In my last post, I reviewed how a Canadian Controlled Private Corporation (CCPC), such as a professional corporation, is like a dam reservoir. Use your corporation to regulate the flow of earned business income to smooth cashflow. That minimizes the money lost to our progressive personal tax system.
Also like a dam, a corporation allows us to collect a large reservoir of capital (money) to invest and grow. But beware, if your reservoir becomes too large and stagnant, the tax skeeters can breed in it. Let’s explore how to avoid that.
Main Aspects of Corporate Investing
When you earn income through a corporation, it is only partially taxed. That tax deferral leaves a large amount of capital to invest. Invest that money to earn more income within the corporation. However, you must understand how corporate investment taxation works in order to grow that money efficiently.
The tax code has several provisions to blunt tax-deferred corporate investing. A high tax is collected up front. That tax is partially refunded when you flow the money out as dividends and pay personal tax. Further, if the corporate investments produce too much passive income, then the overall corporate tax rate may rise. Again, flowing more money out of the corporation (and paying personal tax) helps to attenuate that issue. However, at some point even that becomes inefficient. I call that state corporate bloat.
So, to use your corporation to invest effectively, you must understand these aspects. Leave capital in the corp to invest, grow it efficiently, and maintain efficient cash outflow. You may need to also think long-term to avoid corporate bloat as you age.
Corporate Tax Deferral: More Money to Grow Now
One of the biggest advantages of the CCPC structure is tax deferral on active business income. The pool of money left in your corporation after expenses, taxes, and dividends is called the retained earnings.
Those retained earnings have been taxed at the lower corporate rate, leaving a larger money reservoir than if we took that income personally. A stagnant pool of water doesn’t grow anything except mosquitoes. We need to invest it to grow. The effect of the “corporate tax deferral advantage” at 6% annual growth is shown below. This is the type of chart most advisors will show you to make you excited.
You must pay the deferred tax to get the money into your hands to spend.
The partial taxation of corporate income leaves a larger amount of money to invest and compound. However, it still has a tax liability baked into it. You must pay the rest of the tax to get that money out of the corporation and into your hands. The money you have in your hands in the end is what matters – not the pre-tax value.
The line separations in the above chart mostly reconverge if you take money out at the same rate as you deferred the tax from at the start. A TFSA and RRSP are equivalent since they are both also tax-sheltered. If you squint, you will see some slight differences. A detailed explanation is beyond the scope of this post. However, a personal taxable account underperforms because even though you remove the tax liability at the beginning (by starting with after-tax money), you accrue a new tax liability with deferred capital gains moving forward. A small corporation can also look to outperform slightly due to the fact that we are ignoring tax drag from income and capital gains can flow very efficiently out of a corporation. More on that latter.
Tax deferral may or may not be an advantage.
The above model assumes that you contribute and withdraw at top personal rates. It also assumes that the corporation is perfectly efficient (that is not always the case). Under those circumstances, tax deferral is largely a wash. However, tax deferral can improve or worsen the overall tax-bite if the contribution and withdrawal rates are different.
If you defer the tax while in a high personal bracket and pay when you take it out later in a low one, then that is a tax savings. More after-tax money in your hands. Conversely, if you defer tax while in a low personal bracket and then take it out later in a higher one, then you are left with less.
Fortunately, most people earn and spend more in their accumulating years than during retirement. However, that may not be true if you live frugally and build a giant corporation. The money needs to come out some time and the taxes paid. If you are drawing a low taxable income now and forced to take a higher one later to decant, then you may pay more tax.
Corporate Investment Tax Drag
The tax deferral model shown in the previous section ignores the drag on investment growth from the taxation of investment income. We call that unfortunate reality “tax drag“. The capital growth doesn’t cause tax drag unless gains are realized from selling. However, interest and dividends received generate an annual tax bill to be paid.
Does Tax Drag Matter?
The tax deferral on earned income for a corporation leaves you more money to grow initially. However, in a corporate investment account, there is tax paid on the income generated by those investments. Tax drag blunts the rate of growth. In a compounding fashion over time!
The tax drag for investments in a corporation can be minimal or it can eat up virtually all of the passive income. It depends on the amount and type of income plus how you dispense money from your corporation. If you applied a 1.5%/yr tax drag to the investment income in the above model, it decreases the annual after-tax return to 4.5% from 6%. That flattens the growth curve as shown below. “Investment Taxation” may be boring, but I bet you could think of some exciting things to do with the money in the “orange tax drag gap”.
Fortunately, a 1.5%/yr tax drag is just an example of what can go wrong if a corporation becomes inefficient. That can be reduced with some basic knowledge of how investment income in a corporation is taxed to guide us. So, tape your eyelids open and let’s proceed.
Corporate Investment Tax Drag Depends on Income & Out-Flow
To discourage using professional corporations for tax deferral, passive investment income within a corporation is taxed upfront at a rate close to the maximum possible personal tax rate. Like the other attempts at tax integration, it is not a perfect.
As you can see in the chart below, the upfront tax on investment income generally does not favor corporations. It is also vital to note, that this comparison is assuming top personal tax rates. If you are in a lower personal tax bracket, then the relationship could change to further favour personal investment income.
Keep Money Flowing Through Your Corporation to Combat Tax Skeeters
Fortunately, this high upfront taxation is not the end of the story. When you pay dividends out of your corporation to live on, then you pay personal tax on those. That also releases some or all of that upfront corporate tax back to the corporation.
That is called refundable dividend tax on hand (RDTOH). This lessens the tax inefficiency of a corporation for interest, and it negates it for eligible dividends. The inefficiency of foreign dividends improves but is still pretty bad because reclamation of foreign withholding taxes reduces the RDTOH refund. I will cover this in more detail in the next post on corporate investment tax integration.
To avoid the drag on investment growth in our corporate reservoir, we need to keep the money flowing. Stagnant water will allow mosquitoes to propagate. Keeping it flowing will power the “refundable taxes turbine” of our corporate dam. [Editorial Note: Any resemblance between those levying these taxes and blood-sucking insects is purely coincidental.]
Limits On Corporate Size and Income
Corporations that have more than $10MM in assets lose their small business deduction linearly until it is eliminated by $50MM. Reasonable. I wish I had that problem.
Recently, the Federal Government imported some genetically modified tax skeeters in its attempts to further discourage tax deferred investing via small corporations. These new active-passive income tax thresholds to bump corporations out of the lower small business tax rate came into effect in 2018.
Active-Passive Small Business Deduction Limit Shrinkage
Passive income is bundled together as adjusted aggregate investment income (AAII). For every dollar of AAII that a corporation earns above $50K/yr, the small business deduction threshold will shrink by $5 for the subsequent year.
For example, if your corporation earns $75K passive income this year, then the SBD threshold will shrink by $25K times 5 = $125K. That means if you earn more than $375K active income the following year, the excess active income will get taxed at the higher general rate.
Attenuating the active-passive business tax bump.
If you have “too much” AAII coupled with “too much” active income, you will pay the higher general corporate tax rate (~27% vs 12-13%) on your active business income over that amount. That is about a 13-14% increase. However, it occurs at a 5:1 rate for the passive income over $50K. So, that is effectively a 65-70% tax hike on passive income.
If your corporation pays dividends out to fund your lifestyle, then tax integration attenuates the impact. Yes, you are paying personal tax – but you need personal money to live on! When the corporation gets bumped up to the general tax rate, it also generates GRIP. That GRIP allows some of the dividends that you pay yourself to be eligible dividends (taxed at a lower rate) than the regular ineligible dividends. The lower personal tax reduces the net impact to a 40% overall tax bump compared to ~70% hammer. Still a massive increase in tax drag, but not as draconian. If you are not normally paying out dividends to live on, then hammer-blow is not softened.
An unintended consequence of the active-passive tax grab is that Ontario and New Brunswick did not follow the Federal lead. As a result, tax integration was broken and through a complex mechanism, the new rules may actually reduce taxes for a small group of high-income, big corp, big spenders. In New Brunswick, it is 6.66% – The Tax Break of The Beast.
The Frugal Living & Bloated Corporation Dilemma
A corporation is a great tax deferral vehicle. That is beneficial if you are in a high personal tax bracket now and will access the money later while in a lower one.
In the interim, the tax drag on unrealized capital gains is zero. Plus, when they are eventually realized, the capital gains may be moved out efficiently via a tax-free capital dividend. In contrast, the tax drag on growth from income (interest and dividends) in a corporation is not always as efficient as personal investing.
Investing via a low-income spouse may beat a corporation.
Compared to a low personal tax bracket, a corporation is usually less efficient. However, it can come pretty close, if you are flowing out dividends to fund your lifestyle and releasing the RDTOH back to the corp. To invest via a low-income spouse, they must have some income, either from an outside job or working for you. The high-income spouse can cover costs of living to preserve the low-income spouse’s income to invest separately without attribution.
A corporation has lower tax drag compared to investing in a high personal tax bracket – unless is starts developing inefficiencies.
Developing Corporate Bloat
The problem of tax drag becomes a dilemma if you spend very little to live on and build a corporation with a large amount of passive income. Corporate bloat. The chart below shows the effect of tax drag on growth of a corporate account compared to other account types.
When running efficiently, a corporation is similar to a personal cash account in the hands of an average-income person. However, if you have trapped RDTOH (moderate bloat) or trapped RDTOH plus passive income limit SBD-shrinkage (severe bloat), the efficiency becomes terrible. Moderate bloat (dark blue line) and severe bloat (purple line) are show in the chart below illustrating tax drag of a growth portfolio.
RDTOH Trapping in a Corporation
If you have a large corporation generating passive income, then you may face a dilemma. You may need to weigh how much personal tax you pay from distributing more dividends than you need to live on against how much RDTOH gets refunded to the corporation.
Trapped nRDTOH from interest and foreign dividends in the corporation.
The interest or foreign dividends received by the corporation are taxed at ~50% upfront. You are then faced with either the drag of that upfront tax or taking out money in a higher personal tax bracket to release the RDTOH. If your personal rate is higher than the corporate refund, then it doesn’t make sense to pay out extra dividends just to release the RDTOH. The breakpoint over which RDTOH gets trapped varies by province and is shown in the table below.
For example, if I live in Ontario and my personal income from my corp to live on is $160K salary, then my net personal tax rate if I give myself an extra ineligible dividend is 41.79% (after gross-up and dividend tax credit). If my corporation collected $100 interest, then $50 in corporate tax is due. I would have to give an ineligible dividend of $80 to release the refundable portion of the corporate tax (nRDTOH). To do that, I would pay $33.43 personal tax. The refund of non-eligible (nRDTOH) to the corp is only $30.67. So, it does not make sense to pay myself a dividend just to empty the RDTOH. I would lose more money to tax that year. The corporation had 50% tax collected on the passive income, but the RDTOH is trapped.
Trapped eRDTOH from eligible dividends income to the corporation.
If the corporate passive income was received as an eligible dividend, then it was taxed at 38.33% upfront in the corporation. In Ontario, I could pay out dividends to release the 38.33% RDOTH back to my corporation up to a personal income of $220K before it becomes trapped. Over $220K in Ontario would put me in the 39.34% net personal tax for eligible dividends.
So, interest and foreign dividends can lead to trapped RDTOH in a corporation at moderate income levels. It is not a problem for eligible dividend income except at very high income levels. Further, eligible dividend RDTOH can only get trapped in Manitoba, Newfoundland, Nova Scotia, Ontario, and Quebec where the personal tax on eligible dividends can get extremely high (>38%).
Changing how you pay yourself may release trapped RDTOH.
One way to release trapped RDTOH is to pay less salary and more dividends instead. One advantage of salary is that it is slightly more efficient than dividends when you integrate corporate and personal taxes. Another is that salary allows for RRSP contribution room or building service for an Individual Pension Plan later. It also gives you some Canada Pension Plan which is a decent investment. So, you may lose some of that by trying to release all of your RDTOH. That could be a problem, if RDTOH trapping happens early in life.
