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Dividend Investing Strategy – Invest through your Corporation

Although I’m a fan of index investing, another strategy that I follow and use is dividend growth investing.  The strategy is pretty simple and covered relatively extensively in the archives, but it’s basically investing in strong dividend companies that have a history of increasing their dividends.  Not only do investors receive a steadily increasing stream of income, there are tax benefits courtesy of the dividend tax credit.

Related: When to Buy Dividend Stocks

The Dividend Strategy

For entrepreneurs who have companies with excess cash, an accepted strategy is to get the cash out in the most tax efficient manner possible.  But what about those who are going to withdraw the money to invest in dividends anyways?  Does it make sense to leave the money in the corp to invest with?

It is generally accepted that investing in equities within a corporation isn’t overly tax efficient as the investment income is taxed the highest corporate tax rate.  But, after contacting a few accountants, I’ve discovered that eligible dividend income received by a corporation can flow through to shareholders and still receive the dividend tax credit.  In addition, the corporation would receive a refund on the tax paid for the dividend.  Effectively, once the dividend flows through to the shareholder, the corporation would not owe any tax for eligible dividends received.

The Benefits

Ok, the corporation does not pay any tax, so what?  The benefit is that the corporation (assuming Canadian Controlled Private Corporation – CCPC) pays relatively low amounts of income tax on revenue received (depends on the province, but assume approximately 15%).  This means that that the corporation would have higher after tax capital to work with compared with if the money was withdrawn from the corporation.

For example, Mr. Investor owns a company that generates $100k in revenue, after corporate tax, it’s about $85k left in the account.   Assuming no other personal income, if this amount of withdrawn as a non-eligible dividend, he would be left with about $75k to invest with.  Assuming 4% dividend yield, the $75k would generate about $3k per year in dividends.

Since Mr. Investor is all about the distributions, it may make sense for him to invest the capital within the corporation.  Why?  Because instead of $75k to invest, he would have $85k to invest behind the corporation.  The company would then flow through all eligible dividends to the shareholder which results in no net tax payable by the corporation.  In this case, Mr. Investor would receive 13% more dividends per year simply by investing through a corporate account rather than withdrawing from the corp and investing personally.

Yet another advantage of investing through the corporation is if the company is setup for dividend sprinkling.  This would allow the company to control the flow of eligible dividends to the shareholder that would pay the least amount of income tax.

The Drawbacks

While the strategy appears sound, there are drawbacks.  For starters, dividends can affect old age security benefits.  If eligible dividends are large enough, they are prematurely trigger clawbacks, such as the old age security clawback.  As well, this strategy works best for those who plan on maintaining the capital.  Once capital starts being withdrawn, there are tax implications, especially for seniors.

Related:  Clawbacks and Income Tax on Seniors

Final Thoughts

This strategy is not for everyone but it may work for those who first, have a corporation with excess cash, and second, wish to maintain capital while using distributions only.  One thing to note is that dividends have a negative impact on seniors because of the dividend gross up.  Finally, if you are considering this strategy, it’s extremely important that you talk it over with a qualified accountant.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 14 comments… add one }
  • SmithyCA July 24, 2012, 3:23 am

    Having large investments inside a corp earning non-active business income can impact the corporations eligibility for the life time capital gains exemption should there be a share sale. To qualify, 90% or more of the corporation’s assets must be used to generate active business income. This could be impaired by implementing this strategy. Something to keep in mind.

  • FT FrugalTrader July 24, 2012, 12:09 pm

    @SmithyCA, good point. If the cash amount is large enough to invest with, then transferring to a holding company may be a good strategy.

  • SmithyCA July 24, 2012, 3:27 pm

    @FrugalTrader – There are a number of issues having the funds transferred to the holding company. First, if the money is done via an inter-company transfer you will still have a large asset on the CCPC balance sheet for the funds and would fail the 90% test. If the holdco owns the shares of OpCo you are funnelling up dividends into the HoldCo. You pose the risk of being offside as there would be an accumulation of investments in the HoldCo. The lifetime capital gains exemption generally only works when the shares of the CCPC are held personally. You would want to ensure that the OpCo (CCPC) is held by individuals with a specific class of shares given to the HoldCo so that you could still funnel dividends up. However, if the corporate structure was not initially structured this way you will need to do a freeze on the OpCo (CCPC) and bring in individual shareholders and provide specific shares to the HoldCo to funnel through dividends. At the end of the day, it really comes down to what the corporate structure is between the two companies.

  • Sarlock July 24, 2012, 5:57 pm

    If you’re going to operate with a more complex corporate structure, I would suggest doing what many others are doing (and what I’ve done myself).
    Set up a family trust, family trust owns shares in OpCo. Family members are all beneficiaries of the Trust as well as HoldCo. Dividends from OpCo are than paid to the Trust, the Trust then distributes those dividends how it sees fit: To the individuals or to HoldCo, which can then invest those funds as it wants. HoldCo will be subject to a high tax rate for the income it earns from those funds, however, but this tax is recoverable when this income is finally passed back through the Trust to the beneficiaries.
    How I have mine structured, inelligible and elligible dividends from OpCo (since it earns over $500k/year) flow to the Trust. Elligible dividends flow through to myself and my wife and inelligible dividends flow in to the HoldCo, which receives these dividends tax free. HoldCo then invests those funds and elligibe dividends are earned and flowed back to the Trust and then on to the beneficiaries (myself and my wife, and my children once they reach 18 years of age).
    The other benefit of this structure is that the Trust itself qualifies for the lifetime capital gains exemption if/when OpCo is sold. Each beneficiary gets to receive the $750k excemption… so myself, my wife, and my two children, receive a tax free distribution of up to $750k each from the sale of OpCo.
    Win-win. But it costs a bit of money to set it up and maintain each year, so the corporate income has to be sufficient to warrant this structure. On the flip side, it’s very difficult to do this once your company gets to a certain size, so if you are anticipating your corporation earning good money down the road, set it up in a trust to start with.
    You can also use the trust to invest in/start up future corporations as well.

