Section 6 – Businesses
There are specific tax consequences for individuals who carry on their business through a corporation.
Each year, shareholders-managers must determine the optimal salary/dividend combination to maximize their cash flow.
In 2020, receipt of a salary of $154,611 will allow the shareholder-manager to make a maximum RRSP contribution ($27,830) in 2021. A salary also enables a shareholder to contribute to the QPP/CPP or eventually participate in an IPP (see Section VIII).
The following must also be considered before making a final decision:
- Maintaining the corporation’s small business corporation status;
- Non-reimbursed advances;
- Availability of a dividend refund to the corporation;
Shareholder’s income from other sources, including the impact on the calculation of the cumulative net investment losses and the AMT (see Section VII);
- Possibility of deducting child care expenses (see Section II);
- Possibility of paying a non-taxable dividend (capital dividend);
- Deductions at source;
- Impact on tax instalments and on contributions to the HSF;
- Impact on the contribution required under the Act to promote workforce skills development and recognition.
Paying a salary to your spouse and children may be a way to split income provided they are active in the business and the amounts paid are reasonable for the work performed.
Bonuses may be paid to enhance the shareholder-manager remuneration. When these bonuses are declared before the end of the corporation’s fiscal year, the corporation can immediately deduct them if they are paid no later than the 180th day after year-end. Bonuses, like salaries, are subject to deductions at source and may also allow for certain deferrals (see Section V).
If a corporation declares a bonus no later than December 31, the tax will be deferred if you receive it at the beginning of the following year.
In the CRA’s view, a bonus will be considered reasonable, and therefore deductible, if it is the corporation’s usual practice to distribute its profits in this way or if the corporation has a policy of declaring bonuses to shareholders to compensate them for the profits earned that are attributable to their abilities, knowledge or interpersonal skills.
Loans and Advances
Loans and advances to a shareholder by a corporation are taxable in the calendar year during which the loan was received. The shareholder may not claim a dividend tax credit in this regard nor can the corporation claim a deduction. The shareholder will be able to claim a deduction in the year the loan is reimbursed.
There are two types of exceptions to the inclusion rule.
A loan will not be included in the shareholder’s income if the loan is:
- Between non-residents;
- Obtained from a company whose activities include lending money and if arrangements are made in good faith for the repayment of the loan within a reasonable time period;
- Reimbursed within one year following the end of the company’s fiscal year during which the loan was granted and if the reimbursement was not part of a series of loans or repayments;
Example: If the corporation’s fiscal year ends on July 31, an advance made on August 3, 2018 and not reimbursed by July 31, 2020 will be included in the individual’s taxable income for the 2018 tax year, i.e. the calendar year during which the loan was granted. However, if the shareholder effectively reimburses the loan in 2021, a deduction equal to the amount of the reimbursement may be claimed in the 2021 income tax return.
Bona fide arrangements for the repayment of the loan must be made on the date the loan is granted. The shareholder should actually comply with the planned repayment terms.
A loan is not included in the shareholder’s income if:
- The shareholder owns less than 10%11 of the issued shares of a class of capital stock of the lender and the loan was obtained because of employment;
- The shareholder owns 10% or more12 of the issued shares of a class of capital stock of the lender and the loan was obtained because of employment and the purpose of the loan is to enable the shareholder to acquire either:
- A dwelling for his/her own use;
- Treasury shares of the lending or a related corporation;
- An automobile to be used by him/her in the performance of employment duties.
In addition, bona fide arrangements must have been made for the loan to be repaid within a reasonable time. The following criteria can be used to determine whether a specific loan was granted by reason of the shareholder’s employment:12
- Granting of similar benefits to all other non-shareholder employees or to other employees occupying similar positions;
- The degree of or absence of control over the corporation by the shareholder who received the loan;
- The relationship between the benefit and services rendered to the corporation and the salary earned.
11 Alone or with persons with whom the shareholder is not dealing at arm’s length 12 For rules concerning employee loans, see Section V.
A loan to a shareholder or a person not at arm’s length with the shareholder can result in a taxable benefit when the interest rate applicable to the loan is less than the rate prescribed quarterly by the tax authorities (i.e., 1% for the third quarter of 2020). The benefit amount is equal to the interest calculated at the prescribed rate, less any amount refunded by the debtor to the corporation by January 30 of the following year at the latest. However, no benefit has to be included as interest with respect to a loan whose amount is included in the shareholder’s income.
Example: On January 2, the Company in which Frank is a shareholder and employee loaned him $200,000 interest-free to purchase a home. If the prescribed rate was 2% throughout the year and Frank did not repay any principal before the end of the year, he has to include deemed interest of $4,000 in income for the year.
If your corporation advances non-interest bearing funds which are repaid by declaring a dividend, it is in your interest to have the dividend declared at the beginning of the year.
The taxable interest benefit may be deductible from income if the loan is used to earn property or business income provided the interest deductibility criteria are satisfied (see Section VII).
It is sometimes more advantageous to pay income taxes on a deemed benefit than to pay non-deductible interest, e.g. to purchase a home. In those circumstances, consider getting an interest-free loan from your company.
A private company has an account which enables it to distribute certain gains in the form of capital dividends (tax free) which would not have been taxable if the gains were received directly by the taxpayer. This account is mainly composed of the non-taxable portion of net capital gains, capital dividends received from other companies and the net proceeds of a life insurance policy received upon the death of an individual. Prescribed documents have to be filed with the tax authorities beforehand for a dividend to qualify as a capital dividend.
Taxable benefit for the stand-by charge in respect of an automobile
When an individual receives a benefit for the stand-by charge in respect of an automobile in the individual’s capacity as a shareholder, the value of the benefit is calculated in the same way as for an employee (see Section V). However, if the shareholder’s main activities are the sale or leasing of automobiles (that is, essentially shareholders of an automobile dealership), the benefit cannot be calculated using the reduced rate of 1.5% of the average cost of the fleet of vehicles applicable for employees unless it is reasonable to consider that the benefit is received in the individual’s capacity as an employee.
Responsibility of Corporate Directors
Corporate directors may be held responsible for the corporation’s income taxes, employee withholdings, CPP/QPP, EI, QPIP and HSF contributions as well as unpaid taxes or excess refunds.
As a general rule, corporate directors will not be held responsible if they demonstrated competence and diligence in ensuring that an appropriate system of deduction and remittance of amounts withheld at source is in place and that it operates adequately.
In addition, no legal action may be instituted against a former corporate director more than two years after terminating his/her mandate. A corporate director’s mandate ends with his/her resignation, removal or dismissal, death or inability to carry out his/her duties.
Consider resigning as a director of a corporation which is having serious difficulties; ensure that this resignation is in writing and recorded in the minute book.
This document is up to date as of September 3, 2020 and reflects the status of legislation, including proposed amendments at this date.