57 As an owner of a company, when is it beneficial to claim employment income (salary) rather than dividends (and vice versa)?
Navjot Lalli
In chapter 2, we learned the theory of integration. However, perfect integration rarely exists due to different provincial personal and corporate tax rates as well as differing tax credits. Therefore, as an owner of a company you can choose the most tax-efficient type of remuneration for you and your company. To determine which remuneration is most beneficial, calculate both the corporation’s and owner-manager’s after-tax position using the appropriate provincial tax rates and credits and compare the two accordingly.
Note, the tax rates and dividend tax credits for BC and Ontario – in the following examples – are intended to be illustrative (to show how the various provincial tax rates can impact salary vs. dividend decisions) and are not necessarily intended to accurately reflect the actual tax rates in those provinces. Also, we are ignoring some elements (like CPP and most personal tax credits) to focus on the key salary vs dividend concepts.
Table 1 illustrates the outcome of paying an owner-manager a salary or dividend income of $100,000 from a small CCPC that generated $300,000 in active business income.
Table 1: Corporation’s after-tax position (2019 rates)
|
|
British Columbia |
Ontario |
||
|
|
Salary |
Dividend |
Salary |
Dividend |
|
Active business income |
$300,000 |
$300,000 |
$300,000 |
$300,000 |
|
Less: Salary & CPP |
(100,000) |
– |
(100,000) |
– |
|
Corporate taxable income |
200,000 |
300,000 |
200,000 |
300,000 |
|
Less: Corporate tax (11% in BC and 12.5% in Ontario) |
(22,000) |
(33,000) |
(25,000) |
(37,500) |
|
Less: Dividend to shareholder (Non-eligible dividend) |
– |
(100,000) |
– |
(100,000) |
|
Retained earnings |
$178,000 |
$167,000 |
$175,000 |
$162,500 |
Table 2 illustrates the owner-manager’s after-tax position from the scenario above. Here, dividend income results in greater net income for the owner-manager but receiving dividend income does not allow the owner to contribute into CPP or build RRSP contribution room.
Table 2: Owner-manager’s after-tax position (2019 rates)
|
|
British Columbia |
Ontario |
||
|
|
Salary |
Dividend |
Salary |
Dividend |
|
Salary |
$100,000 |
– |
$100,000 |
– |
|
Non-eligible dividends |
– |
$100,000 |
– |
$100,000 |
|
Non-eligible dividend gross-up (1.15) |
– |
15,000 |
– |
15,000 |
|
Taxable income |
100,000 |
115,000 |
100,000 |
115,000 |
|
Less: Income tax (22.6% avg in BC and 23.6% avg in Ont) |
(22,600) |
(25,990) |
(23,600) |
(27,140) |
| Dividend Tax Credit – In this example Ontario has a better DTC than BC. Note, other personal tax credits have been ignored. |
14,500
|
|
15,500
|
|
|
After tax cash (Cash dividend – tax + dividend tax credit) |
$77,400 |
$88,510 |
$76,400 |
$88,360 |
Table 3 illustrates a summary of both the corporation’s and owner-manager’s after-tax position. Ultimately, receiving employment income provides slightly greater total earnings than dividend income in both provinces, but this will not always be the case due to differing provincial tax rates and credits.
Table 3: Summary of corporation’s and owner-manager’s after-tax position
|
|
British Columbia |
Ontario |
||
|
|
Salary |
Dividend |
Salary |
Dividend |
|
Corporate retained earnings |
$178,000 |
$167,000 |
$175,000 |
$162,500 |
|
Owner-manager’s after tax cash |
77,400 |
88,510 |
76,400 |
88,360 |
|
Total earning and after tax cash |
$255,400 |
$255,510 |
$251,400 |
$250,860 |
So, in these examples there are more retained earnings (and cash) within the corporation by paying out salaries and more after tax cash in the hands of the individual by paying out dividends. This is a very simplified example, if you were doing tax planning with your client you would need to consider the specific after tax cash needs, the specific tax rates and dividend tax credits for your province, personal tax credits available etc.
Interactive content (Author: Saundarya Pradhan, January 2020)
January 2020