However, if the RDTOH doesn’t start getting trapped until late career, then reducing salary to pay more dividends may not matter as much. For example, if you have built a huge RRSP by then, losing some contribution room may not be terrible. In retirement, you are likely to take all of your corporate income as dividends. That would release the trapped RDTOH over time. The problem is when it happens early, drags on your returns, and leaves a big bag of bloat to slowly release in retirement. Some planning may help.
Strategically Pass Gas to Avoid Corporate Bloat
It is common advice from some accountants to “just leave everything in the corp”. The problem with doing that, is that you may develop Corporate Bloat with trapped RDTOH and possibly even a big bump from the active-passive income limits. To avoid this problem, you could strategically move money out of the corporation when you can tax-efficiently do so. That prevents it contributing to future bloat.
This is part of why using an RRSP or spousal RRSP, and possibly a personal account attributed to a lower-income spouse can be helpful. Diverting some money to a TFSA may also be useful. The overall tax-rate may be lower by proactively doing this gradually over time.
Will you get corporate bloat before you are old and don’t care?
Use the Corp vs RRSP vs TFSA simulator to project when or if your corporation will become inefficient. It also shows the potential impact on growth. It also compares different strategies to delay bloat using other account types.
Below is a simulation of an incorporated professional who earns $250K/yr and spends $125K/yr on lifestyle. You can see how the efficiency of the “keep everything in the corp and just pay dividends” strategy plummets when corporate bloat starts at around age 60. In contrast, using the corporation, RRSP, and TFSA never becomes inefficient. The more that you earn & save while spending less, the earlier that corporate bloat occurs. It can be bad to be good.
The other reason to use other accounts, in addition to a corporation, is that TFSAs and RRSPs have less tax drag on growth than a corporation. A low-income person may also have a lower tax-drag in their account than a corporation. Plus, when you access your money down the road, having multiple pots with different embedded tax-liabilities can allow you to make a more efficient drawdown plan.
Strategically using a capital gains harvest is another way to tax-efficiently move money out of a corporation to remove the tax-liability moving forward. Like a tax-ninja. Excess cash could be used to top up a TFSA or personal cash account. That then grows without corporate tax drag or contributing to future corporate bloat.
The money has to come out of the corporation eventually. Usually, that it is best done gradually over time. “Crop-dusting” vs holding it in until you accidentally “clear the elevator”.
Corporate Investment Accounts
Corporate retained earnings are invested via a corporate investment account. This is an account at a brokerage like Qtrade, Questrade, MD Financial, or your advisor’s affiliated brokerage (if you have one). I made a DIY Investor Hub to link the education and tools to start DIY investing.
Setting up a corporate investment account
The process is similar to opening a personal cash or margin account, except there are some extra forms for corporate tax treatment and you need copies of some corporate documents. To make this easier, my interactive DIY investing guide has partially filled forms and links to the paperwork required to open a corporate investment account using Qtrade. Disclosure: I recently partnered with Qtrade to better develop that material and streamline the process for corporate DIY investors. If you use The Loonie Doctor as your referral via my site, then you also support this blog with a small referral fee (at no cost to you).
Your CCPC can have more than one corporate investment account, even at different brokerages. However, that makes tracking for tax purposes more of a pain in the butt. I have used different brokerages over the years and good customer service and simplicity is critical to me. That is how I ended up back at Qtrade.
Deposits & withdrawals from a corporate investment account
The corporation owns the corporate investing account. Not you directly. You put money into it from the corporate operational bank account. For clean accounting, it is also best to transfer money from the investment account back to the operational account before dispensing it to you personally.
What can you invest in via your professional corporation?
A corporate investment account is just a basket to hold investments. Those investments can be financial instruments like stocks, bonds, GICs, or the funds that bundle these instruments together. Such as exchange traded funds (ETFs) or mutual funds. You can learn more about this in the basic training section of the DIY investor hub.
In addition to passive investment income from financial products, your corporation can hold investments like the real estate and infrastructure used in your practice. For professional corporations, like a Medical Professional Corporation (MPC), there can be restrictions on holding passive real estate or alternative investments that are not directly related to your professional practice. Your professional college regulates that.
You may also open a separate corporation, called a holding company, to hold investments like non-medical real estate or a different business. That maneuver adds complexity but isolates that real estate or business from your personal liability.
How a Corporate Account Fits Into a Larger Portfolio
The main advantage of a corporate investing account is tax deferral & flexibility.
You could have 70-88% of your actively earned income (after paying 12-30% corp tax on active income) to initially invest compared to half personally. You must pay the rest of the tax when you eventually move the money out. That may also result in tax savings if your future tax-rate is lower than currently.
While not 100% tax-deferral, like an RRSP, a corporation offers much more annual contribution room. It also offers more flexibility upon withdrawal compared to an RRSP which must convert to an RRIF eventually.
A corporate account is not tax-sheltered. But it can be efficient.
A high rate of tax is charged upfront on passive investment income. It is close to the top marginal tax rate. You can minimize that tax-drag on growth by paying enough dividends from your corporation to release the RDTOH.
Even with the release of RDTOH, interest income and foreign dividend income are less tax efficient in a corporate account than personally. In contrast, eligible dividends flow through a corporation with perfect efficiency.
Capital gains are also very efficient in a corporation. There is no tax drag. Taxes are only paid when the investment is sold, and the gain is realized. Further, half of that capital gain is tax-free. Using that to pay out a tax-free capital dividend instead of regular one could save on taxes.
So, if you were attempting to tax optimize across your portfolio, you would target capital gains and eligible dividend-paying investments to your corporation and try to shelter high interest and foreign dividend-payers in a tax-sheltered account. Of course, tax-optimized asset location becomes very complex quickly. Invest with a good plan longer instead of waiting for a perfect one and missing the market.
Avoid corporate bloat. Crop-dust and use your other accounts too.
In addition to registered accounts, like an RRSP or TFSA, providing better tax drag than a corporation, they also allow you to spread your wealth out. That may be helpful if corporations are targeted for more aggressive taxation again. Even if that never happens, a large corporation may become tax-inefficient if it develops trapped RDTOH or gets bumped over the active-passive income limits. Using other accounts, in addition to the corporation, delays the onset of that drag on growth. Multiple account types also give you to options to decumulate more tax-efficiently in retirement or for big spends along the way.
Where a corporate account fits into your investing sequence.
Most people take a few years to pay off debt, feed the delayed gratification, and max out their registered accounts, and then have money left to take advantage of a corporation. That is when a corporate account makes sense. As a corporation grows, you can then see whether you will eventually hit corporate bloat.
If you won’t get bloated before you are old, then you may not care. One approach is to earn less active income and/or spend more! There are also potential strategies to use like tax-optimized asset location or products like Horizon’s corporate class ETFs to minimize corporate passive income. Of course, there are also more complex products like permanent life insurance or independent pension plans that get pitched as options. The tax-savings of any of those products and strategies may be offset by increased fees and complexity.
Disclaimer: I would recommend discussing with your accountant and advisor. For incorporated professionals, a good accountant is mandatory. A financial advisor may be optional. However, if you use one, this kind of strategic planning for your portfolio is one way they might add value. Accountants and financial advisors may be experts at tax planning and financial planning respectively. Link both these aspects to get the optimal outcome. Being an educated client helps to bridge this divide. Only you can lead your financial team.
Mark, another excellent post! I’m not sure if I’m understanding the following correctly – I pay myself a salary to maximize my RRSP, which is enough for us to live on. On occasion, I need a bit more, in which case I spend from my personal taxable account built up from pre incorporation days. Are you saying I should be paying out eligible dividends from my Corp to release RDTOH if I need more than my salary, or even if I don’t need more in a given year?
On another topic, should we tax loss harvest in a Corporation? I haven’t been able to get a straight answer from my accountant about this. My thinking is no, because even if you empty out the CDA account before doing it (which you must do or you reduce the amount in the CDA account by half of the loss), the CDA account goes negative, so when you go to capital gains harvest in retirement (to avoid the OAS clawback etc.) you have to get the CDA account back up to zero before you will have any money in it to get a tax free dividend.
Thanks Grant! Those are great questions. I would honestly run it by a CPA since everyone’s situation is unique and I am an amateur. That said, I will take a crack at it.
Basically, the corp has already paid 38.33% tax on the eligible dividend upfront. So, if you needed extra money, paying an eligible dividend would release that back to the corp and you would pay personal tax at a lower rate. For example, if you needed $10K and paid that out as an eligible dividend: your corp would get $3833 refunded and you would pay ~$3K of personal tax on the dividend if you were in the $145-160K income range in ON. So, between you and your corp, you would be up $800 after-tax overall. On the other side of the equation is whether you would be triggering tax taking money from the personal account via selling something. That would push it further in favour of taking from the corp due to tax on the realized gain. If it was existing income from the taxable account, then you are no worse off since you are paying tax on it anyway and can just re-invest that rather than take it out. To me, that would all favour taking an eligible dividend.
It is an interesting question about taking money out of the corp even if you don’t need it. It would depend on what tax bracket that bumped you into and whether it triggered OAS clawbacks. In ON, only the >$220K tax bracket has a higher tax rate (39.34%) on eligible dividends than what your corp has already paid upfront. The optimal drawdown strategy for a corp is complex (I think). Kind of like an RRSP, the corp is a tax deferral vehicle. Bleeding the money out of it to melt it down tax efficiently may be better than big lump sums later. There are also fancy (and expensive) maneuvers, like surplus stripping, to remove large sums. I am still in the accumulation phase and this dilemma is definitely getting into the expert accountant/planner realm.
Great question about tax loss harvesting in a corp account. In short, I don’t know the answer! However, I think that I would rather just build my CDA account for tax planning later as you suggest. The one time where I would consider it is if I had realized a capital gain that was going to push me over the active-passive SBD threshold. Still, that would be tricky to do because capital losses can’t carry forward to a future year for purposes of the new SBD threshold rule (nasty bit of fine print). You’d basically have to have a major winner and loser in the same year.
Thanks again for the great brain teasers!
Here’s another twist on this – assuming you need $145k to live on and have $10K ineligible dividends in your Corp, do you take $145k as salary in order to maximize your RRSP, or do you take $135k as salary, so not enough to maximize your RRSP, and $10k eligible dividends to boost your financial assets by $800?
Ooo. Good one. I will add it to my “dividend dilemmas” list. It is easy to flow everything when drawing big money and so much more of a brain teaser when you have to decide one or the other!
Have been thinking about this tax-loss harvesting in a corporation a bit more and would love to have any feedback.
It seems like tax loss harvesting in a corporation might all be about time horizons?
If one accumulated capital losses to use in retirement, it would seem that the benefit of tax deferral is mitigated by the shorter time frame in retirement to benefit from the deferral? (I think the CDA would recover by then due to the lower ACB on tax loss harvesting so less of an issue I’d imagine?)
If one used capital losses against shorter term capital gains (cashing in a capital gain before retirement, one would assume due to a personal need?), then the CDA effect at the time, would likely make it less advantageous. If one needed money on the personal side, the personal side taxation would be far less if getting tax free CDA transfer. Which I guess is why they recommend cashing out the CDA first before harvesting a capital loss…But then hopefully you won’t need to cash in another capital gain out of need, cause then the CDA is negative…so perhaps less punitive if its a “one-time need”?
Overall it seems like the benefit of tax-loss harvesting is lessened in the corp due to CDA in the short term, and the realities that corp investments are typically held for retirement? So it might make sense if you have a specific need in one year (need to cash in a one-time capital gain, hitting up against the SBD deduction), but general accumulation is not as beneficial (especially compared to the personal side…)?