  • Sarlock July 24, 2012, 6:03 pm

    And, of course, consult your tax and law professionals before attempting something like this to see if it helps in your particular situation. It cost me about $10k to set it all up and it was worth every penny.

  • SmithyCA July 24, 2012, 6:17 pm

    @Sarlock – What you have there is a perfect structure for the type of revenue that is being generated. You are right, such a structure does cost money up front. However, you will reap the benefits of such a structure during the life cycle of your business and can easily save in tax many times over what you paid. One should look at the cost as an investment! As you say though, always always always consult a tax and law PROFESSIONAL before attempting anything. I bold professional as you NEED to find someone who has strong experience in this, not your local bookkeeper down the road that does your T1 each year.

  • Steve Zussino - Canadian Coupons July 24, 2012, 6:58 pm

    You bring up many interesting scenarios considering the retirement tax benefits. I always wondering the best way to declare my business income.

  • FT FrugalTrader July 24, 2012, 9:31 pm

    @SmithyCA, what if the HoldCo only held 1 share of OpCo (in a different class) along side other shareholders. OpCo right now is already optimized for dividend sprinkling, i’m thinking about adding another class and selling 1 share to a HoldCo. The HoldCo would then be owned by the same group of shareholders as OpCo and likely in the same classes. That way, OpCo can dividend out to HoldCo without any issues. Am I missing something?

  • Ed Rempel July 27, 2012, 11:04 pm

    Hi FT,

    Good article. Dividend investing in your corporation can give you more dividends with the same amount of cash profit from your business.

    There is one long term drawback that affects the strategy. If you still have your investments in your corporation when you die, there is double taxation. Your corporation has a capital gain on the shares of your investments whenever it sells them, but you also have a personal capital gain on the shares in your corporation.

    Your corporation is worth more because the investments in it have gone up, so you both you and your corporation are taxed on that gain.

    Most corporation tax is effectively integrated with the personal tax of the owner, but this is an exception.

    For this reason, it is beneficial to plan to deplete the investments during your lifetime.

    You mentioned in your article the complications that can come from withdrawing the capital. Generally, you should look for a method to withdraw your capital slowly over the years.

    The worst case scenario is that you should withdraw all the money just before you die. That way, you only pay capital gains once.

    Ed

  • Ed Rempel July 27, 2012, 11:08 pm

    Hi Sarlock,

    Good post. I have 2 questions:

    1. How did you structure the ownership of the holdco? Is it owned by you, your wife and the family trust? I noticed that the holdco flows dividends back into the trust, so how does this happen?

    2. What is your plan to deal with the 21-year rule? After 21 years, you need to wind-up the trust. Since it owns shares in your companies, there could a significant tax cost on winding up the trust. (I’ve seen some situations like this where there was a huge tax cost.)

    Ed

  • Ed Rempel July 27, 2012, 11:15 pm

    Hi FT,

    I believe your idea would work. The holdco needs to pay fair market value for the share, but generally you can pay dividends to one share class only. Make sure you get professional advice on this.

    Smith is worried about you ability to use the $750,000 capital gains exemption. Is this a concern for you?

    Ed

  • FT FrugalTrader July 29, 2012, 8:24 am

    @Ed, one of the benefits of starting a holding corp is to get the cash out of the optco to help qualify for the capital gains exemption. If the holdco owns a single share (preferred share) of the optco, would the optco still qualify for the cap gains exemption?

  • Ed Rempel July 30, 2012, 1:17 am

    Hi FT,

    Preferred shares normally pay out a fixed dividend, so they are something like creditors. You want to pay out extra profits to holdco with varying amounts, so you would probably want a separate class of common share.

    You could have holdco buy a separate share of opco and own only 1% of opco. In this case, the remaining 99% could still get the capital gains exemption. Only individuals, not companies, can claim the exemption.

    This is an aggressive position that may work but may be considered too aggressive by CRA, since it results in a separate share class that only owns 1% of opco but gets nearly all the dividends.

    You can avoid the question and retain access to the capital gains exemption for 100% of the shares if you have a trust own the share and make holdco a beneficiary of the trust (similar to Sarlock’s structure). Then a dividend of extra profits or cash in opco could be paid to the trust and then allocated to holdco.

    This is a better structure, but more expensive to set up and maintain. Depending on your situation, this may or may not be worth it for you.

    This type of topic has many options and you should really get advice from an expert. Like many accountants, I understand the main issues, but am not an expert on figuring out the best possible structure for your specific situation. Getting this type of advice may well be worth it for you over time, assuming the profits of your business add up somewhat over the years.

    Ed

  • FrankoW April 19, 2014, 2:15 am

    Hi FT,

    Thank you for the informative article. I am in a similar position as you, in that I am starting to accumulate cash in my corporation and am looking for tax-efficient ways to pay it out.

    Forgive my ignorance, as I’m fairly new to all this, but what exactly is the benefit of passing on the eligible dividend income paid to my corporation down on to myself personally? Wouldn’t I still end up being taxed on these dividends personally?

    I don’t really understand the difference between paying myself out from the corporation and investing the after-tax money versus what you’re suggesting, unless the whole idea here is that the dividends paid out from my corporate equity holdings would be larger (pre-personal tax) from inside the corporation than outside, after I’ve paid personal tax on the withdrawal?

    Frank

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