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Budget 2013: Changes for Small Business Owners

There wasn’t too much big news for the 2013 Federal Budget, but there was some noteworthy changes, especially for Canadian small business owners. There were two tax changes for small business owners, one good and the other not so good – they included:

1. Lifetime Capital Gains Exemption

Lets start with the good news.  The lifetime capital capital gains exemption has increased from $750,000 to $800,000.  What does this mean?  Basically eligible small business owners who sell their shares can shield $800,000 of their profit from tax.   Not only is the federal government offering a $50k boost, they will adjust the $800k to inflation annually going forward.

2.  Non Eligible Dividends

Now for the not-so-good news.  To be straight to the point, more personal tax will be paid on non-eligible dividend distributions to small business shareholders.  The federal government is increasing the personal tax payable by reducing the dividend gross up from 25% to 18% but slightly increasing the dividend tax credit from 2/3 to 13/18.

Before the 2013 federal budget, if business owners withdrew their profits from the company as dividend only, there would be a small advantage (~2%) over other methods, however, this small loophole has been closed.  This tax change works out to be a 2% increase on federal tax rates.  The total damage will not be known until the provinces announce their budgets for 2013.

There is a silver lining to the reduced dividend gross up, particularly for seniors who still own a small business.  Seniors in this category can now withdraw more from their company via dividend without triggering old age security clawbacks.

See below for the exact language used in the Budget 2013 documentation.

To ensure the appropriate tax treatment of dividend income, Budget 2013 proposes to adjust the gross-up factor applicable to non-eligible dividends from 25 per cent to 18 per cent and the corresponding dividend tax credit (DTC) from 2/3 of the gross-up amount to 13/18. Expressed as a percentage of the grossed-up amount of a non-eligible dividend, the effective rate of the DTC in respect of
such a dividend will be 11 per cent. This measure will apply to non-eligible dividends paid after 2013.

A hypothetical example of withdrawing $1000 from a small business results in paying $36.67 more in federal tax per $1000 in small business/non-eligible dividends.

  • old rules with 25% gross up and 2/3 federal DTC: $1000 * 25% * 2/3 = $166.67 DTC
  • new rules with 18% gross up and 13/18 federal DTC: $1000 * 18% * 13/18 = $130 DTC

Are you a small business owner?  Will these new rules change the way that you withdraw profits out of your company?

8 Comments, Comment or Ping

  1. 1. Jordan

    Hi FrugalTrader — I assume these dividend tax credit changes also impact investors holding dividend-bearing Canadian equities in taxable accounts?

    If so, are you planning to make any changes to your Smith manoeuvre account or any of your other investments as a result?

  2. 2. PBarkwell

    To the comment above; this only impacts dividends paid out from Candian Controlled Private Corporations (earnings taxed <500k) and so has no impact on your leveraged position.

    Also; to the author, it should be noted that 13/18 is larger than 2/3.

  3. @Jordon – the impact is only non-eligable dividends. For people holding canadian equities, these are Eligable dividends, and nothing is effecting them right now.

  4. 4. Jordan

    @Danesh — thanks for the clarification here, cheers!

  5. 5. Sid

    Does this also hit those with a “Professional Corp” (doctors/lawyers/etc.) who pay themselves/family with dividends?

  6. @Sid, it will affect all CCPC’s, so yes, the Professional Corps as well.

  7. @PBarkwell, my bad, fixed!

  8. I have to be honest, the change effecting the increased tax on pulling money as a dividend doesn’t seem like that big of a deal to me, if I’m wrong will someone please explain. I am happy about being able to keep the extra $50K when selling shares in the business though. However, what is even better news than that is the fact that it is going to keep up with inflation going forwad, finally something that makes sense.


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