That is largely my take on tax-loss harvesting in a corp. I used it this year because I had also realized a gain this year that would have bumped me over the SBD threshold. Realizing a loss still allows it to be applied against a gain for the tax on the investment income as per usual. However, one wrinkle in the new tax rules is that a loss can only be applied against a gain in the same year for determining the “adjusted aggregate investment income” that can shrink the active income threshold for the SBD. So, if you tax loss sell and don’t apply it that year it could be wasted. If you aren’t ever going to hit the threshold, then it wouldn’t matter.
Otherwise, given the long time frame and benefits of the CDA for moving money out of the corp, I personally wouldn’t bother tax loss selling in a corp unless a specific reason. A personal taxable account is a different story and it is good for tax deferral in that context.
Thank for doing this LD!! Thanks Grant for asking re the tax loss harvesting in the CCPC. That is the part that is really irking me. Do I even need to tax loss harvest and how much of a gain before I even bother with tax gain harvesting.
I tell my accountant my overall strategy and his job is to make it as tax efficient as possible while side stepping land mines. We certainly take out a blend of salaries and dividends since dribbling monies out of the Corp is the optimal way to go.
I will be increasing our salaries when we breach the SBD wall and that’s about it. But it hasn’t gone fully live yet in terms of first final tax year end so shall be interesting to compare notes in a year.
Hey Dr. MB. I will be following your adventures with interest. It is great to see what those further ahead on the career/life curve are thinking about and doing. It is less discussed and in my mind more complex.
I think it makes sense to not tax loss harvest in a Corp (to avoid making the CDA go negative) and delay tax gains harvesting until retirement. Then you keep the capital compounding over the years, and then tax gain harvesting enough each year or so in retirement to give you enough tax free dividends to avoid going into the next tax bracket, avoid OAS clawback etc.
This is one of the most clearly articulated explainations I’ve read in this topic. It’s very very well done so thank you LD.
Thanks Neil. I do find this stuff a bit dizzying. Breaking it into small chunks to make diagrams and linking those with why it matters helped me also. I keep finding things that I could have done better in my personal portfolio!
if you were to withdraw only dividends from a corp to live on…..would it be best to take this out as active business income generated dividends (I guess these would be deemed to be ineligible dividends? for tax purposes) or use the proceeds from your canadian dividend paying stocks that are in your corp? I am a bit confused by which is more tax advantageous and how this all fits in with the RDOTH
Hi Sue. Great question! This is where I think there is an opportunity for people (and where it is confusing!). When you pay a dividend out of your corp’s operational account, it doesn’t matter where the money came from (active income or investments). Example: I have $10K in my operational account from active income that I want to pay out to live on. My corp investment account got $10K of eligible dividend income. I can re-invest those eligible dividends in my investment account (this is what I do via DRIP). I don’t need to move the “eligible dividend money” from the investment account to pay that out. My corp will develop a GRIP balance of $10K due to receiving those eligible dividends. That means when I want to pay myself a dividend, I have the option of making it an eligible dividend or an ineligible one.
NOTE: I had to correct my original response here.
If my corp pays me a $10K eligible dividend, then my corp would be fully refunded the $3833 tax that it paid for receiving the eligible dividend (net tax of zero). If I were in the ~$150K ON personal tax bracket, I would pay ~$3K in personal tax on receiving the dividend from my corp.
If my corp pays me a $10K ineligible dividend, then my corp pays $3833 tax for receiving the eligible dividend and is refunded that (net tax of zero). I would also pay ~$3800 personal tax on the ineligible dividend in the $150K ON personal tax bracket.
So, in this situation – by paying an eligible dividend from my active business income I pay $800 less personal tax on moving the same amount of money out of my corp compared to using an ineligible dividend. Receiving eligible dividend income to generate GRIP is what gave my corp the ability to pay an eligible dividend. If I were to pay the ineligible dividend now, then I still have that GRIP room and can pay a tax saving eligible dividend later. The difference is not letting the government keep my money longer than necessary when I could use it instead.
It is important when using GRIP and paying out eligible dividends to execute it all properly with the help of your accountant. I hope that answers your question. There are other wrinkles that can come up, but I don’t want to muddy the waters too much. This is a lot to digest already, but I plan on making a “sim lab” post to give some real-life examples of how this all works. My goal with this article was to give an overview with some general rules of thumb about what investments are efficient in a corp account versus other accounts. That will hopefully lay the groundwork for deciding how to organize our corporate account meshed in with other accounts like RRSPs, TFSAs, and personal taxable accounts.
Thanks again for asking a great question. I am sure there are many others with the same one. I tried to simplify it with diagrams, but I still have to think it through step by step!
thank you for getting back to me. Does your accountant decide if you are issuing yourself an eligible or ineligible dividend? so lets say for example you decided that for a corporate year, without taking any salary from the corporation, you issue yourself a cheque every month as a dividend from your corporate bank account. Lets say this amount was 60000 a year (so 5k a month). How does this work with whether it is deemed to be an ineligible dividend or eligible dividend? I thought all corporate issued dividends from a professional corporation were ineligible and only those issued from a dividend paying canadian corporation (stock) were deemed to be eligible? I guess I”m confused about how you go about dispensing yourself an eligible dividend. I hope I am asking my question the right way. It looks like one needs to have had investment income in the form of dividends in using your example, to make this work? and if you don’t have any investment income the 10K lets say you take out of your operational account (I think corporate bank account ?) and issue yourself a cheque you are using the example that you can decide if its an eligible or ineligible because you also had 10K of eligible dividends that were generated and are on paper anyway part of the GRIP balance that you can access? and deem this to be an eligible dividend for tax purposes if you want to? so the bottom line for us newbies it to start generating dividend income via tax efficient canadian dividends so you can build up a GRIP balance to have more options and consult with your accountant who hopefully knows about this and can advise at the end of the corp year about what will be a corp. ineligible dividend vs eligible and hopefully help you reduce your taxes owing (I am in Ontario).
Ah, I see. Not all dividends from a small corp need to be ineligible. I go over the process of how a small corp can give eligible dividends here. You do have the right bottom line though – invest to build some GRIP (as long as you don’t bump yourself over the passive income threshold) and work with your accountant to figure out dispensing eligible dividends when able.
Basically, a small corp (like an MPC) can give an eligible dividend if it has a balance in its paper GRIP account. It gets that GRIP balance from either earning income above the SBD threshold and paying some tax at the higher general corp rate and/or from getting eligible dividend income. Your accountant needs to calculate your GRIP balance at tax time. You need to declare and minute it as an eligible dividend when you write yourself a cheque. Personally, I do this together with my accountant when we meet face to face for my corp tax filing and to plan for the year ahead or liase with him via email on it if unexpected things come up. It is important to get the paper trail right.
does your account go over with your what your GRIP balance is when you meet for your year end review? and from there, you and the accountant then determine what you can take out as an eligible dividend and what would be ineligible based on what amount you have as a GRIP balance. So subsequently, if you issue yourself a cheque each month, some or all may be eligible or ineligible or a blend depending on this scenario and what makes the most sense from a tax saving point of view. If I have issued myself a dividend I only write on the cheque it was a dividend paid for month “x”, not identifying if it was for an eligible or ineligible dividend- I guess this matters a lot moving forward if you start to accumulate a GRIP balance? should an excel spread sheet I use for the dividend column I use when I issue myself a cheque be separated to include both of these distinctive dividend cheque types? Your response really clarified a lot for me. Thank you
My pleasure! Good practical questions.
My corp year end is Jul 31st and we do my corp taxes in early Sept. That is when we meet. My accountant goes over my revenue, expenses, taxes, retained earnings, cumulative realized capital gains/losses, GRIP, and RDTOH balance with me. We plan what I want to have as my dividends etc for the calendar year (personal tax year). Admittedly, I had no idea what he was talking about and just did what he suggested until this past year. I discovered that I have been carrying a GRIP balance despite paying out lots of dividends. There was a loop-hole that made that a reasonable strategy in the past, but the last Federal budget closed it. We discussed and will be emptying my GRIP and eRDTOH as much as possible moving forward.
I like having my corp tax year end in the summer because it gives a few months to sort these things out before the end of the personal tax year (Dec). It is also a less busy time of year for him – so he takes his time with me. Meeting in Sept also gives a few months to tidy up eligible versus ineligible dividends over Sept-Dec. I then get my personal T-slips showing those dividends done in January for the preceding year. Eligible dividends are supposed to be declared as such when given. That basically means noting it as such in the corporate minutes and your accountant tracks it on the tax filings. I should probably note it in my spreadsheet too – good idea. Every accountant probably handles the mechanics of the process a bit differenly I suspect.
I’m afraid I’m confused about this sentence in your comment “If my corp pays me a $10K ineligible dividend, then my corp pays $3833 tax for receiving the eligible dividend.” Could you elaborate? Thanks!
Ah! You are right! Good catch. Paying an ineligible dividend will also release eRDTOH. eRDTOH is released by either an ineligible or eligible dividend. Releasing eRDTOH using a higher taxed ineligible dividend would be pretty inefficient, but allowed. The GRIP balance would be carried forward to allow an eligible dividend later. Personally, I would want the cash in hand asap. nRDTOH is only released by ineligible dividends. The new rules splitting the original RDTOH into two got me. I need to fix this and email Sue.
my corp year end is June 30 so I will talk with my accountant about the types of things you discuss with yours. Really just starting out with being able to invest in the corp….style trying to figure out if its best to take a blend of salary/dividends…..ie to get max cpp or just do all dividends. I do get some T4 income for child care benefit unless my spouse claims it. It is good that there can be flexibility about how one goes about paying themselves in a calendar year. Does your accountant use T3s and T5’s to figure out your dividend/income for tax purposes for the corp or use your statements? given that these are issued for a calendar year and your year end is July.
Hey Sue. I was just about to email you. I made a small correction to one of my responses above. See – this stuff makes my head spin too. I was trying to answer and keep my kids at bay for a few minutes at the same time yesterday.
I use a combination of salary and dividends. I like the RRSP room from salary plus some dividends to keep my corp investment tax flowing. I also spend enough that I don’t really need to choose one over the other. It is a bit different for everyone. The more I learn, the more I appreciate my accountant. I give him both my detailed transaction statements from my corp investment accounts and the T-slips that get issued and he just does it. I am not sure what exactly he relies on.
Great post by the way…Just to change gear or topics for the moment…why is there no talk of an IPP, it can be a good source for another income stream and is tax deductible from your corp. I just set one up this year after a LOT of research and likely annoyed my accountant with all my questions, Excel sheets, etc…at the end of the day, it helps create a deduction from your corp., Gives you another income source in retirement…any thoughts on an IPP?
Hi Hipeonmoney! Thanks for stopping by. IPPs have been on my todo list. I mentioned them in my overview of strategies post back in April but haven’t made it back yet. Having spent so much time researching/testing, you probably know more than me. My general take is that they can be helpful when you get a bit older – especially if you missed building an RRSP or want to roll more money into that type of structure. I don’t think I will use one personally because I have a pretty good multi-source plan with my RRSPs, TFSAs, Corp Account, and my lower income wife’s taxable account. I may also retire well before age 55 also – which may complicate an IPP a bit. They do come with more rules and fees. That may be worth it for some situations and not others. I honestly need to spend some time looking at them in more detail. What do you see as the major advantages/disadvantages and where an IPP would work best?
