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What does a Corporation mean to you?

Your Corporation is your child: you put in your every effort to grow it healthily.  Your Corporation has its own legal personality, carries on its own businesses, and possesses its wealth in its own bank account.  Also, it files and pays its own taxes. 

Your Corporation is an extension of yourself: you embed your goals within it.  Your Corporation brings in profit to achieve the goals of you and your loved ones, just in the same manner that you would personally earn the income to support your family. 

How could you benefit from a Corporation?

When you direct your Corporation to distribute its wealth to you, there are certainly tax implications to consider.  However, you are allowed to arrange this legitimately to minimize your taxes.  With proper arrangements, you may yield a return much higher than a well-managed investment portfolio or even the investment in real estate in a city with high housing demand.  This is because your Corporation is taxed (in BC, for example) at a flat rate of 11% or 27%, while you, personally, are taxed progressively from 0% to 53.50%, and you could pay taxes at 11% in the corporate level rather than 53.50% in the personal level.  This discrepancy in personal and corporate tax rates reflects Canada’s policy objective of encouraging investment in small business Corporations, which forms the backbone of the Canadian economy.

As the owner-manager, you can arrange to effect certain transactions between you and your Corporation to achieve overall tax savings.  Your Corporation could

• pay you a mix of salaries and dividends that triggers the minimum amount of taxes,
• distribute to you tax-free funds in certain transfers with you,
• take over your mortgage or life insurance and pay them off much faster,
• redirect the earning from a high tax rate person to a low tax rate person,
• hold its wealth to fund your living expenses at much lower tax costs, etc.

It is an exciting fact that a number of rules in the tax law allow you to capture many opportunities; however, bear in mind that these rules are complicated. The tax law also contains numerous provisions to penalize the misuse and abuse of these rules.  Further, the Canada Revenue Agency polices that all year round, and it is never pleasant to deal with them in these matters.

What should you be aware of when using your Corporation?

If you take out all the earnings of your Corporation in a year to your personal account, often, you would not be able to capture the opportunities discussed above.  The tax law deliberately makes this happen to reflect another policy objective: to keep corporate earnings within your Corporation and reinvest them to grow your business.

If you are already in a high tax rate before any remuneration from your Corporation, it may not make sense for the Corporation to pay you anything.  Otherwise, you may be paying your personal taxes at 40% or 50%, while you could have only paid corporate taxes at 11% - 27%.  As time goes by, you may be surprised how much time value of money you have lost.

If you are owing to your Corporation, the amount may not be taxed immediately. Still, the tax law may regard you have received a benefit from using the money, which is 100% taxable for you personally.  In other cases, the tax law may include the whole loan amount retroactively in your personal tax return resulting in insane amounts of additional taxes plus interest charges.  In either of these scenarios, your Corporation would not get any deductions, as opposed to paying you a salary for that amount in the first place.  As you can see, this is a severe tax consequence.

By no means can we exhaust the penalty provisions and traps in the tax law in this article; perhaps we, both practitioners and taxpayers, should just remember that this is the most challenging law in Canada.

Other considerations about your Corporation:

Many business reasons for using a Corporation include credit protection, convenience to deal with vendors and customers, facilitation to business partnerships, ease for internal trades, access to subsidy programs etc.  As you may have felt, your industry expertise and judgement, and the advice from your advisor play essential roles in it.

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