Did someone say…tax free?

How business owners can get money out of their company tax free 

Attention shareholders and owners of a Canadian-controlled Private Corporation (CCPC)! This could be your “Diamond in the Rough”. What is that Diamond? Capital Dividends -the holy grail of dividends. Why? Funds that are allowed to go into the Capital Dividend Account can be paid out of the corporation to you personally…TAX FREE. I got ahead of myself a bit here. Let me back up a bit.

To understand what the Capital Dividend Account (CDA) is and how it works, there is one thing we need to clarify first: a CCPC can pay three types of dividends to its shareholders.

Two of these dividends are often referred to as a “Regular Dividend” which is paid from the company’s earnings or profits and is taxable to the shareholder. Within the regular dividend there is a distinction; Eligible and Ineligible dividends. We’ll leave the definition of these to another blog but simply, ineligible dividends are from active small business income and eligible generally covers the rest.

The other dividend is through what is called a “Capital Dividend” which is paid from the company’s assets or capital base and is TAX FREE to the shareholder. So how do you get Capital Dividends?

The Income Tax Act (ITA) defines the CDA as a special Corporate Tax Account which is not included in the company’s financial statement, that gives its shareholders designated capital dividends, tax free. This notional account tracks capital gains and losses from the sale or disposal of a company asset. This asset can be in the form of Real Estate, Stocks/Bonds and proceeds of Life Insurance. Let’s look at a couple of examples:

  1. The sale of a building or stock. The CCPC bought the asset for $100k and sold it for $1 million. The capital gain on this asset is $900k ($1 million – $100,000) and 50% ($450,000) is taxable. The corporation pays its tax and distributes the rest to its shareholders as a taxable “regular” dividend. The other 50% of the gain ($450,000) which was tax free to the corporation is still held in the corporation. How do we get that to the shareholders? Since this gain creates a $450k credit to the CDA ledger, according to the ITA, it can now be distributed to its shareholders tax free as a “capital” dividend.
  2. Life insurance proceeds. If a CCPC is the owner, payor and beneficiary of a Life Insurance policy to fund a shareholder’s agreement, keyman protection or debt elimination, the proceeds of that policy will also create a credit to the CDA ledger. If an insurance company paid $1 million as a death benefit to the Corporation, then the CDA gets a credit of $1million less the ACB (adjusted cost base varies depending on the type of Policy) according to the ITA. This means that the shareholders can get roughly $1 million as a tax free “capital” dividend.

Without getting too technical, this is one valuable way for businesses to get tax free income out of their CCPC. The most important thing about working with the CDA ledger is timing. Since this account tracks both Gains and Losses, planning is critical! CDA is not available to public corporations and does not work well for foreign/non-Canadian shareholders. Working with your financial professional can help facilitate the opportunities the CDA offers in the most effective and efficient way for the business and its shareholders.

Connect Wealth is an independent financial planning firm that offers holistic advice to clients based on their current goals and future aspirations. We use well-established workflows and cutting edge technology to maximize planning efficiencies while simplifying the process for clients. Learn how you can maximize your financial opportunities at www.connectwealth.ca

retirement

How to safeguard your retirement…

Have you ever been scuba diving? With scuba diving, you need to plan your dive, how long, what depth, do you have the right gear, etc. If you make a big mistake there are no do overs, it could cost you your life. Retirement planning is similar, you only get one shot at it and the difficulty is, people will only do it once in their lifetime. Fortunately, as a planner we get to experience retirement many times over as we walk alongside our clients.

For people that are in the building phase (ages 30-55) and those that are in their final approach to retirement (ages 55-65), it is crucial to make sure that certain key elements have been looked at. Read more

taxes
In life and finances, the government is our biggest business partner, usually in the form of taxes.

If you are a business owner:
1.  You are a tax collector (payroll taxes, GST, PST).
2.  The government is your business partner (corporate taxes).

As a family, taxes are often your largest expense:
1.  Income tax (as high as 45.7% of every dollar you earn).
2.  Sales taxes (GST, PST).
3.  Property taxes, and so on.

Fortunately, the government has provided different vehicles to help us plan when we pay our taxes (RRSP, TFSA, pensions, IPPs). These can all be great vehicles to help us defer, smooth out and/or lower our tax bills.

Read more

critical illness insurance

A recent study found over 8 million working Canadians are at risk of going into debt, delaying retirement or downsizing their home in order to cope with a critical illness.  When a critical illness occurs, the primary financial impacts are loss of income and inability to meet living expenses.

Critical illness insurance was created (by a doctor, not an insurance company) to help address these issues.  It provides a lump-sum payment upon diagnosis of any one of up to 25 serious illnesses, including heart attack, stroke and cancer. Read more