Yes, they certainly do have some interesting rules…the only major disadvantage I can see is they are controlled like any other pension – basically yearly payment is 2% of total T4 income over the years…for me personally, its another income source: RRSPs, IPP, TFSA’s, Corp Account, rental properties etc…advantages – if you have lots of income/retained earnings/excess cash each month/year and are closing in on your SBD, then it allows you to funnel some of your retained earnings with a tax deduction…it also assumes 7.5% return each year…if it is less, then you can top it up again with a tax deduction to your corp…if you retire before 55, you can also do a bridge lump sum contribution to fund the years between retirement which again is tax deductible…I guess I was wondering more about your thoughts…not much written out there about them and was looking for some other perspectives and justification on me setting one up! 🙂
I hear you. One of my friends who is financially pretty savvy has been thinking about it and trying to research. We are both undecided but still in our early 40s. I actually spent some time directly speaking to a financial advisor that does deal in them to get as much info as I did in that previous post. I couldn’t find much on the internet either. Are you able to invest in whatever you want or does it have to be specified funds?
Yes, definitely you can choose your investments/securities/asset allocation…in order to open one you need to be at least 40 and have past years of T4 income…something to look into nonetheless and as you mention in most of your posts, each individual needs to see if their situation makes it worthwhile.
Thanks. As a side note, I look forward to following your blog. Great to have another blogger for high income Canadian finance on the scene.
The IPP has a few disadvantages :from an article in the medical post (edited)
1) unlike a spousal RSP, you cannot split income with your spouse;
2) since you require ongoing services of an actuary, the administrative expenses are higher than with the RRSP
3) you don’t have the ability to withdraw funds prior to retirement; and
4) you need T4 earnings to maximize the current IPP contribution, which is similar to maximizing your RRSP contributions. (not as much an issue since income splitting via dividends is pretty much toast)
Thank you, love your blog…very detailed and accurate…maybe one or 2 people will have some interest in some of the topics I have on the slate to write about. 🙂
Great blog post, one of your best. This stuff took me ages to learn and comprehend and you’ve summarized everything in an extremely straightforward manner.
Just curious as to your thoughts on portfolio asset class allocation based on the tax ramifications of investments held inside a corp.
There’s articles online addressing asset allocation for TFSA vs RRSP vs non-registered but nothing comparing TFSA vs RRSP vs corp.
Here’s my (amateur) opinion:
-Corp: prioritize cdn equities first, avoid interest income (unless held in a swap etf)
-TFSA: prioritize US and international equities
-RRSP: prioritize interest income +/- US listed ETFs to avoid witholding tax?
Thanks! Glad you asked. I am actually putting an approach together. I am making some model portfolios about it. My overall thoughts are very similar to yours.
Hi LD, thanks for a great post. Question re: CDA – you said “While Capital Dividends may be tax-free, they do come with some accounting fees – generally in the $750-$1500 range.”
is this $750-$1500 included in one’s regular accountant corp taxes fees, or do accountants regularly charge EXTRA for managing a CDA on top of their regular corp tax fees?
Thanks for answering my noob question!
That is not a noob question, but a good one. My understanding is that it is in addition. However, different accountants will likely have different fees to a degree. Some may also depend on how clean your record keeping for investments are therefore how much time it takes them to sort out. Personally, I haven’t done any capital dividends yet (I am waiting until I am older). That was just the price range I have heard bantered around. Perhaps a reader who has dipensed from their CDA can comment.
Great blog LD .
I did a CD for 100 k a few years ago. It cost my corp about $500 extra. I prepared the resolution for the minute book (no lawyer needed) so this may have saved me a bit.
I will wait until my CDA balance is over 100 k to do another (unless I need the cash before then) .
I was told not to withdraw the entire CDA balance as their would be penalties (if overdrawn) so I left 15k in to be safe. You can request your CDA balance annually when your T2 return is filed but if its calculated incorrectly, its your problem , not theirs
Thanks Jeff! That is really helpful info.
Hi! I would really love to see a model portfolio for a Canadian physician corporation. I want to move my MD management invested corporation funds to funds with a lower MER. I had planned to put them into VGRO or VBAL as I was drawn to the Couch Potato Plan but thought VGRO or VBAL would be even easier. Does that plan sound okay? Or will I just be trading the investment fees from MD management for extra taxation?
I’m at the point where I need a simple plan that minimizes the fees I pay. I don’t need it to be the best, most nuanced plan- I would just like it to be a pretty good plan if that makes sense!
Hi Rebecca. I am working on the model portfolio actually. These articles are to lay the groundwork so that I can refer back to them.
Saving on the MER of funds is generally a way bigger difference than nuances of taxation from portfolio tweaks. Yes, it can make a difference over the long haul. However, getting invested with a good plan and sticking with it is better than not.
A simple plan is: 1) figure out your rough allocation of equity:bonds that suits your risk tolerance. 2) An example using the couch potato portfolios: Preferentially direct the ZAG allocation to your RRSP and the VCN allocation to your corp. Put the XAW allocation wherever the leftover room is. If needing to put bonds in the corp, then ZDB or HBB is a good substitute for ZAG in a corp account. If your passive income in the corp is likely to push you over the SBD threshold, it can be more complicated – but you can change course at that time. Most plans evolve with time anyway.
Hope that is helpful. My usual cover my butt disclaimer: It is general advice only and I am a doc (not a professional advisor).
Could you explain how the tax efficiency of eligible dividend income is lost if your active business income is greater than the SBD?
I’m in the unenviable position of being a member of a large partnership where for the past few years, tax law changes have required that SBD needs to be shared amongst all partners. So the allocation of SBD allocated to each partner is a portion of the 500K limit and given the number of partners I share with, essentially, all my active corporation income is above the SBD.
As an aside – does this also mean that I should be able to issue solely eligible dividends to empty my corp when the time comes to wind it down?
Thanks for your advice!
That is an excellent question. I have been meaning to write a post on it, but haven’t yet. The basic issue is that tax integration doesn’t favour you once you are bumped over the SBD threshold into the general corporate rate. I’ll give an example using Ontario.
The general corporate rate is 26.5% and the SBD rate is 13.5%. So, when bumped, you pay 13% more tax on the active income. That isn’t all lost. Active income above the SBD threshold also generates GRIP at a rate of 72 cents on the dollar of income earned. That means that you can pay 72 cents on the original dollar earned as eligible dividends when you pay out dividends. Those are taxed favorably compared to ineligible. However, the total tax as the dollars move from your corp’s earned income to your pocket is 2% worse than if you had earned the income directly as salary. There is a table here on page 10 that shows the efficiency or cost for each province. You can reduce that loss by paying out more salary than you need – however, that also means that you are losing the tax deferral advantage of the corp. Not good.
So, eligible dividend paying investments have a tax loss of 0% when passed through a corp below the SBD active-passive threshold. Above it, they reduce your SBD threshold on active income by $5 for every $1 dollar of eligible dividend your investment pays. That bumping into the general rate then makes you pay more 2% tax on the $5. So, that is 2%X5=10% more tax. Pretty nasty! Once your SBD is completely eliminated, more eligible dividend income investments beyond that aren’t as bad again since you have nothing to lose. I guess if you have a super-teeny SBD space then that may not be as big of a deal since you have essentially nothing to lose. Definitely the realm of an accountant for determining one’s individual situation (I really am a doctor).
If you are totally above the SBD threshold, then you are generating GRIP and would be able to pay out mostly eligible dividends when drawing down. There would likely be some ineligible too depending on the general corporate tax rate of your province. For example, in Ontario, you would have $73.5 left after the general corp tax, but only generate $72 GRIP. So, $1.50 of the retained earnings would be an ineligible dividend when paid out. Eligible dividends are a mixed blessing. Lower personal tax rate, but the gross-up could also bump your taxable income for determining OAS clawback if you are planning on collecting that when older.
Hopefully, my long-winded answer hasn’t caused more confusion. It warrants a full post with flow diagrams for me to make sure that I get it all straight I think!
Thank you for your explanation of why eligible dividend income is less efficient once your are above the SBD. I am understanding more 🙂
As I learn more about investing within a MPC ( with many thanks to your website!), I came across another point of difficulty . There are numerous articles that illustrate the tax deferral and/or tax savings that have been calculated for investments within vs outside a CCPC. The comparison is always versus taxation at the highest marginal personal rate and even then, the benefits are marginal.
When I re-run the calculations at lower personal tax brackets, the tax savings and deferral benefits become significantly less and quickly favour investing outside the corporation. As your personal tax bracket gets lower, it becomes increasingly disadvantageous to invest within a corp.
So, for the given examples to apply, one needs to draw enough personal income to be taxed in the top marginal tax bracket? Also, if your personal income bracket was low enough, would the relative increased taxation on investments in a corporation vs personal eventually outweigh even the tax deferal benefits of corporate taxation on active income?
This is not just an academic question. I’d like to know how much and what type of monies (salary vs dividends) should flow to me vs remain in a corporation. It’s a complicated question which I’ve never really heard a good answer to (aside from enough to support your lifestyle which is an answer to a slightly different question). From a purely investment tax efficiency point of view, does it make sense to flow enough through personally to put yourself in the top (or at least higher) personal tax bracket?
Does any of this make sense? Am I missing something?
Thanks very much for your feedback.
Those questions come up frequently. Everyone’s personal situation is different and it gets more complicated at lower marginal rates. So, I would listen to your personal accountant over anything that I say. However, a few rules of thumb.
The main advantage of a corp is if you are making a lot of money and saving more than you can stuff into an RRSP and TFSA. Those vehicles are usually the most efficient and will beat out a corp in the long run. The tax deferral advantage of a corp is its main one and as your personal average tax rate shrinks, that differential does too. You would need a very low income to have your average personal tax rate actually be less than a corporation. For example, an income of $25K in Ontario has a tax rate of 16% while a corp is 13.5% (soon to be 12.5%). Those in a low tax bracket or not saving more than they can put in their RRSP/TFSA probably do not usually benefit from incorporating (unless they can income split with a spouse – most cannot). The rules are set up to discourage using corps solely as an investment vehicle to stockpile money. You need to be making and spending enough to keep the money flowing plus save enough excess beyond RRSP/TFSA to keep extra in the corp. Hard to do without a big income.
In terms of how much to take out and how to flow it out. The advice to not take out more than you need to live on generally stands up. There can be some nuances when you account for CPP and EI as to whether to pay salary vs dividends. Particularly when taking low amounts out. However, most recommend salary as the main payment (since it is favored by tax integration compared to dividends) and enough dividends to get your RDTOH refunded (usually not much). Plus, salary up to $145K increases your RRSP room. Increasing salary just to get more RRSP room can result in the loss of some tax deferral. Only 18% of the salary increase makes more RRSP room. When you take out extra salary just for that reason, 18% gets 100% deferral because of the RRSP deduction, but the other 82% gets taxed as personal income. If your personal tax rate is higher than the corp one (it usually is), then you lose that deferral on the 82%.
Hope that is helpful and thanks. Both reading the blog and for some good questions!
Thanks so much for taking the time to answer my question! I really appreciate it. I was getting bogged down in the nuances; this gives me confidence to move forward with ETFs.
My pleasure and good luck!
This is a fantastic article and just wanted to pass along some thanks for writing a well-informed piece on this complex matter. I landed on this article yesterday during some searches and have since consumed almost all of your blog articles. It’s not just Doctor’s that need to consider these various corporate structures but other professionals as well. My spouse and I are engineer’s and partnering in operating firms is typically structured similarly I think (same as legal corps, etc). Albeit, engineering probably at the lower end of the income spectrum and less consistent (feast or famine). You may have inspired me to encourage my kids to consider medicine as a future career path. 🙂
We’ve been removing money from our corp almost entirely through dividends or shareholder loan repayment (repaying initial capital loaned to corp to buy shares in an operating company) but have reached the stage where where TFSA’s are maxed, RRSP contribution room is consumed, and cash is accumulating so I am evaluating options such as personal unregistered investments or investments inside the corporation.
Again, thanks and looking forward to more.
