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Private Canadian Corporations and Taxes – The Basics

For those of you with personal businesses that are growing, it may come to the point where you will want to incorporate. There are numerous benefits of setting up a private corporation for your small business, among them include:

  1. Litigation protection.
  2. Lower business income tax.
  3. The ability to sell your business up to $750k tax free ($1.5 million tax free if joint ownership with spouse)
  4. The added ease of selling/transferring your business if/when the time comes.

The above benefits are explained in detail in the post about whether or not you should incorporate your business.

Lets talk more about number 2, the lower business income tax. As a side business, many people believe that incorporating will result in a big tax break. This is true for the business income only. Once the money is withdrawn in the form of salary or dividends, it works out to be about the same as if the income was earned in your personal hands. As a side business though, the largest benefit of corporations with regards to taxation is tax deferral and the ability to keep more of business income out of the government hands initially so that it can grow over time.

How low is the small business private corporation tax rate? According to Ernst and Young, here are the 2008 private corporate tax rates sorted by province (federal and provincial combined):

Province Tax Rate on <= $400k income/yr
Tax Rate on > $400k income/yr
NL 16.00% 24.50%
PE 14.20% 35.50%
NS 16.00% 35.50%
NB 16.00% 35.50%
QC 19.00% 30.90%
ON 16.50% 31.50% (>$500k)
MB 13.00% 32.50%
SK 15.50% 29.50% (>$500k)
AB 14.00% 29.50%(>$460k)
BC 14.50% 30.50%
NT 15.00% 31.00%
NU 15.00% 31.50%
YT 15.00% 22.00%

As mentioned above, these low income tax rates are great if company earnings are kept within the business accounts and not withdrawn. It allows low taxation and the money can be invested in the markets.

Tomorrow we’ll go through a couple of corporate tax scenarios to see if there is a tax efficient way to withdraw corporate income.

Please note that i’m not an accountant or tax professional. Use the information above at your own risk.

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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.

{ 20 comments… add one }
  • MoneyGrubbingLawyer August 18, 2008, 11:52 am

    FT, I look forward to your follow-up article on getting money out of your corporation. Nothing like a good dividend sprinkling and income splitting discussion to start off the week!

    A small point on your initial post- keep in mind that if your corporation is a personal services business, you don’t get the advantage of lower small business tax rates, regardless of your income, and your deductions are severely limited. For a PSB, incorporation can actually increase your tax burden significantly.

  • Dividend Growth Investor August 18, 2008, 12:01 pm

    FT,

    That’s a nice article. I was wondering if you could also make the same table by income and province for two other types of income
    1) Work Income
    2) Dividend Income from stocks

    Thanks!

    Dividend Growth Investor

  • MoneyGrubbingLawyer August 18, 2008, 12:14 pm

    @Dividend Growth Investor – earned income and dividend income information would be pretty hard to organize in one pretty chart like corporate income, although FT may surprise me!

    However, you can get the info in charts by province at http://www.taxtips.ca/marginaltaxrates.htm, or through the nifty calculator on E&Y’s site at http://www.ey.com/GLOBAL/content.nsf/Canada/Tax_-_Calculators_-_2008_Personal_Tax .

    Hope that helps a little!

  • FT FrugalTrader August 18, 2008, 12:49 pm

    MGL, can you explain the term “personal services business” in more detail? What kind of business would fall into that category?

    DGI, unfortunately here in Canada, passive income within a corp is taxed at the highest rate which makes it undesireable as you can imagine. In addition to that, it is taxed AGAIN upon withdrawal.

  • MoneyGrubbingLawyer August 18, 2008, 1:23 pm

    Ft, personal services business is bascially when the main business of the corporation is providing a service that would normally be provided by an employee, and the person performing the service is a controlling shareholder of the corporation. It’s also known sometimes as being an “incorporated employee”. The actual definition under the Income Tax Act is complicated, but that’s the gist.

    A typical scenario would be if I decided that, rather than employing me directly, I wanted my employer to hire my company to perform the work, and the company would then have me provide the services on its behalf. The goal in doing this would be to have the income from the employer accrue to the company at lower small business rates, rather than at my higher personal rate. This is a common approach for many professionals (lawyers, doctors, vets, etc.), but the PSB rules really complicate matters. You could also come within the PSB definition if you’re a consulant being hired to do work that an employee would normally perform.

