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.
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 This means that that the corporation would have higher after tax capital to work with compared with if the money was withdrawn from the corporation.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 Assuming no other personal income, if this amount of withdrawn as a non-eligible dividend, he would be left with about $75k to invest with.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.
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
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.If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).