitive taxes under the corporate income attribution rules.

Optimal combination of salary and dividends

Keep in mind that the active business income of a CCPC is eligible for reduced tax rates both federally and provincially or territorially due to the “small business deduction”. To take advantage of potential tax savings, CCPC owner-operators often pay themselves a salary and dividends.

Previously, when active business income exceeded the business limit set by the federal government, a company could pay “bonuses” to not exceed this limit. Indeed, the combined corporate and personal taxes to retain this excess income and pay it out as dividends often exceeded the tax cost of a “bonus”.

Cash conversion of “full” adjusted cost base (ACB)

If you bought your company from someone else, it is possible that the acquired shares have a “full” ACB (commonly called “hard ACB”). This information may be relevant if you plan to withdraw funds from your business. Essentially, the “full” ACB refers to the amount you paid when buying the shares. It can be converted into cash (or debt to be repaid) through a holding company, allowing you to access the capital you have invested without paying tax.

In other words, a holding company can be set up to acquire shares of your operating company upon payment of consideration equal to the ACB of those shares. This way, you could receive proceeds, in cash or as debt, up to the cost base of your shares, without paying tax. Incorporating a holding company may have other benefits as well as raise other issues to consider. Your BDO advisor can help you determine if it makes sense to incorporate a holding company in your situation.

Repayment of shareholder loans

To finance the start-up or growth of your business, you may have granted it a loan as a shareholder. Now that your business is profitable, you could get some or all of that loan back. Like a return of capital, any amount you receive in repayment of your loan is tax-free.

Your company may also start paying you interest on your shareholder loan. Be aware, however, that while it can deduct any interest paid, that interest will be taxable to you as investment income. It is also important to mention that in some cases, the TOSI rules will apply to interest income from private corporations earned by individuals at the highest tax rate. Therefore, before paying interest, it would be a good idea to determine whether the new split income rules apply to your situation to avoid undesirable tax consequences.

Payment of return of capital

There is another potentially tax-free method of distribution where you could pay yourself a dividend from your corporation’s capital dividend account.

This account is a notional balance that generally represents the non-taxable portion (currently 50%) of any capital gain (or similar receipts) that a private corporation has realized on the disposition of a capital asset (tangible or intangible). If there is a positive balance in a company’s capital dividend account, it can be distributed to Canadian resident shareholders as non-taxable dividends. Thus, the non-taxable portion of the company’s capital gains (and similar receipts) will not be taxable in the hands of the shareholders who receive it.