    The details of how PSB rules work are too complicated to go in to here, but that’s an overview. It’s enough to know that if you are going to use a corporation to provide employee services, you should check with a good accountant or tax lawyer to make sure you’re okay.

  • Little Ms.Scrooge August 18, 2008, 1:42 pm

    Hello FT
    Very timely article for me, thankyou FT.
    Can you also include any information on withdrawing money out of a professional incorp. account in the form of a shareholder loan. What are the terms of repaying it back to the incorp.? Also if the proffessional is no longer working/earning for the incorp. -like prolonged illness/loss of job, can he/she withdraw his regular income- providing there is funds available or does the nature of incorp change and other rules/laws come into play.
    I am not sure to what details you are planning this topic FT, but if any one has any info on universal ins. held by incorp. I would appreciate it.
    thank you
    Little Ms. Scrooge

  • Chuck August 18, 2008, 3:11 pm

    Ms Scrooge:

    Here’s an excerpt from http://www.mnp.ca/04library/index_taxMistakes.php

    CRA has specific rules about corporate shareholder loans. Since corporations often pay tax at preferred rates, CRA is concerned that owners could take money out of their company without paying personal income tax on it. CRA specifies that if a shareholder owes money to the company on two consecutive year-end balance sheets, the principal portion of the loan must be included in the shareholder’s net income for tax purposes. It also notes that a series of loans and repayments will be viewed as one continuous loan. This prevents the shareholder from paying the loan off just prior to year-end and then re-borrowing the money just after year-end so the loan does not show up on the balance sheet.

    Also I have an incorporated business and looked into a universal policy on myself paid by the business. There are rules concerning purchasing (universal) life insurance policies by a business. The key one being that if the corporation is taking out the policy and expensing the cost – the corporation must be the beneficiary. If you (the owner) is the beneficiary, it then becomes a taxable benefit. Any good insurance agent should be able to advise you of the specifics.

  • Mark August 18, 2008, 3:21 pm

    Does anyone know where to find a list of the requirments of selling your corporation tax free? I tried the revenue canada website, but you just loop around in endless circles of pdf links.

  • Rene August 18, 2008, 4:42 pm

    I’m very interested in the possibility of investing within the corporation via universal life insurance. I hope the next post deals with this topic.

    Chuck mentions it becoming a taxable benefit if the owner is the beneficiary. Does that mean tax will be paid on the payout when the owner dies?

  • Little Ms.Scrooge August 18, 2008, 7:00 pm

    Thank you Chuck for the link.
    Little Ms. Scrooge

  • Thicken My Wallet August 18, 2008, 9:07 pm

    I would emphasis your mention of the cited tax rates is for “business income only” means you can’t set up a holding corporation, hold shares and bonds and do nothing else and be eligible for the low corporate tax rate. In this case, the corporation is making “passive income” and is subject to taxation at the highest marginal tax rate (approaching 50% in Ontario).

    Mark- try this link, it even cites the section of the Income Tax Act:

    http://www.taxtips.ca/smallbusiness/capitalgainsdeduction.htm

    I would also make this point- people under-estimate how much administration is required to run a corporation. There’s a lot of bureaucracy involved and you have to weigh the opportunity costs of sitting on a Sunday afternoon doing your books with the tax savings.

    The tax savings only become significant once your taxable income is quite high too so if you make $60K as an employee and $65K of taxable income in a corporation, it may not be worth it (remember that a lot of business deductions available to corporations are also available to sole proprietors). Corporations are great tax-planning tools if you have significant taxable income (especially if you have families to spread the tax burden). Otherwise, it could be not be worth it. In other words, speak to your profession before you incorporate to see whether the pros outweigh the cons.

  • Sarlock August 18, 2008, 10:55 pm

    I’d like to echo Thicken’s remarks: Running a corporation is a lot of work (I run a couple of them). Unless you are willing and able to do all of the regulatory filing yourself (minute book, GST returns, annual financial statements, tax returns, etc), you will end up paying a professional as much or more in fees than you would make in any sort of tax savings, unless you run a sizeable corporation with good revenue. If you are setting up a corporation with the primary aim of dodging some tax, tread carefully, as the government is wise to a lot of schemes. Have a legitimate business that you wrap your corporation around, then take advantage of the opportunities that incorporation affords you.