Thanks for the feedback and sounds like you are doing great! I may write from a doctor perspective (since it is what I know), but this site is absolutely aimed at all professionals. We definitely share the same issues in terms of managing our lives, finances, etc. Please share with your colleagues – I am hoping to reach as many of our brethren as possible.
Hi, I am new to this and trying to make sense of these seemingly contradictory statements:
“In order to discourage the use of professional corporations for tax deferral, investment income within a corporation is taxed upfront at a rate close to the maximum possible personal tax rate.”
“A corporation preserves more money up front to invest. You could have 70-88% of your earned income to initially invest compared to half personally.”
Can you help me make sense of it? Thanks!
Thanks for the question/comment. I will need to clarify it in the text better. The first refers to “passive” investment income and the second is “active income” earned from directly doing business.
The intention from a government standpoint for the lower tax rate on earned “active” income is for the business to have more money to invest in expanding and growing itself. If that money is passed out of the corp to the individual, the remainder of the tax is paid. That way earning income directly from work should be similar after-taxes by the time it reaches an individual whether it was paid directly or passed through a corp (tax integration).
It wants to discourage use of a corp as simply an investment vehicle where the money saved from the lower tax isn’t used to grow the business, but passively invested instead. The corporation has an advantage for investing compared to an individual because it has more upfront after-tax money to invest. More capital to grow and earn investment income. In terms of the investment income itself (interest or dividends), they make the tax on that investment income higher (to be close to what it would be at the top personal rate). That makes it no advantage, or a disadvantage, on the investment income (dividends/interest) unless you pass income out of the corp and pay personal tax on it. They do allow for some passive investing in corp because a business does need to be able to save and grow money for big purchases or to float through a downturn in the business. They also recently added the extra measure of limiting the amount of passive income before the small business rate on active income is lost. That is also to discourage small businesses from saving too much rather than spending the retained money on growing themselves.
I hope that helps clarify.
Hi Loonie Doctor – huge fan of your blog. As someone starting out and trying to plan an investment strategy for within an MPC your blog has been my crash course in financial planning.
My question is related to tax integration with respect to interest earned within a corporation. I understand how tax integration works with business income, dividends, and capital gains – but I must be missing something when it comes to INTEREST earned on corporate investments. From what I can tell it seems like the effective rate of tax on interest earned in a corp is over 70% when it eventually is paid out to an individual.
For example, if my corp earns 10k in interest, it will pay a 50.17% rate of tax on that interest in Ontario, resulting in a net of 5k roughly.
If I then want to pay myself 10k, I can either do it:
1. As salary, which would result in a 10k deduction for the corp but would only deduct against business income at the 12.5% rate, NOT against the tax on interest (I think). So I’d have 1250 of tax refunded to the corp, meaning the corp has paid 3500k in tax to get 10k out. But then I’d be taxed AGAIN personally on the 10k; if my marginal rate is 48%, that results in ~8500k tax paid to get 10k out of the corp.
2. As non-eligible dividend, which would be grossed-up by 16% to 11600. If my marginal rate on dividends is 48% that’d result in 6032 after tax but before div tax credit. After the 15% Ontario+federal tax credit is applied, that’s 7801, a rate of tax of 22% on that 10k of dividend distributions.. but this is all AFTER I’ve paid 5k of tax in the corp! So for 10k in interest, I was taxed 72% in order to get it out as dividend.
I must be missing something. I’m a conservative person and my preference would be to use low-risk interest earning investments to minimize risk of loss of principle.. but if it’ll be taxed >70% I can’t justify that strategy. Hoping you can clear this up.
Good questions, and yes, it is confusing. If you are investing for interest, it is likely to be very little income. You would likely be paying your salary against your earned (active) corp income. The personal tax on salary is deducted against corp income tax (12.5%) – so basically the same as earning directly. Salary is meant to flow through actively earned income. To flow through only interest income, it would be very inefficient and not what a corp is for.
Flowing through the interest income would be as ineligible dividends. The piece that I think you are missing here is that when your corp pays the 50.17% upfront tax, 30.67% goes into the RDTOH account. That $3067 would be refunded to your corp when you pay out a dividend. This discourages pooling income without passing it through. So, the rate on letting it sit is 50% up front. If you flow it through, it is ~19.5% tax (50.17% tax minus 30.67% refund) in the corp and a whatever your net personal rate is after the gross-up and dividend credit (about 47.4% at the top marginal rate in Ontario). That 47.4% would be applied on the equivalent of the dividend you are paying out (ie for $10K interest, you would pay out a $10K-$1950= $8050 ineligible dividend). The $8050 taxed at 47.4% is $3816 in personal tax. So, the total tax on $10K interest when flowed through is $1950 by corp and $3816 by you equals $5766. About 3% worse than personally earning it.
Part of the confusion is that you don’t need to pay dividends from the interest income per se. You can leave that invested and pay a dividend from the money that you have earned actively. That releases the RDOTH even though the money is left invested. So, a corp has an advantage in that you can have a large partially taxed chunk of money (about 87.5% of what you earned instead of 46% in Ontario) to invest (tax deferral). For just passing investment income through rather than paying dividends from active income, it has a 3% tax inefficiency. So, a corp is mainly worth it when you earn and spend enough to keep money flowing from your active income – but you invest enough in the corp without touching it for many years to take advantage of the tax deferral. This really shines with capital gains oriented investments.
Here is an article with a chart showing how RDTOH works. I had to make a diagram to get it!
Thank you so much for this article. I have been researching this quite a bit and got variable results. Yours is clear and easy to understand.
I am wondering if you have updated figures for your table “Investment income tax: CCPC vs top marginal rate” now that the rates have changed for 2019 in Ontario.
The tax rates for 2019 on eligible dividends and passive investment income (interest, capital gains) are actually not changed.
What did change was that the personal tax brackets moved a bit (due to inflationary adjustment) and the small business tax on active income decreased slightly. That decrease in the tax rate on business active income was accompanied by an increase to the inelibigible dividend tax rate for when you give an ineligible dividend out.
Thank you so much, once again, for your easy to understand post.
I noticed someone commented about which account should contain which investments. Together with some articles from 5iResearch, and the following PDF, I came up with the following plan for allocating funds in various accounts.
Canadian stocks and ETFs of Canadian stocks
US stocks (in US account to avoid outrageous currency conversion fees use Norbert’s Gambit)
US ETFs that own US stocks and ETFs
US ETFs that own international stocks directly
Interest income, including trusts, GIC, Bonds, Bond ETFs
Canadian ETFs that own international stocks directly
Canadian growth stocks
Canadian ETFs that own US stocks directly (only if needed and MER justifies it)
Canadian preferred shares
Canadian ETFs that own Canadian stocks directly
Canadian ETFs that hold US listed ETFs
What do you think? Any other suggestions?
Great summary and comment! That is basically what my Robocorp portfolio building tool does. You should try it out if you haven’t already.
A couple of points, though. It partly depends on the province and tax bracket. I have done a bunch of calculations of the FWT, dividend yield, eligible divs etc. from scratch in the different account types that I will eventually roll-out discussion of.
In essence, Canadian pref shares could work well in a corp if you are going to be below the SBD and are flowing the eligible dividends through. They have a high eligible dividend yield (4-5%). So, if you are going to have too much passive income, then they may not. They tend to be slow growing – so selling and moving them to an RRSP may not be a huge deal from a capital gains point if needed down the road. I do this. They could also work well in an RRSP because they are slower growing and high yield and I like to share my slow growth with the government since I have larger high-growth corporate and personal accounts.
The other aspect is the big yield of Canadian equity (~2.8%). Again, in a corp where you pass that through to move money out of your corp tax-efficiently, that is good. However, that high yield can make Canadian equity less tax-efficient the lower-yield US and EMM indexes in a personal taxable account. This is true for most provinces at the top marginal rate (basically all except SK and NB). In the remaining provinces, it may be better to have US and EMM in a taxable account than even the general TSX. Ironic, isn’t it. I added a set-up of corporation vs not and province into Robocorp to account for these factors in the algorithm. Eligible dividends can also be really nice in lower marginal tax brackets. It is complex and I will build that piece into it in the future.
The other asset class to mention are REITS. With their high distributions and tax complexity in a tax-exposed account, I would favor holding them in my TFSA or RRSP if using them.
The other point I would make about the TFSA is that it is impossible to predict which part of the world will grow the most. My mission with the TFSA is growth & I consider it precious to not squander. So, I favor having some mix reflective of the world economy even if it means a little tax inefficiency to avoid having all of my TFSA eggs in one region or asset class. I would keep bonds out of there at all costs unless I were approaching a time where I needed to draw from it (my last resort) and only put preferreds in there if I did not have room in my RRSP (or possibly corp).
I gave a look at your Robocorp, and it looks great. I will have to spend more time on it, though.
Thanks for your response. It got me thinking even more. I was wondering about having 2 new categories: Gold (for high inflation and trouble) and Mining (mirrors the general economy, but leveraged). This is a personal feeling of mine, and likely not shared by everyone. I was wondering which accounts would be best to put those stocks? They aren’t dividend stocks, and not always growth. My feeling is to place them in the TFSA, as they would likely be sold high, and bought low.
Another question is how do you decide which stocks are allocated as growth vs income stocks. Generally, I have been thinking that if a stock has a dividend less than inflation, I consider it growth (or just a bad stock).
A last consideration was REITs. I don’t bother with those as I feel that I have enough equity in my house. Investing further in real estate would result in an overall portfolio distribution heavily weighted in that category. What are your thoughts on that?
Thanks again, and I hope I am not asking your opinion on too many things at once.
I am not a big gold/miners fan and wouldn’t know where to put it. Gold is tough because it is basically a speculative asset/currency play. I say speculative because it is only worth the value people arbitrarily attach to it and doesn’t actually produce anything. Some argue it is a currency, but I am not sure how that would play out since it is not backed by the assets or ability to tax the assets/productivity of a country like a fiat currency. It has been currency-like historically, but we may have truly had a shift in paradigm. If anything it is like a short of the USD or a hedge against financial Armageddon. It is not for me, but I do understand the appeal and have dabbled in it in the past. I learned, that I am bad at predicting the future 🙂
Most have enough of their net worth tied up in their house as you say. Probably overconcentrated into real estate for most, I suspect. REITs can be a low fuss option for those who don’t. They are also different from a primary residence in that they are spread out amongst residential and commercial real estate which are a bit different. They also produce income – a house does not unless you take out the equity in it as leverage to invest. For most people, regular equity is where to take the risk. For some, REITs can add in some income and diversification. They have a similar long-term total return to the stock market, similar volatility, but are only moderately correlated to it. I have a small weighting (about 5%). Again, likely optional for those who prefer simplicity or have a lot of real estate exposure already.
Regarding capital dividend account, if i realize a capital gain from selling stocks, does this mean half of it goes to my personal account tax free, and the other half is taxed at approx 25%? The chart above says 25% but not sure if that is based on the entire amount of the half that is taxed? Also the other half that is taxed, does this then go into your personal account after it is taxed? And does it raise your income tax bracket? Thanks! (I am confused)
It would be 25% of the entire amount. For example, a $100 capital gain would allow for a $50 capital dividend (tax-free pay-out to your personal account after your accountant does some paperwork). The other $50 gets taxed in the corp at about 50%, for about $25 of tax. Of that $25 tax, about $15 is refundable (nRDTOH) to the corp when you pay yourself an ineligible dividend.
I know, it is a bit nebulous!
Thank you, that makes much more sense. To clarify, the 50% portion that is tax free, does that add to my personal tax bracket if I am paying myself some salary?
Right. Capital dividends don’t add to taxable income. That means no clawback of income-tested benefits or bumping of tax brackets.
Thanks for the great resources. One question that has come up after reading many of your articles:
Is there a good calculator for estimating your retirement “nest egg” which takes into account being incorporated? None of the online calculators I’ve looked at seem to capture this important element.
