How to invest inside a corporation
As a new owner of a corporation, I’ll admit it’s a brand-new world for me to consider how to invest inside a corporation.
I’m in the very fortunate position to be still working full-time, so I don’t need any income at this point from the corporation to cover my living expenses. But it might not always be that way. That’s especially true, when I consider semi-retirement / working on my own terms in a few years.
So, I’m considering my possibilities including how to invest inside a corporation now.
It seems there are many issues to consider when deciding what to do with your corporation’s surplus of funds. What options are available? What are the tax implications of those options?
Whether you can invest some or most of your corporation’s surplus I feel this post is for you (and me).
Salary or dividends from a corporation?
Previously on My Own Advisor, I wrote a post about whether you should pay yourself a salary or a dividend, which can be a complex decision for many business owners.
That decision has pros and cons on both sides of the accounting ledger.
Yet few blogposts existed in my research about how to invest any money inside a corporation, and what that might entail tax-wise.
Of course, none of this content is direct tax advice for you, but I wanted some support to demystify what I understand and what may or may not be the best course of action for me to consider.
So, for more support on this topic today, I want to welcome back a not-so-grumpy accountant Neal Winokur to the site.
Neal Winokur, CPA, started his practice in 2013 and his grumpiness has grown steadily over time – when it comes to our Canadian tax system. An active blogger, several of his articles have been published in the National Post. Neal continues to feel a moral obligation to speak out against any Canadian tax system flaws while educating others as best he can.
You may recall I profiled Neal’s excellent book The Grumpy Accountant here.
Neal, welcome back to the site!
Great to be back Mark and happy to contribute to discuss this subject with you. By the way, I’m not sure why you think I’m “not-so” grumpy! There is so much to know and navigate for business owners. Our tax system is not helping them!
OK Neal, last time we talked, we discussed the concepts of “active business income” and “small business deductions” – essentially within a Canadian Controlled Private Corporation (CCPC), their eligibility for the “small business deduction” which allows the first $500,000 of profit to be taxed at the low 12.2% (combined Federal+Ontario) rate. Profit above $500,000 is taxed at 26.5% (combined Federal+Ontario). That’s a lot I know – does that mean I should invest all surplus cash?
Like we discussed in our previous post together Mark, I think it’s important for business owners in your position, to take out as little money as possible from the corporation each year. Essentially, take out only what you need for personal use (and some extra to max out your TFSA and possibly RRSP, RESP etc.) but then, leave the rest in the corporation.
That said, this approach may not work for others – business owners need to figure out what surplus funds they will actually have. Let me explain.
If the business needs money in the coming 1-2 years, that money should probably not be invested. Just like your personal finances, any money needed in the short-term should remain safe and liquid. There are a few reasons why your corporation may need the excess cash.
First, you may need any surplus cash to pay income tax – a profitable business may be required to pay regular income tax instalments. These instalments most often will equal the amount of income tax paid in prior years, assuming the level of income is the same as the prior year. The importance of paying these instalments, on time, is huge because missing tax instalments can be costly.
Second, and we discussed this in your last post Mark, Harmonized Sales Tax (HST)/Goods and Services Tax (GST) is also paid on an instalment basis. There will also be penalties if instalment payments are late or missed. Instalments are based on the amount of HST/GST owed in the previous year, assuming if the income is the same as in prior years. HST/GST is calculated when the HST/GST return is prepared. This is done on a monthly, quarterly, or annual basis.
Lastly, depending upon your business (even though you might not have many ongoing expenses Mark), there could be slow periods or months where your revenues are low. As a business owner you need to anticipate these periods – they will happen. Corporate debt may occur now and then. A business owner may need to consider paying down that debt. Alternatively, corporate debt can fund new purchases or investments for the business.
So, in summary, small business owners have lots to consider and investing might not even be an option.
Neal, excellent considerations including keeping any HST/GST charges “set aside” for future remittance. I’m doing that now.
OK, let’s dive a bit deeper. What ways can business owners invest? Can they invest in taxable account? RRSP? TFSA?
Business owners have some flexibility in terms of where to invest their money. They can make use of their Tax-Free Savings Account (TFSA) assuming they have the contribution room. One should always double and triple check their TFSA contribution room before making the contribution in order to avoid over-contribution penalties. If a business owner pays themselves a salary from their corporation, they will create RRSP contribution room and they can contribute to their RRSP and invest within the RRSP. They can also invest through non-registered investment accounts owned personally. Of course, a business owner can also invest funds within the corporation itself. There are advantages and disadvantages to all these different accounts so one should always consult their tax/financial/investment advisor before deciding. It should also be mentioned that the decision will also depend on one’s short-term, medium-term and long-term goals.
Are investments inside a corporation treated any differently than personal investments? (i.e., taxable, RRSP, etc.)
