Understanding Your Investment Tax Slips

A dividend is a payment distributing profits to shareholders of a corporation that has been declared by the company's Board of Directors. This occurs when a resolution is passed and signed by all directors; the original copy of the resolution must be filed in the company's minute book. The dividend must apply to all shareholders in a class equally. 

It is highly advisable to have a lawyer draft your dividend payable resolution and not rely upon templates found on the internet. You don't want to fool around with anything to do with corporate governance.

Three dates are important when declaring a dividend:

• the date the directors resolution approved the dividend - this is important to prove the declaration was not back dated; dividends cannot be declared in the past
• the date the dividend is being declared payable to shareholders - it must be the same date as the declaration or a future date
• the date upon which the shareholders of record is determined - only shareholders as of this date are eligible to receive the declared dividend 

Statute governing the declaration of dividends

Each province's corporation act governs the rules around declaration of dividends. For example, section 43 of Alberta's Business Corporations Act states:

43   A corporation shall not declare or pay a dividend if there are reasonable grounds for believing that (a) the corporation is, or would after the payment be, unable to pay its liabilities as they become due, or (b) the realizable value of the corporation’s assets would thereby be less than the aggregate of its liabilities and stated capital of all classes.

A Canadian Controlled Private Corporation (CCPC) is a private corporation that is primarily owned and controlled by Canadian residents. The tax system in Canada allows a CCPC to access a small business deduction on its first $500,000 of active business income, letting it pay taxes at a significantly lower rate. This effectively decreases the tax burden of small businesses.

However, if a CCPC's income exceeds $500,000, the business income over that threshold will be taxed at the general corporate tax rate, which is higher than the small business rate. This does not directly affect the type of dividend a small business owner can pay to themselves, but it impacts the tax treatment of those dividends.

When a CCPC earns income taxed at the lower small business rate, the dividends paid out of this income are considered to be "other than eligible dividends" and have a corresponding lower dividend tax credit for the individual shareholder. However, any income earned above the $500,000 threshold that is taxed at the general corporate rate results in "eligible dividends". This means that the dividends have a higher dividend tax credit, which can result in a lower tax bill for the individual shareholder.

Therefore, as a small business owner, if your CCPC's income exceeds $500,000, you could choose to pay yourself eligible dividends out of the income taxed at the general rate, potentially reducing your personal tax liability. You should consult with a tax professional to identify the most tax-efficient way of paying yourself dividends in this situation.

General Rate Income Pool (GRIP) is a notional account or concept under the Canadian tax system for private corporations. It represents the total aggregate amount of income retained by a corporation that has been taxed at the general corporate tax rate, as opposed to the small business deduction rate.

The GRIP balance comes into play when determining the type of dividends a corporation can pay to its shareholders - eligible or non-eligible dividends. If a corporation has a positive GRIP balance, it can pay out eligible dividends, which come with a higher gross-up and tax credit rate, potentially leading to a lower personal tax liability for the shareholder.

A Canadian Controlled Private Corporation (CCPC) generates a GRIP balance through earning income above the small business limit (currently $500,000), which is then taxed at the general corporate tax rate. Other ways a CCPC may increase its GRIP balance include receiving eligible dividends from other entities or selling eligible capital property at a profit.

The GRIP balance is reduced when the corporation pays out eligible dividends to its shareholders. This means the CCPC must have a positive GRIP balance to continue paying out eligible dividends. 

Calculating the GRIP balance can be complex due to the many variables and rules involved, so it is always a good idea to consult with a tax professional who is knowledgeable in this area.

In Canada, eligible and non-eligible dividends are taxed differently due to the features of the Canadian tax system known as the Dividend Tax Credit. The purpose of the Dividend Tax Credit is to compensate for the fact that corporations have already paid tax on the profits from which these dividends are paid. 

In simple terms, the tax rate on eligible dividends is lower than on non-eligible dividends because eligible dividends are paid from income that has been taxed at a higher corporate rate. This is a part of Canada's system of integrating corporate and individual taxes to prevent double-taxation of dividends. Each province has different tax rates and credits, so the actual impact can vary depending on the taxpayer's province of residence.

Foreign dividends received by a Canadian resident, whether an individual or a corporation, are generally subject to Canadian income tax. The tax treatment though can vary depending on the circumstances.

For individual taxpayers, foreign dividends are typically included in income and taxed at their marginal tax rate. However, they do not qualify for the dividend tax credit that applies to eligible and other than eligible dividends from Canadian corporations. Foreign tax credits may be available to offset any foreign taxes paid on these dividends to avoid double taxation.

If a Canadian corporation receives dividends from a foreign corporation in which it has a significant interest (generally 10% or more), those dividends are typically not subject to Canadian income tax, but this varies depending on the terms of any applicable tax treaty and other complex tax rules.

Again, Canadian tax law, especially when it comes to international matters, can be quite complex and subject to changes. It is recommended to consult with a tax professional to get current and personalized advice.

Capital gains refers to the increase in value of an investment or real estate that gives it a higher worth than the purchase price. In Canada, only 50% (see Note 1) of the value of any capital gains are taxable. This is considerably less than the tax applied to interest income or earned income, making it a preferable form of income for many. If you have any capital losses, they can be used to offset capital gains in the current year, any of the three preceding years, or any future year.