I agree with you that the amount you should withdraw from your corporation should be the amount you need for your lifestyle. But in my particular situation, I feel like I’m living more frugally than I need to, but I don’t have such a large excess of retained earnings in the corporation that I can just crank up the salary/dividends without careful consideration.
So it would be nice to know: “What is the minimum I need to retain in the corporation each year to allow for a comfortable retirement?” (The answer to this question might also be of use to those considering leaving a legacy, purchasing permanent life insurance, etc.)
The corporate account seems to act a lot like an RRSP since it’s tax deferred, but the exact rate of taxation at the time of withdrawal (retirement) seems more challenging to predict. The retained corporate earnings seem analogous to the “contributions” in a RRSP in that they will be taxed in a similar way when they ultimately flow out to the individual. But there is also the tax on investments in the corporate account to account for (I think you estimated about 1% in one post).
If one adheres to the passive indexing ETF strategy you suggest, presumably one could predict the rate of return from a corporate account, factoring in the proportion of investment income dividends vs. interest vs. capital gains at retirement (presumably the majority would be the latter… but exactly how much I’m not sure – would be nice to have a sense).
Maybe this is complicating things too much. But anyway, would be curious on your thoughts about all of this.
Hi Rich. I haven’t found anything like that either. I have made an Excel calculator that I made which more or less does this. However, it is huge – too big to put on the internet. Plus, it is really complex, confusing, and cumbersome to use. I will get back to it at some point to simplify it and make it workable. Not sure when though. I have a backlog of stuff to do (and summer approaches 🙂
Tax drag on a 60:40 balanced portfolio in a corp is about 0.5%/yr below the passive income limit and 1.5%/yr if over it. It can be negligible if you use the corp in conjunction with an RRSP and TFSA to keep the income in the corp down (like how my Robocorp portfolio builder works).
– For CCPC based in Ontario only –
Dear Loonie Doctor,
Just met with our accountant and there is a small account inconsistency in how small business income is being taxed and it relates to the 50K passive income limit. Apparently, the new Conservative Ontario government, refused to go along with the 50K passive income limit from the federal government for CCPC. Therefore provincially, the first 500K of small business income remains at the favourable rate of 3.5% (Ontario provincial rate) regardless of the amount of passive income.
If you are over the 50K passive income limit, things get interesting. Eg, if you have 75K of passive income, you are over the limit by 25K and the small business deduction (federally – not provincially) is limited to 375K. (25K over limit x 5).
For the first 375K, nothing changes. For the next 125K, the federal rate is 15% but the provincial rate remains 3.5%. The loophole is that the post 18.5% tax amount is added to the GRIP pool (General Income Rate Pool) from with you can pay eligible dividends. Because the CRA does not differentiate income taxed at the general corp versus the hybrid rate (general rate of federal and lower rate of provincial), it treats the income as if you had paid the general corp rate of 26.5 % but you actually only paid 18.5%.
This pay be an opportunity for individuals to declare 150K of passive income (300K of capital gains as it is taxed at half the rate) to negate the federal small business deduction and benefit from the 500K income taxed at the “hybrid rate”. My accountant believes that it applies for this tax year but my be changed in the future.
This is my understanding but my account isn’t great at explaining things. As I am not in the positive to declare over 50K in passive income, I did not delve further. For the benefit those who can take advantage, would you investigate for us Loonie Doctor?
Help us Loonie Doctor,
You are our only hope
Thanks George for pointing this out. Love the Obewan reference. I was wondering how this fly in the ointment would be operationalized. They have made things so complex in the effort to squeeze out a little extra from a small group of people.
I will check into it, but not sure if there is a definitive answer. CRA is allowed to “interpret” things in how they actually implement tax law. So, I wouldn’t be surprised to see this “interpreted” and followed up with a tax bulletin in a future year. I ran the math on it. If this is correct (I would listen to your accountant over anything I say), then it translates to a combined personal/corp tax rate of 51.33% at the highest marginal rate compared to the usual marginal personal rate of 53.53%.
Thanks for the reply. The tax savings might not be worthwhile for people to sell just for the benefit but it (likely temporarily) turns the 50K passive income limit, which was suppose to be a penalty, into a modest benefit.
Yeah. I was thinking about it. You would have to be sitting on a big gain and be planning to spend it probably to make it worth triggering capital gains taxes. Of course, if the capital gains inclusion rate were to go up in a year or two and you got the money out now, that may not be a bad thing. Who knows?
It is funny how there are often unintended consequences to new taxes.
”Setting up a corporate investment account is a simple process and similar to opening a personal one. You fill out some forms. Instead of personal ID for a personal account, you will need to provide a copy of the face sheet from your Articles of Incorporation as your “ID”. We will go through how to do this, step by step, elsewhere”
Where is this elsewhere?
I have been having trouble filling out the questrade form for my corp acct, any guides?
Hi Jean. I haven’t gotten to doing it yet. I don’t know of any guides, but I bet the Questrade customer support people could walk you through it. I use the MD Direct Qtrade platform which was very easy and their customer was very good, but they are likely similar.
in the tax rate chart above, are dividends from dividend paying stocks counted as “eligible dividends”?
Hey R. The dividends from Canadian publicly traded companies are eligible dividends. The dividends from non-Canadian dividend-paying stocks are foreign dividends and taxed at the regular income tax rate.
Thanks for the article. Quick question. I’ve got a CCPC and it’s mainly now just generating passive income. If I have APPLE shares that throw off dividends, do those go onto the Schedule 3 and marked YES as Foreign Source, YES as subject to part IV tax?
Or do they just go on Schedule 7 under Other Property Income?
I thought they just went on Schedule 3…..now I’m second guessing myself…
Hi Ryan. Good question. I rely on my accountant to do the actual filing of tax returns and don’t know the answer.
Wonderful article and I am glad you are kind enough to share your findings with others.
Although the tax savings is almost not worth the effort, I got inspired to invest through CCPC after reading your post.
I was looking at Dividend Growth ETFs with Canadian Eligible dividends and cant seem to find them easily. It looks like even Canadian Div ETFs could have a small portion of in-eligible stocks. Will this disqualify my eligible div distributions or it usually shows as two separate line items. Do you have any suggestions given you have been researching this for a bit now.
Hey IT Geek.
There are a number of Canadian dividend growth ETFs, but they tend to have higher MERs. Here is a link to a description of a bunch of Canadian Dividend focused ETFs. The Canadian dividend growers are highly concentrated in the banks, utilities, and energy infrastructure. I personally just use a broad Canadian market ETF rather than a dividend-focused strategy. For example, VCN pays about 2.8% eligible dividend. Still a decent yield and more diversification. Eligible dividends flow nicely through a corp, but so do capital gains. There are pros/cons to either strategy.
Different types of dividends will be different lines on the tax receipts. So, should be no effect on your eligible dividends.
Thank you for the very good articles on your website, helped me make my decision to move to ETFs and open a corporate investment account earlier this year. My porfolio is allocated accross my personal and corporate accounts (that took some doing and thinking – lots of variables); your calculator helped alot there as well.
The only thing that is puzzling me now is how to properly declare my corporate earning (my fiscal year ended July 31st) without having the details of the distribution (T3 details published March timeframe). As an example I hold XIC in the corporate account, looking at last years distribution on CDS they distributed pretty much eveything (eligle & non-elible divs, cap gains, ROC, income & reinvested cap gains). All of these (except ROC) needs to be allocated properly on the T2 to credit the correct accounts (CDA, RDTOH,nRDTOH), but the level of detail to do so is not yet available. All I can see now on Blackrock website is total distribution…
I’m I overlooking something, how do the others manage this? I guess one way could be to move my anniversary to match calendar year or up to February (right before the Q1 distribution), but would like to avoid doing this. Googled away and no joy, then asked my accountant and the best thing he could come up with is waiting and declaring deferred income next year when the details of the distributions are known, which sounds like a good way to get CRA to throw a fit.
Any insight on how others manage this would be appreciated.
Thanks Bee. Happy to hear about your taking action and control! Congrats.
We have the same fiscal year end. It is convenient for planning since staggered with personal taxes. Plus, it makes it easier on the accountants to not have it all amidst the tax season rush. Our accountant handles the investment income issues for us (probably as yours is suggesting). We just give him our summary of investment tracking and he crosschecks with our investment statements/forms. We have never had any issues. If there were, he would get it sorted directly with CRA much more quickly than I could (one of the big plusses of a good service accountant).
Thanks for the reply LD. I noticed after posting SUE had the same question above. If I ever figure out “the right way” to manage this or get more details on what CRA expectations are I will post them back here. Keep up the good work !
Thanks Bee. That would be great!
My corporate year end is April 30. My previous (retired) accountant’s assistant and he could never completely understand this issue.
So I guess and reconcile the following year. It’s not an issue for most ETFs … so for example I assume all of XIC is eligible dividend. If some of it is ROC or phantom reinvested distribution or whatever, I find out about it the following corporate tax year and reconcile.
Below, I have pasted my instructions for myself (I can’t remember year to year at this level of detail) if that is helpful.
Corporate investments: annual bookkeeping
Transactions occur on settlement date.
Weighted average cost basis (in CAD). ETF reinvested distribution increases ACB: ensure received amount equals distributions. ROC lowers ACB.
For purchases/sales of USD holdings, convert to CAD with daily rate. USD distributions: total and use annual rate.
To complete tax characterized distributions, ADD distributions Jan 1-Dec 31 (previous year) PLUS estimated distributions Jan 1-Apr 30 (current year) MINUS estimates for Jan 1-Apr 30 (previous year) – do not use T slip amounts
April 30 bookkeeping entry (payer corporation xxx direct brokerage)
List all transfers from May 1 to April 30. Input inflow and cumulative inflow.
Previous statement+inflow+taxable changes=preliminary.
Preliminary-cash-total ACB=loss on US exchange
Add loss on US exchange to cumulative discrepancy
Preliminary-loss on US exchange=new statement
Call xxx discount brokerage for foreign property maximum market value.
Complete T1135: need foreign property maximum market value, gross (not net) income, etc…
GRIP to eligible dividend
CDA to capital dividend (mail T2054, Continuity of Capital Dividend Account, certified copy of resolution)
Thanks icudoc, that’s perfect. Just finished setting up the “icudoc consolidation spreadsheet” in which I paste distribution details from CDS services excel files and it calculates everything, works great. Will manage this myself, since as you say some accountants do not have much exposure/experience with managing this. Looking back a few years for XIC at most the estimate will be 10% off for Q1/Q2, any big (reinvested) cap gains would be distributed at Q4. For the other holdings I have its foreign income and the spread will be even tighter.
Thanks for sharing !
Love the info here, it’s about the best I’ve found so thanks! I have a question about CDA and using swap etfs… I know swaps will soon be dead but it seems Horizons has found a way to keep them going… That said, I’ll refer to them as swaps here for simplicity sake. Also, I know there are many pros and cons with swaps but I’d like to focus on how you would actually use them in the draw down phase.
Does it make any sense to maintain a swap etf portfolio for retirement? In my case there will be two people drawing on the CCPC portfolio… one near the highest tax bracket, and one at the bottom. I would envision the higher bracket individual taking CDA dividends while the bottom bracket would take regular dividends.
If this does make sense, how would one achieve it practically speaking? Would you sell entire portfolio positions (EG all HXDM) when it’s up to maintain the CDA at a healthy level and re-buy the position immediately? I think you’d have to keep the CDA at a pretty healthy level to guard against downturns but in theory you should always have one asset that is above water over a year or two. You may also not want to let it get too high in case the government steps in yet again.
Or, is this foolish? Would I just be better off with a more vanilla etf portfolio? I have asked my accountant but he just says it’s always better to realize capital gains.
