If you are the owner-manager of a private Canadian corporation and have surplus cash accumulating in your company, you may be wondering whether to retain the funds in the company or withdraw them while paying as little tax as possible. If so, there are a number of questions you should consider before you take action.
If you have surplus cash in your corporation, ask yourself if you will need it for business purposes in the short term.
Is there a business need for the cash?
If you have surplus cash in your corporation, ask yourself if you will need it for business purposes in the short term. Will you need to use the cash to pay installments of income tax or GST/HST? Does your business experience seasonal slow periods when cash flow will need to be supplemented? Consider whether you will have to pay down debts or make any major purchases in the near future.
If you have excess cash that won’t be used for business purposes, the investment income earned on this surplus cash will be taxed at the corporate investment tax rates, which may be slightly higher than the top personal tax rates, the rates vary by province/territory.
Do you need the surplus cash for personal purposes?
Do you have personal expenses that are coming due, such as income tax installments that must be paid on time? You may also be considering a major purchase like a vacation property or planning to help out with a family member’s education costs, wedding expenses or house down payment. If you know you will need to withdraw surplus funds from the corporation to meet these personal expenses, consider when you will need the funds. It’s important to understand the tax consequences of making the withdrawal and whether it will be possible to make several withdrawals over a period of time to minimize tax costs.
What are the funds going to be used for?
If you don’t need the surplus funds immediately for business or personal purposes, what are your reasons for moving funds out of the corporation? Sometimes, it may be beneficial to withdraw the funds from the corporation, as investment income earned on the excess funds remaining in the corporation may be taxed at a slightly higher rate than the highest personal tax rate. High levels of passive income could also reduce your corporation’s ability to access the small business tax rate on active business income in certain circumstances. A good starting point is to analyze your long-term goals, which could include:
- Planning for retirement – Are you going to use the funds for your retirement by contributing to an RRSP, IPP or RCA?
- Estate planning – Do you want to enhance the value of the estate you will pass on to your family? Many potentially effective estate planning strategies involve insurance-based solutions. The funds may grow on a tax-sheltered basis and may be accessed at retirement to supplement retirement income, or they may be paid out tax-free on death.
- Asset preservation – If you want to mitigate the risk of funds being subject to claims from corporate creditors, consider transferring excess cash to a holding company. There are various ways to accomplish this.
- Tax planning – Keeping excess investments or an insurance policy in a corporation may disqualify your shares from being QSBC shares so that you are not entitled to the capital gains exemption on the sale of your business. Therefore, you may want to withdraw excess funds from the corporation. A proper corporate structure may allow you to extract cash from the operating corporation on a tax-deferred basis.
Withdrawing funds from the corporation
If you’ve decided to take funds out of your corporation, consider potential strategies that could help you make the withdrawal and minimize the tax consequences.
Expense reimbursement – Keep records of business expenses you paid personally. If your corporation reimburses you, you won’t pay tax on the funds you receive and the corporation may get a tax deduction for the business expense.
Repayments of shareholder loans to the company – Shareholder loans, such as personal assets you transferred to the company without payment or dividends declared but never paid to you, can be repaid without tax consequences. You could also consider other nontaxable methods such as paying a capital dividend if your corporation has a positive capital dividend account balance.
Taxable methods of withdrawing funds from the corporation include paying yourself a salary or dividend. Although paying a taxable dividend results in personal tax, it may at the same time create a tax refund to the corporation if the corporation paid refundable taxes to the CRA when it earned passive income. Income splitting opportunities may also be available, for example, by paying a reasonable salary to a lower-income family member for services rendered or paying dividends to adult family member shareholders (keep in mind that there are rules that may cause the dividends to be taxed at the top marginal tax rate in the hands of the family members).
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Business planning quick tip
You can use a simple “decision tree” to analyze the issues related to surplus cash in your business and how it may be used:
- Consider whether there is a business need for the surplus cash any time in the foreseeable future.
- If there’s no business need, consider whether you have an impending personal need.
- If not, consider longer-term goals, such as retirement or asset protection.
- Should you decide to withdraw surplus funds, consider the most tax effective ways to do so.