Note 1*: Effective June 25, 2024, the capital gains inclusion rate will increase from 50% to 67% for (1) capital gains over $250,000 per year for individual, and (2) all capital gains for corporations and most trusts. This change does not affect the principal residence exemption.

These are things you cannot do to lessen your capital gain tax burden:

• Current rules do not permit elections to realize a gain or loss on property without an actual transfer.
• Capital gains cannot be averaged over multiple years to stay under the threshold.
• Individuals cannot share their $250,000 annual threshold with corporations they own.
• The 67% exclusion rate applies across all sectors and all assets. There is no preferential treatment.
• There are no special rules based on how long an asset has been held.

* CPA Canada News October 15, 2024 article Taxpayers in limbo: Compliance in uncertain times says "The legislation to enact these proposed changes has not yet been introduced in the House of Commons, and with the minority government stuck debating parliamentary privilege and facing multiple non-confidence motions, it is hard to determine when, or even if, these tax proposals will reach royal assent.".

Source: Department of Finance News - Fair and Predictable Capital Gains Taxation June 10, 2024

Lifetime Capital Gains Exemption (LCGE)
As of June 25, 2024* and until December 31, 2025, the lifetime capital gains exemption (LCGE) can shelter up to $1.25 million of gain realized on qualified small business corporation shares. Indexation, which began in 2015, will resume in 2026. Before June 25th, it was $1,016,836 for 2024. Only gains that exceed a cumulative net investment loss (CNIL) are eligible for the exemption.

The LCGE is calculated on CRA Form T657 and reported on your personal tax return in Part 1 of Schedule 3.

The rules for LCGE are very complex and require advanced tax planning to ensure you qualify. It would be prudent to obtain professional advice on this matter due the complexity of the rules.

* CPA Canada News October 15, 2024 article Taxpayers in limbo: Compliance in uncertain times says "The legislation to enact these proposed changes has not yet been introduced in the House of Commons, and with the minority government stuck debating parliamentary privilege and facing multiple non-confidence motions, it is hard to determine when, or even if, these tax proposals will reach royal assent.".

More >> Historical LCGE maximums

The Canadian Entrepreneur's Incentive (CEI)
The Canadian Entrepreneur's Incentive (CEI) becomes available January 1, 2025. It will provide a capital gains inclusion rate equal to one-half of the usual rate on up to $200,000 of capital gains qualifying shares per individual over their lifetime. It will increase in $400,000 increments each year until it reaches $2 million in 2029. This incentive is available over and above the LCGE.

An Individual Pension Plan (IPP) is a defined benefit pension plan tailored to provide retirement benefits for a single member, typically the business owner or a key employee. An IPP is established by the company on behalf of the individual.

Here's how IPPs generally work:

1. Establishment: The company sets up an IPP with a pension plan provider on behalf of the individual. All of the required documents and legalities are taken care of during the setup. This plan is registered with the Canada Revenue Agency and provincial pension regulators.

2. Contributions: The company makes tax-deductible contributions to the IPP each year on behalf of the individual which are consequently invested. The amount of annual contributions is calculated based on several factors, including the individual's age, employment earnings, and years of service to the company. 

3. Retirement Benefits: The resulting pension at retirement is based on a formula that takes into account the individual's years of service and their career average earnings. 

4. Minimum Returns: One of the significant benefits of an IPP is that it can guarantee minimum returns, and if the investments underperform, the company can contribute additional amounts to ensure those minimum returns are met.

5. Annuity Purchase: At retirement, the IPP assets can be used to purchase an annuity, be transferred to a Registered Retirement Income Fund, or a combination of both.

6. Creditor Protection: IPP assets are often protected against claims from creditors, offering a significant advantage for business owners.

Setting up an IPP comes with a high extent of administrative responsibility and costs, and the paperwork can be relatively complex compared to other retirement savings options like RRSP. It's also important to keep in mind that the funds in an IPP are locked-in until retirement, meaning they can't be accessed easily if needed. However, with its higher contribution limits and potential for guaranteed income upon retirement, an IPP can be an attractive option for business owners and high-income employees looking to maximize their pension savings.

It's recommended to seek professional advice from a pension consultant and tax advisor, who can provide personalized advice considering your specific circumstances and goals before proceeding with an IPP. This is a great example where having a map BEFORE you enter the forest is so much better than getting lost in the forest!

Some ideas to discuss with your lawyer or accountant:

• incorporating your business means you cannot be sued personally, however there are some exceptions (I.E., you guaranteed the corporation's debts making you liable; you can be sued personally and your company's assets seized)
• using multiple corporations to protect assets from the creditors of your operating business
• setting up an IPP or Retirement Compensation Agreement (RCA)
• purchasing professional liability insurance

Absolutely! Offering a retirement plan can make a company more attractive to potential employees, regardless of its size. It's a benefit that shows the company values its employees' long-term well-being and security. It can also help in retaining employees, as it adds an extra layer of financial protection and incentive for them to stay.

In competitive job markets, potential employees look at the complete compensation package, including salary, healthcare, and retirement benefits. If a small business owner can afford to offer a retirement plan such as an IPP, it could give them an edge in attracting and retaining high-quality personnel.

However, establishing and maintaining a retirement plan does involve certain costs and management responsibilities. It's essential for a small business owner to carefully assess their financial capability and get professional advice to make sure it's a feasible and beneficial move for their business.