  • The Financial Blogger August 18, 2008, 11:44 pm

    FT,
    the trick is to use your company to pay for expenses. There are no benefit to pay 19% (in my case ;-) ) within your company and then, another 30% in dividend ;-)

    The good news is that Canadian Gov created several laws so the incorporation can pay several expenses that the individual can benefit as well without being taxed (legally off course!!!).

    I’m actually preparing a post about that ;-)

  • Cannon_fodder August 21, 2008, 2:30 pm

    My brother-in-law has his own business (motorcycle repair shop) and he only now is getting incorporated. I always thought that the liability protection provided by incorporation would be all he needed to justify the expense.

  • MoneyGrubbingLawyer August 21, 2008, 2:39 pm

    @Cannon_fodder – Limited liabilty is certainly a great reason to incorporate, but it’s important to know that a corporation doesn’t fully absolve you of liability. I discussed this in my post Should I Incorporate?. Given that a lot of smaller operations would (or should) have CGL insurance anyway, sometimes incorporating just isn’t worth it.

  • FT FrugalTrader August 21, 2008, 2:50 pm

    MGL, if a business is under a sole proprietorship, would you know what kind of price range that liability insurance would fall under? Also, can you recommend some companies that provide liability insurance for sole proprietorships?

  • MoneyGrubbingLawyer August 21, 2008, 3:09 pm

    The cost for CGL insurance for a sole prop varies very widely, because the actual risk depends in large part on the actual business being carried out- a low risk business, such as a small interior decorating operation, would only pay a fraction of the cost of a construction or contracting operation.

    Most brokers that arrange insurance for incorporated businesses can also offer it to sole proprietors- corporate status usually isn’t a requirement (or at least not when I last checked-about 2 years ago). Check with Anthony and Wedgwood- I have had good experiences with both. You could also check with Johnson, although I’m not sure whether they offer commercial coverage.

  • Tax Resource August 22, 2008, 9:27 pm

    There are some good points in the artice and The Financial Blogger brings up an interesting point, which is deductions. If you were a sole proprietorship, the same deductions are available.

    Also, the intergration of small business and personal income tax that for the most part reduces the ability to realize any savings from deferral or tax savings on investment income.

  • Little Ms.Scrooge August 26, 2008, 1:50 pm

    Hello all
    If there is any body still looking for info on Universal Ins. here is a link
    http://financialjungle.com/category/passive-investing/

  • Rodney Thibeau May 10, 2012, 10:11 pm

    In regards to investing withing the corporation. One should look that the benefit of buying a whole life par insurance policy- not universal life- due to market conditions.

    A par life insurnace policy grows tax deferred, and cash valuethat is declared is also tax free – by a colleteral loan and the death benefit is tax free. Is should be corporately held, paying less tax dollars from the company to fund it rather than personally funding it. So for example, with my company there is a product called 20 pay life, which you pay the premium for 20 years, after 20 years is all paid up. Every year the company pays a dividend, which our company has been paying a dividend since 1886, right now the dividend is 6.9%, once that dividend is declared every year, you can’t lose it.

    So for example a 40 year old male, invest 25,000 a year into a life insurance, takes the money from the company. The life insurance is owned by the company. At 65, the cash value of this illustraion is 1.1 million which has grown tax deferred for 25 years. The death benefit is 2.7 million which is tax free. The policy is paid up in 20 years. The cash value that you have at 65 is tax free through a colletaral loan from the bank, which happens all the time. So now you were able to pull out 25,000 a year from your holding company to fund a policy that was owned by your company so no tax on withdrawing the money because it’s still part of the company. Now it total you took out 500k over 20 years and getting 1.1 million tax free. Easy way to shelter money.

    I know the concept may be difficult to undertand for some, but it works. Just think for business owners that puts money away in a GIC every year, on passive income from the company the tax rate on that growth is 51.7% in nova scotia, so why not put the money into a tax shelter vehicle like life insurance. There are only so many things that are tax shelter, your home, RRSP, TFSA and life insurance. Life insurance is the only one that has no limit on what you can put in. It all depends if your insurable.

    This is one way to get money out of a company tax effectively…. Corporately Funded Life Insurance – Par products

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