April 2008: by Jos Herman

Explore your options... explore dividends

As discussed in my last article, the new dividend rules perhaps will change tax planning for Canadian Controlled Private Corporations (CCPC's) or at least provoke discussion as to alternative compensation options for owner-managers in the future.

Where in the past it was the norm to bonus out to the shareholder/employees any corporate earnings in excess of the amount eligible for the small business tax credit (currently $400,000 but increasing) it will now be almost the same, in combined corporate/personal after tax dollars, whether the corporation bonuses down to the lower tax level or pays corporate tax at the higher rate and dividends out to the shareholders.

Under the new dividend tax rules, from a combined federal/provincial perspective for 2008, we see a reduction of personal tax rates for ineligible and eligible dividends received shown in Table 1.

Table 1: Reduction in tax rates
	Ineligible	Eligible
Federal %	19.6%	14.5%
Provincial %	11.23%	5.85%
Net tax %	30.83%	20.35%
Reduction in rates %		10.48%

If you then compare the personal tax rates for the various forms of income received, such as ordinary income (i.e. salary/bonus), dividends, and capital gains for 2008, there is a difference in tax to be paid shown in Table 2.

Table 2: Tax rates for different income
	Taxed @
Ordinary Income (highest)	44%
Ineligible dividends	30.83%
Eligible dividends	20.35%
Capital Gains tax	22%

For most individuals, they are most familiar with receiving a salary or bonus (and potentially being taxed at the 44% tax rate). This is not untrue for businessowners. In order to draw monies out of a corporation, receiving a salary or bonus is usually their first thought.

The right form of compensation (including dividends) is certainly one that the owner-manager must consider an individual choice that factors in his/her own circumstances, such as:

Does the corporation have the ability to pay eligible dividends? A corporation's capacity to pay eligible dividends depends mostly on its status. If the corporation is a CCPC, it can pay eligible dividends only to the extent of its "General Rate Income Pool" ("GRIP"). In general terms, it is the balance reflecting taxable income that has not benefited from the small business deduction or any other special tax rates. This also includes eligible dividends received from other corporations. If your CCPC has never earned active business income over the small business limit, then the corporation may not have the ability to pay eligible dividends.

Are you currently contributing to an Individual Pension Plan (IPP)?

As you may or may not know, an IPP is a tax-driven registered pension plan catered to individuals who would like to accomplish more retirement savings than what an RRSP can offer. The prime candidates for IPP are usually profitable corporations that are looking for additional retirement savings opportunities for owners or key employees. Generally, under this plan, the individual would require annual earned income of greater than $100,000. Dividends would not qualify as earned income, so the benefits of such a plan may be compromised if no salary is taken.

Do you have non-active shareholders (i.e. family) in the corporation? Finally, if the corporation has nonactive shareholders, there is an opportunity to compensate such individuals with dividends without the risk of the amount being subject to CRA's reasonability test (like a salary or bonus would be) or subject to CPP premiums.

These questions are highlighting some of the thought process that may take place on a simplified level. The solutions may be a combination of salary and dividends, or layering in some other strategies that benefits the owner-manager in times where profits appear to be increasing and creating excess cash in Saskatchewan corporations.

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About the author
Jos Herman, CA, is a Financial Advisor with Assante Financial Management Ltd.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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