Hi Dave. Great questions. I can give you my general thoughts as a non-accountant but would use a professional accountant for your specific situation.
I would only consider swap-ETFs if they made sense for me for my risk-reward comfort level. The risk is more legislation to get at the planned corporate-class structure solution and the reward being less tax in the interim (except maybe for the HXT fund since a regular Canadian ETF would pay tax-efficient eligible dividends that the lower-income spouse could benefit from). Personally, I use HXDM since the taxes on international equities is large and I find the tax-savings worth the risk. Similarly, I am also considering HBB if I need to hold bonds in a tax-exposed account (hasn’t happened to me yet). I personally haven’t found the US market version that compelling – US dividends are pretty low and the swap fee is high relative to plain vanilla US market ETFs. The right balance is different for everyone.
If I already had a swap ETF portfolio built during my accumulation years, I would likely just maintain it for retirement. I would avoid realizing capital gains prematurely and losing the tax deferral. I would also be careful about letting the taxes drive my investments. I would sell as needed to rebalance rather than simply for my CDA. Generally, that would mean harvesting stuff that is up – so likely not an issue anyway. My accountant also suggests if you have a positive CDA balance, to clear it out right away rather than risk it going negative. We did that recently – I had some realized capital gains due to selling to rebalance. We didn’t need the extra money at the time, so we simply used it to live on and decreased the amount we needed to draw from the corp for a few months until we were out of cash again. The CDA is nice for tax-planning, but I still think maintaining the right investment allocation and tax-deferral are bigger priorities.
Hope that is helpful.
Very much… Thanks! In my case I had recently pulled the funds away from a poor performing money manager so essentially I’m starting from scratch with an unregistered portfolio. With the accumulation phase essentially over (no more will be added, one person working at top marginal tax rate and one not) I’m looking to minimize taxes going forward but I do understand that one needs to be careful not to let the tax tail wag the portfolio too much.
Since pulling the funds we had realized some gains so the CDA balance was already healthy. I was considering building the Horizons portfolio to keep a good balance there, allowing the high earner to pull from the CDA while the no-earner took the taxed half up to 50k.
To summarize, this is probably not the right way to go for a few reasons:
1. Selling entire positions to realize enough gains… and then rebuying will cause drag because of the bid-ask spread
2. Selling and buying entire positions may cause losses, and there’ll be a temptation to time rebuys
3. The portfolio isn’t fully diversified and fees are higher so expected returns will be lower
4. Legislative risk still exists
5. It’s probably naive to think that I’ll always be able to keep the CDA positive enough
6. In my situation the tax advantage isn’t large enough to justify it
So, in the draw-down phase, assuming a blank slate, a fully vanilla etf portfolio is probably the way to go. I’m not sure why the accountant was on board with the Horizons idea!
First off let me congratulate you on your blog. It is probably one the most thoughtful, well explained blogs on financial planning for professionals I have ever seen. So many things that were a mystery to me are now clear. Thank you soo much!
Now, I have a quick question: You’ve said in multiple instances that “Frequently cashing in and realizing capital gains is tax inefficient…” Can you expand on that?
I’ve always thought that capital gains were the most tax efficient of all strategies since only 25% is taxed. Let’s say I hold ZWC (Canadian dividend covered call) in my Corp which pays a monthly distribution of dividends, capital gains and ROC and also HXS (swap etf) which would be capital gains once realized. What would be the disadvantage of cashing out the profits once a year through an eligible dividend and CDA?
Capital gains are the most tax-efficient form of investment income since they are only taxed at half-rate. However, if you don’t need the money and can avoid cashing them in, then the tax is deferred. That leaves more money now to keep compounding until then.
For example, let’s say my tax rate is 50% and I realize a $100 capital gain. I then pay tax and have $75 left to continue growing. If I don’t really need that money for 20 years, it stays invested. That $75 would compound at 5% over 20 years to be $203. Of that $203, $128 is a capital gain. Cashing that out would be $32 tax. After-tax money in 20 years is $203-$32=$171.
If I had left that capital gain unrealized, the $100 would compound over 20 years at 5% to give $271. Of that, $171 is a capital gain and realizing it would trigger $43 tax. After-tax money in 20 years is $271-$43=$228.The reason why it is so much more is that for those 20 years the full $100 is working for you rather than $75 for and $25 for the government. Even though it feels nice to get money into your hands via a CDA “tax-free”, the government has actually already taken its cut. That capital dividend is simply the half of the capital gain that would not be taxed in either your or the corp’s hands (they have already taken the tax on the taxable half).
Regarding eligible dividend paying ETFs. You can flow those eligible dividends through your corp yearly (via the GRIP they generate) and that is almost always an advantage. The swap ETFs are more tax efficient than standard ETFs because they reduce tax (by converting income to capital gains) and by deferring paying that tax as long as possible through not realizing the capital gains until needed. The structure of the swap ETFs will be changing to a corporate class structure to adapt to the recent government attack on them. Hopefully, that benefit will be preserved in a cost-effective way, but the details aren’t clear yet.
Hope that helps answer your question and thanks for reading the blog!
I should have specified, I’m 54 and will be retiring in the coming year, so I’m not really in the accumulation phase any longer. I’d say that 1/2 of my nest egg is still in the corp, so I’m looking at different strategies to draw the money out with the least amount of tax burden. So aside from losing the compounding growth, I’m guessing there is no other disadvantage to cashing in the capital gains on a yearly basis.
If ever you decide to write an article on the “retirement phase” or how to optimize drawdown, please let me know!
Ah. I see! Yeah drawdown is more complicated and depends on the money needed and different sources etc. In general though, the same principles of tax reduction and tax deferral apply. The standard answer is to draw from a taxed account first, tax deferred second, and tax-free last. However, it is more likely a combination of the three that is optimal in any given year.
One nice thing about the capital dividend account is for getting some extra cashflow out of the corp in a year where you need it without bumping yourself up a bunch of tax brackets.
This type of drawdown planning is very individual situation specific and one of the areas where I think a fee-only financial advisor could shine.
First, thanks a lot for this blog. It’s an amazing resource as it’s so tough to stitch all this information together on my own.
If you had an imbalance in your overall portfolio where your corp had the majority of your financial assets, what would you invest in after getting to your maximum comfort level of Canadian exposure (Canadian dividend producing assets)?
Based on what you’ve written, holding long-term growth assets seems like a good idea, but I’m having a tough time finding Canadian listed ETFs that meet that criteria. There’s a wider variety of ETFs on US exchanges (including specialty growth ETFs like IUSG) but I’m not sure if there are any disadvantages to U.S. denominated assets in the HoldCo. My accountant hasn’t been very helpful in this area.
Any insight you can provide would be great. Thanks again!
Thanks for the comment. I actually put together some portfolio builders to help with this question. Robocorp Rookie (in the right side bar) will build a portfolio based on your goal asset allocations and try to put them in the most efficient accounts from a tax perspective. I tried to choose what I think are the most efficient ETFs for that. There is also a fancier more customizable beta version for rebalancing.
If you want specialty ETFs, then the US-listed ones do tend to have better MERs. However, you also get into having to do CAD/USD exchange. You would also want both a USD and CAD corp investment account so you don’t get dinged with exchange fees every time a dividend pays out. Exchange between a CAD and USD account can be done cheaply using Norbit’s Gambit. That said, for simple broad US market exposure, XUU is Canadian-listed, has a low MER, and the FWT is partially reclaimable in a corp account just like a US-listed ETF (fully in personal or RRSP). A US-listed ETF may also have a slight advantage for emerging markets coverage by removing a layer of FWT. For Non-NA developed markets, XEF holds their stocks directly and has an MER that makes it very efficient for FWT and fee drag. The US-listed sister fund is IEFA (Developed) and IEMG (Emerging). These ETFs are used as examples in my portfolio builders and their details are described here.
Thanks for reading and I hope that helps!
Hi LD, thanks for getting back to me. I just tried out the Robocop Rookie. What a great tool. Thanks for developing it.
The ETFs you’ve selected for the Corp account seem to imply that it’s probably not worth getting a US account for the slight FWT advantage that you mentioned. I also think I’m getting a bit of tunnel vision on finding an ETF with near-zero distributions, which is probably not feasible for any ETF… they need to buy/sell as part of their ongoing operations and will have some dividend yielding assets. The only alternative I could see would be to personally select a portfolio of growth companies and forgo the ETF route, which doesn’t seem worth the effort.
For your pref shares allocation, do you use an ETF like CPD or pick the individual securities yourself?
Yeah, a USD account for US exposure is probably not worth it for a corp for most people. A USD RRSP may be if it is large.
Regarding zero distribution funds. There are a couple of options, but they carry their own risks. One is to use Canadian-listed swap-ETFs. The risk with those is that the government will change the rules and shut them down. They just took a swing, but Horizon is restructuring them to a corporate class structure that should accomplish the same thing.
The other option works best if you have an RRSP and corp account. You could split your US exposure up. QQQ (Nasdaq 100) as a surrogate for US large cap growth in the corp (dividend <1%). Brk.B like a US large cap value surrogate (no dividend - but has the increased risk of being over-exposed to the insurance industry and being one stock - although really a conglonerate) could be in a corp. IUSV for US value has a higher dividend and could go in an RRSP. IJS or IJR could be used for US-small cap (dividend ~1.5%). This approach is more complicated, less diversified, and would have areas of over and under-exposure to the broad US market. However, it is an approach so figured I'd mention it. I set our portfolio up this way, but not sure I whether worth it or not.
For preferred shares, I use an ETF rather than individual securities. Preferreds are pretty complicated and have a heavy retail presence. I have used ZPR (rate-reset) when I loaded up on some when interest rates were totally in the toilette and also HPR. HPR is actively managed, but the MER is pretty similar to the other preferred share ETFs. Active management is generally not helpful, but there could be an argument for it in the preferred space since it is a relatively less efficient market.
Hope that is helpful.
Hi Loonie Doctor,
My investing strategy in the Canadian professional corporation account has been to invest 50% in a triple leveraged USD ETF (UPRO, SPXL, TQQQ) and the keep 50% in short term bonds. With periodic rebalancing I have been able to take advantage of the extra volatility offered by 3X leverage, yet have enough dry powder to deploy during market corrections. The strategy worked amazingly well over the last 5 years.
My question is how will the above ETF’s be taxed by Morneau’s attack on derivative/swap based ETF’s? While Horizons have figured out a way to circumvent the tax grab, will holders of the 3X ETF’s be affected? What resources can I access? My accountant is as confused as I am.
Thank you Loonie Doctor.
I am literally writing an article about the changes right now. It is focused on the Horizon funds, but I learned a bunch. Was very confusing, but I got it after chatting with some of the Horizon folks. The problem was not with the derivative aspect, but from how income was allocated. ETFs that make regular distributions of dividends are explicitly excluded. So, I don’t think it will affect the funds you are talking about it. Their original legislation would have affected all ETFs and mutual funds, but that has been pushed off and tempered because it was so ridiculous and logistically difficult to implement.
Hi Loonie Doctor,
While UPRO, SPXL and TQQQ make the occasional dividend payment, they do not pay out on a regular basis. Some years they make no dividend payout whatsoever. I have no idea if I should continue using these ETF’s or switch to Horizons. My preference would be the former since the 3X are excellent products with near perfect tracking and low expense ratios. Horizons 2X are not nearly as good.
How can I be sure not to run afoul of CRA and run the risk of a big fine? My accountant has no idea. I am very confused.
Thank you Loonie Doctor.
Hey Al. I honestly don’t think you have anything to worry about. All of the changes take place on the back end and are for the fund company to sort out. All you would see is more distributions. However, the other thing is those funds are domiciled in the US. So, I don’t think any of the Canadian Federal budget even applies to them. That is the fine line the Canadian government needs to walk. If they hammer Canadian funds, money is mobile and it will simply go to exchanges in other countries. The only thing for an investor to do with these changes is for Horizon ETF owners. If they own one of the ETFs that is being put into the corporate class structure, then they need to do a tax form to avoid realizing gains from the funds rolling into the new structure.
