In the recent 2018 Federal Budget, the finance minister introduced new legislation that affects business owners that have passive assets within their corporation and associated corporations.
Before we dive into the mechanics of how this grind down works, we need to first review what the Small Business Deduction (SBD) is and how corporate taxes work. We will discuss how the grind down of the SBD works in another post.
In simple terms, Canadian corporations have access to two types of active business tax rates: (1)
- The Small Business Deduction – In AB the rate is 11% and you can elect to utilize this rate for the first $500,000 of income
- General Tax Rate – In AB the rate is 27% and mandatory after $500,000 of income
I emphasize elect because it’s a choice, you don’t have to utilize the SBD – you can also elect to pay the General Tax Rate for the first $500,000.
Now you may ask yourself why anyone would elect to pay a higher tax rate within their corporation. Let me explain how non-eligible and eligible dividends work and you may understand.
Dividends are described as after-tax profits paid to shareholders from a corporation.
- Non-eligible dividends are paid from profits where the SBD was utilized.
- Eligible dividends are paid from profits where the General Tax Rate was utilized.
Your accountant will keep track of your available non-eligible and eligible dividends from two notional accounts called your Low Rate Income Pool (LRIP) and General Rate Income Pool (Grip) – respectively.
Now, let’s quickly dive into the basic taxation of dividends to shareholders in a simple manner!
Via a system known as integration, when you pay out a dividend from a corporation the taxes payable will roughly equal the same as if you had paid it out as a salary. The CRA recognizes that you paid some taxes corporately so they essentially will tax you the difference.
Assuming you had no other income to declare, if you paid out non-eligible dividends it would be tax free up until roughly $20,000 whereas if you paid out eligible dividends it would be tax free up until roughly $60,000.
The reason for this is they know you paid taxes corporately and they’re essentially trying to equalize the taxes exactly as if you had taken it out as a salary.
The system isn’t quite perfect but it’s definitely getting better.
I will encourage you to schedule a free 30-minute strategy session with me.
What this session will highlight is:
- If you have unforeseen liabilities threatening your future
- How you can be more efficient with your finances and save on taxes
- How you can receive maximum after-tax value from your company if/when you sell
- How you can pass down your business to your family without sacrificing your goals
- If your planning has something missing from it
So please schedule a session and I look forward to exploring how we can help you.
(1) Tax rates current as of 2019