Investment income earned within a corporation is subject to tax each year. The tax rates are different than they are if the investment income was earned personally. For example, let’s assume a business owner earned $10,000 of capital gains, $10,000 of interest income and $10,000 of dividends within their CCPC (Canadian Controlled Private Corporation) and let’s assume the CCPC is resident is in Ontario and this occurs in the 2021 tax year. The taxes payable will be as follows:
- $10,000 of capital gains:
- 50% of the gain is taxable and 50% is tax-free
- The 50% taxable portion is included in taxable income and the tax rate on this income is 50.17%
- Therefore the tax will be $5,000 * 50.17% = $2,508.50
- $10,000 of interest income:
- Interest income is fully taxable and the tax rate on this income is 50.17%
- Therefore the tax will be $10,000 * 50.17% = $5,017
- $10,000 of dividends:
- Let’s assume “eligible” dividends earned from publicly traded Canadian companies and let’s assume the business owner does not pay out a dividend to him or herself for simplicity
- The tax rate on the dividends will be 38.33%
- Therefore the tax will be $10,000 * 38.33% = $3,833
Please note all of the above mentioned taxes can be reduced by the owner declaring a salary and claiming the salary specifically against the capital gains and interest income. And the dividend tax becomes refundable to the corporation (as part of RDTOH refundable dividend tax on hand) once the business owner pays out a dividend to him or herself. The mechanics of this are beyond the scope of this article as it gets complicated! Again, our tax system is not helpful to small business owners Mark!
Also, remember the tax-free portion of the capital gain flows into the “capital dividend account” (CDA) and then the CDA can be paid out with a tax-free dividend to the owner. But this can be a complicated bureaucratic process and the CDA is more complicated than it seems so the details and mechanics of this are beyond the scope of this article and a competent tax advisor must be consulted!
Neal, I’ve heard about some “double-taxation” that may occur inside a corporation – is that true, does it exist? When with dividends or not? I like owning dividend paying stocks in my personal taxable account. Is this advisable for a corporation as well?
There is no double taxation, Mark. The Canadian tax system has a principle known as “integration” in which on an overall basis, the overall income tax paid should be the same (or at least similar, it’s not perfect) whether the income is earned personally or within the corporation.
I too love owning dividend paying stocks. As I described above, you can have your corporation own dividend paying stocks. The tax on the dividend income each year will be refunded to the corporation when the corporation pays out a dividend to the shareholder. You will pay personal income tax on the dividend based on your personal marginal tax rate. So, the idea would be to pay out the dividend to yourself in years in which you have a lower level of income. This is similar, in principle, to trying to time your RRSP withdrawals in years in which you have lower levels of income.
Make sense. I will be considering owning dividend paying stock in my corporation later this year or potentially an all-in-one ETF for simplicity.
That brings me to this. Seems to me as a business owner that runs a corporation, you can invest “for growth” (i.e., for capital gains) or “for income” (i.e., via dividends) or both? Is one better over the other? What do some of your clients do and why?
Well, this type of investment advice is beyond the scope of my role which is to try to explain to people the tax consequences of different types of investments. That being said, whether one wants to pursue a growth strategy or an income strategy depends on one’s particular circumstances. For example, someone with a very long-term outlook who is far away from retirement might have more tolerance for risk and can therefore pursue more of a growth strategy. However, one closer to retirement with a lower tolerance for risk might want to consider more of an income strategy. From a tax perspective, the nice thing about a growth strategy is that you don’t pay a penny of tax until shares actually sold. Unrealized gains are not taxed. The taxable event occurs only when the stock is sold, whereas income earned from investments is taxed each year. Please of course keep in mind reinvested dividends are still taxable each year.
Good points. So how is any income taxed when you decide to pay yourself income from the corporation? Is there a good tax table we can point to?
This really depends on whether you pay yourself a salary from your corporation or a dividend or a combination thereof.
This is my favourite tax calculator:
These are my favourite tax tables showing the different tax brackets based on your province:
We discussed the salary versus dividend issue previously here which was great fun!
Generally speaking, every dollar you withdraw from the corporation for personal use must be recorded as personal income, unless it is repayment of shareholder loans.
Great stuff Neal.
Folks, I’m just starting to scratch the surface when it comes to investing inside a corporation. No doubt I’ll have more questions for Neal and even more considerations for how I manage my corporation as time goes on.
I hope this post helped share some insights about how to invest inside a corporation for any of your small business plans.
A big thanks to my friend Neal Winokur again for his insights. I hope to have Neal back again on the site to talk tax stuff.
About this post and Neal:
Neal Winokur, CPA, started his practice in 2013 and his grumpiness has grown ever since. An active blogger, several of his articles have been published in the National Post. Neal feels a moral obligation to speak out against the inherent flaws, unfairness and needless complexities that define Canadian tax. His dream is for the Canadian tax system to be massively simplified to the point where his job as a tax accountant would no longer exist. His wife won’t be too happy about this, but it’s for the good of the nation!
This post is about general tax perspectives and is not considered personal tax advice to My Own Advisor or any reader. You are encouraged to seek professional tax expertise whenever you are in doubt or should you need any support for your personal or corporate investing needs.
For other business owners – how do you invest inside your corporation? Insights? Thoughts? Personal tax tips?