Thank you so much Loonie Doctor.
Pleasure. Spent the week looking into this. Glad it came in handy.
I love and appreciate your posts. I am trying not to waste your time but I am interested in the financial aspect of physicians and MPC. I tired searching and rereading your posts and performed a web search but I can not find any information on this topic.
Have you considered investing on margin in a MPC ? I have a IB account and the margin rate is 3.15% which I understand is tax deductible from the corporation. If you invest 100k and then take even the smaller margin ei 50% (not the maximum 70%) from the ETF investment then the potential return is 6% – (3.15*0.815)=3.43% or 6-(3.15*0.735)=3.68% on the 50K thus increasing your initial return by roughly 1.7 or 1.85% on the initial investment. Using compounding that is more than paying an investment advisor or same as using mutual funds over time, ei large benefit to your portfolio. Of course this loses its potential once the margin rate goes above 6% or so. What are your thoughts ?
You can invest on margin. For readers, that means using a loan (leverage) to invest. As you suggest, the math of that strategy works well. The cost of interest is deductible as an expense. Over long periods of time, it should become easier to pay back because the loan stays the same while inflation (and hopefully wages march on). You would need an expected return that exceeds the interest, and again, that has historically been the case over long periods of time since equities usually grow at a rate greater than inflation.
The difficulty becomes one of execution. Leverage increases potential return, as you point out, but it also increases risk. If your investments decrease in value, the amount owing stays the same. That can be very emotionally provoking to people, cause them to deviate from the long-term plan, and then realize a loss. It heightens behavioral risk. I discuss a bit about the pros/cons of leveraged investing in the context of using home equity for income-splitting a couple of years ago.
However, I have used leveraged investing before. It needs to be a deliberate, planned decision knowing the risks and your own behavioral fortitude. When I have done it, it has usually followed a major market drawdown (20% or more) and has been selective.
Great question! Thanks!
Hi LD thanks for all of the insight.
Example little more simple than current situation but fairly similar. If my revenues are sitting roughly at 600k per year- I pay out expenses of salary and supplies roughly 100K.
Taxed on 500K at roughly 9% = 45K in tax. Retained in the corp is 455K. How does my corporate class fund helping me reduce the passive income and how is this helping my CDA? I understand the corp class fund only issue cdn dividends and capital gains which is tax efficient.
Just curious as to how this flows into CDA, and what becomes nRDTOH?
Accountant tried to explain it but left me more confused- tried to read more online but no real case studies or examples.
Thanks for all the support!
That $500K is the active income (probably taxed at closer 12.5% when fed/prov combined) for $62500 tax. The retained earnings are then invested. I will use a simple example of investing in one fund to illustrate. The index it covers returns 6%/yr plus 2%/yr in dividends for a total return of 8%/yr. Over time your portfolio in the corporation grows to $3M through returns and new investing each year.
At that point, if you had invested in a conventional fund in your corp, it would be paying $60K/yr in dividends to your corp. Your corp has an active income of $500K and a passive income of $60K. That $60K is $10K over the passive income limit and shrinks your small business deduction to $450K. So for your $500K of active income, $450K is taxed at 12.5% and 50K is taxed at the higher general corp tax rate (~27%) to give tax of $71500. Your corp pays an extra $9K in tax due to the $10K of passive income over the limit. You get some of that back when you pay our dividends to yourself because you can pay some eligible dividends at the lower rate from the active income that was taxed at the higher general corp rate (via GRIP). Still nice to avoid the problem if you can.
If you had used a corporate class ETF then you’d have no passive income in a year unless you sold some of your investments. The corp class funds grows at 8%/yr with no dividends (hopefully). It does this by offsetting the dividends received from the stocks against the expenses or losses of other funds in the corporation. So, basically there are capital gains and no income distributions. If there weren’t enough expenses/losses to write off, then there would be an eligible dividend distributed. Hopefully, shouldn’t happen often, but it could. If you did sell, then half of the capital gain would count as passive corp income and half would go to your CDA. The CDA half could be paid out tax-free and the taxed half generates nRDTOH that is refunded when you pay out an ineligible dividend. There are lots of variables at work which makes it complex for an individual – so, I made a corp class ETF calculator that compares corp class vs conventional ETFs.
Hope that is helpful. I’ll have to work on some cases with pictures. I did make one using HBB a while back that does this.
Ok thanks LD!!!
So just want to clarify a couple points
Each year decide to invest retained earnings with a corp class – I earn 8% (assumed). So with a starting balance of 500K in retained earnings I earn 40K / year – since it is in a corp structure and hopefully no dividends- this is a full capital gain, so therefore no passive income? If I wanted to pull this out each year I can pull this out as CDA and nRDTOH.
Assuming I can, I can than redistribute roughly 20K to a CDA and pull out tax-free, the other 20K would be issued as an nRDTOH and would trigger a non-refundable tax of 19.5% and if I chose to withdraw it from the corp. So essentially left over with 30.67% of 20K..?
This becomes personal money and would that be further taxed?
Hey Jon. That is right. You would give yourself half the capital gain as a 20K capital dividend (tax free) and half as a 20K ineligible dividend that you’d pay personal tax on. The corp paid 50% tax on the taxable half of the gain ($10K tax on 20K) and then gets $3067 refunded as nRDTOH to the corp.
Hi, wanted to clarify realized capital losses in corp trading account. Are these deducted from corp revenue for the year? Can the losses be deducted from future years realized capital gains?
A realized capital loss is not deducted against the active income of the corp. That is taxed normally.
They can be deducted against other realized capital gains, either in the current year or another year. That saves on the tax on passive income for the corp.
Thanks. I know its difficult to give specific advice, but in a general sense, for someone in their first five years of practice who have 50% of their portfolio down (100% equity), would it be better to tax loss sell or hold and hope it goes back up to maximize CDA?
This happening so early in your career is a good thing. You don’t have near the invested capital that you will over your career. Still hurts psychologically in the present though. I personally wouldn’t tax loss sell in my corp unless I had gains to set if off against in a given tax year.
Thanks. Another question that I cant find an answer to is, what would be an example of a scenario where tax loss selling in corp would be preferred over maximizing CDA?
Hey RK. The one time that I can think of is if you had some large capital gains in a year that would bump you over the active-passive SBD threshold. Some tax loss selling to bring your taxable capital gains in that same year below the passive income limit might be useful.
1. I have just incorporated my company to route my consulting work through it. I am in the highest tax bracket in BC. I am thinking of investing money in a tech start-up in exchange for equity shares. Originally I intended to receive the shares under the company name to pay a lower capital gain tax when there is a liquidity event (e.g. company gets sold/bought over). However, my accountant suggested to receive the shares under my name as this investment would be deemed as passive income attracting a higher tax.
2. I am also going to get a second tranche of shares from the same company as part of my consulting work with them. My consulting work would be considered as active income so there is no confusion around that.
Overall, I am unsure if my start-up investment would be considered as active or passive. If it will be considered as passive (even though I am engaged in the start-up as an advisor) should I receive the shares in my personal name vs. the company name. My main intention is to pay a lower capital gain tax when the company is sold (2-5 yrs. down the line).
Thanks so much.
Hey Milton. I agree with your accountant. The capital gains taxes in a corp is actually not lower. There is a slight inefficiency due to the taxable half being passed out as an ineligible dividend. The main advantage of the corp is that money you earn is taxed less up front so you have more capital up front. In this case, you are really investing your human capital. You are already in the highest tax bracket, so even when you do realize the gain down the road it won’t bump you into higher brackets since you are already there. Just my two cents.
Very good post. I have always wondered how to invest retained earning in CCPC, other than GICs which are paying nothing these days. Which brokerage is the best for CCPC investment account? I am trying to decide between Qtrade and Questrade. Is there any annual fee or any other admin fee for having CCPC investment account with Qtrade?
Thanks AJ. Either Qtrade or Questrade are pretty similar. I use Qtrade because I find it super easy for doing Norbit’s Gambit to change US and CAD between the USD and CAD account. I believe fees for either are per trade and negligible.
wow. this is the best described article i have ever read on this topic. it is so well written. thank you so much! i still find parts confusing but i am very inexperienced and i’m still learning (im only 22). i look forward to meeting an accountant shortly and figure out what is the best path for me.
Thanks for the excellent post. Do you have any knowledge or experience about whether a Medicine Professional Corporation can invest in private placements offered for an Accredited Investor?
I don’t have personal experience with it, but I don’t think it is an issue. I would check with my accountant because different provinces have different wrinkles.
As always, thanks for being so thorough with your posts. I’ve just been having trouble wrapping my head around one thing (and maybe this has been mentioned in your other articles that I have not read).
1. I was wondering whether tax-loss harvesting is beneficial at all. From what I understand, by tax-loss harvesting, you are reducing your CDA and in essence, reducing the tax-free payout to shareholders so more often than not, it seems to be disadvantageous. The only scenario that I can think of where you may need to harvest is to reduce your gains so that you can still be below the SBD threshold. However, is that the only benefit?
2. Also, are you allowed to hold on to your CDA for years and not pay it out right away? if so, do you still have to prepare a CDA continuity schedule and declare an election or do you just have to be aware of it and whenever you actually want to pay it out, you pay it out (preferably when you retire)?
3. Also, you mentioned that in order to receive the refundable tax credit, you’d need to actually pay out the ineligible/eligible dividends. If you hold on to these until retirement and not pay it out in order to grow your investments, would all of the refunds be provided then? Do you recommend paying it out earlier instead?
4. Finally, when the corp pays out the eligible/ineligible divs to shareholders, won’t shareholders then be able to claim DTC and reduce their personal tax further?
Thanks again for publishing these articles!
Those are great questions and I have spent some time thinking about them over the past year.
1) I don’t see much benefit of tax-loss harvesting in a corp for the reasons you state. If I were over the SBD threshold, my more likely approach would be to give myself some bonus salary to drop my corp income and invest that money personally. That gets money out of my corp instead of adding to my passive income problem. A personal account at its worst is no worse than a corp account. The main advantage of a corp account is the tax deferral which you are essentially losing when you hit the passive income limits. Now, temporarily I haven’t been doing that because in Ontario (and New Brunswick) the tax integration is broken and going over the limit is actually generates more GRIP for my corp while it pays a tax rate lower than the general corp rate. I don’t expect that situation to last when the government finally gets around to making a budget.
2) I have been paying out my CDA when I have enough in there to justify the accountant fee. I don’t need the money, but I can also move it out of my corp without having to sell investments (I pay it from retained earnings that I haven’t invested yet). I then invest that money personally for the same reason as described in #1. I have gotten it out of my corp tax-free. That keeps my corp from bloating further to an unwieldy size. It is also handy to have some after-tax money invested because it triggers very little tax to realize some gains and pay for a big ticket item as needed or for lifestyle later on.
3) Whether to pay out dividends to release RDTOH depends a bit on your tax bracket. For eligible dividends, if you personal tax on them is <38.33%, then it makes sense to pay them out (get 38.33% tax refunded to your corp) and then invest the money personally. That makes sense for most people in most provinces, except for some super-taxed ones like Ontario where the top rate is about 39% (marginal rate minus the tax credit) on eligible dividends for example. For ineligible dividends and nRDTOH, if your net tax on the ineligible dividends is under 30.67%, then it makes sense to pay them out and get 30.67% refunded to the corp and invest the excess personally. That income breakpoint varies by province.
I just recently put a CCPC Income Dispenser calculator on my site that tries to optimize how to pay out money from a corp accounting for all of the above.