Owner-Manager Remuneration
Introduction
Owner-managers who carry on business through corporations constantly face the dilemma of deciding
whether to pay themselves by way of salaries or dividends. On the one hand, a salary is a deductible
expense to the corporation and allows owner-managers to generate RSP contribution room. On the
other hand, a dividend may provide tax deferral flexibility and is generally taxed at a lower personal
income tax rate than a salary. The purpose of this article is to explain the concept of integration in the
Canadian income tax system, which is an important concept to be considered when determining a
remuneration strategy for owner-managers. This article will examine: i) various tax changes that may
influence owner-managers’ viewpoints on what the most effective remuneration strategy may be, and ii)
identify some considerations that owner-managers should keep in mind, when determining their optimal
salary/dividend mix.
Concept of integration
Canada’s corporate and individual income tax system is based on the concept of integration – a
concept that ensures that individuals will not be subject to double taxation and therefore are indifferent
between earning income directly or indirectly through a corporation. This concept may sound fair and
simple; however, full integration is only a theory built upon certain income tax rate assumptions (See
Illustration 1 on Perfect Tax Integration). In practice, full integration is rarely attainable due to numerous
combinations of corporate and personal tax rates at the federal and provincial/territorial levels and the
fact that these rates are constantly changing over time.
As a result of Canada’s less than perfectly integrated income tax system, tax costs or savings exist.
Consequently, owner-managers can minimize taxes by paying themselves the most tax effective
salary/dividend mix, and therefore accumulate greater wealth for retirement.
Owner-Manager Remuneration
Illustration 1: Perfect Tax Integration
Earning
income
inside a
corporation
Corporation:
Active business income
Corporate tax @ 20% combined rate*
Net Corporate Cash Available for Distribution
$1,000.00
($200.00)
$800.00
Individual:
Dividend income from corporation
Dividend gross-up @ 25%
Total Taxable Income
$800.00
$200.00
$1,000.00
Personal tax @ 43.5% combined rate**
Less: Combined Dividend Tax Credit (DTC)***
Net Personal Income Tax
Net Cash to Individual:
Active business income
Less: Taxes paid at the corporate level
Less: Taxes paid at the personal level
Net Cash Flow
Earning income
personally
$1,000.00
($435.00)
$200.00
($235.00)
($435.00)
$($435.00)
$1,000.00
($200.00)
$800.00
($235.00)
$565.00
$1,000.00
$$1,000.00
($435.00)
$565.00
*
**
Assumes income is eligible for the Small Business Deduction
Assumes federal tax rate at 29% and provincial tax rate at 14.5%
(50% of federal rate)
*** Combined Dividend Tax Credit Calculation:
Dividend Gross-Up @ 25%
Federal DTC (2/3 x $200)
Provincial DTC (2/3 x $200 x 50%)
Combined DTC
$200.00
$133.33
$66.67
$200.00
Various tax changes and their impact on the remuneration strategy:
Historically, owner-managers were advised to pay an adequate salary from their corporation to
generate sufficient earned income to allow maximum contributions to their RSP. Taking a salary was
preferred over a dividend payment because in the past the overall (combined federal and
provincial/territorial) top marginal tax rate for individuals was higher than the rate that was used in the
integration theory (combined federal and provincial/territorial personal tax rate of 43.5%). In addition,
the overall small business corporate tax rates in most provinces/territories were lower than the
corporate rate used in the integration theory (combined federal and provincial/territorial corporate tax
rate of 20%). As a result, owner-managers were more likely to accumulate greater wealth by drawing a
salary, making maximum annual RSP contributions (allowing for tax-free growth until the funds are
withdrawn at retirement), investing the active business income (net of the small business tax) within the
corporation, and withdrawing amounts from the corporation as dividend payments as required.
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Owner-Manager Remuneration
The Eligible Dividend and Non-eligible Dividend Tax Regime
In 2006, the government of Canada introduced the concept of “eligible” and “non-eligible” dividends to
correct some of the integration deficiencies that exist in the corporate and personal income tax
systems. The tax treatment is different between these two types of dividends, in order to account for the
fact that corporations pay different rates of tax on different types of income. For example, eligible
dividends can be paid by corporations whose income is subject to the general (higher) corporate tax
rate, and the more favorable tax treatment of these dividends to individual shareholders reflects this
higher rate of tax already paid by the corporation. In this case, when an individual shareholder receives
an eligible dividend, the cash dividend is subject to a gross-up (38% in 2014) and the shareholder
receives an enhanced dividend tax credit which reduces the overall effective tax payable by the
shareholder on this dividend.
On the other hand, Canadian-controlled private corporations (CCPCs) are taxed at a lower corporate
tax rate on their active business income up to the annual small business limit (for 2014, generally, the
limit is $425,000 in Manitoba, $350,000 in Nova Scotia and $500,000 federally and in the remainder of
the provinces/territories). When this after-tax corporate income is distributed to an individual
shareholder as a dividend, the dividend is taxed less favorably to the individual shareholder to reflect
the lower tax initially paid at the corporate level. That is, although the shareholder is subject to a lower
gross-up (18% in 2014) on the dividend, the shareholder is entitled to a lesser dividend tax credit.
The taxation of eligible and non-eligible dividends to an individual shareholder in Ontario is shown in
Illustration 2.
Illustration 2: 2014 Individual Tax on Dividends in
Ontario
Cash Dividend Received
Dividend gross-up (38% or 18% x $100)
Taxable Income
Federal Tax at 29%
Dividend Tax Credit (6/11 x $38 or 13/18 x $18)
Total Federal Tax
Provincial Tax @ 13.16%
Provincial Dividend Tax Credit (10% x $138 or 4.5% x
$118)
Provincial Surtax (56% of provincial tax)
Total Provincial Tax
Total Individual Tax on Dividend
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Tax on Eligible
Dividends
$100.00
$38.00
$138.00
$40.02
($20.73)
$19.29
$18.16
($13.80)
$10.17
$14.53
$33.82
Tax on Non-Eligible
Dividends
$100.00
$18.00
$118.00
$34.22
($13.00)
$21.22
$15.53
($5.31)
$8.69
$18.91
$40.13
Owner-Manager Remuneration
Corporate and Personal Income Tax Changes
Over the past few years and in the current year, various tax changes at the federal and
provincial/territorial levels have generally resulted in a reduction in corporate income tax rates as well
as an increase in personal income tax rates with respect to both eligible and non-eligible dividends. The
changing tax treatment to dividends is accomplished by adjusting both the gross-up and dividend tax
credit amounts.
Re-evaluation of the Traditional Remuneration Strategy
These tax changes have not resolved the integration problem completely. However, these changes
mean that owner-managers need to continue to re-evaluate with their professional tax advisor on an
annual basis whether they should pay themselves a salary or dividend in order to optimize their
remuneration as well as their personal and corporate after-tax cash flow.
The tax changes noted above appear to suggest that owner-managers from corporations taking
advantage of the small business tax rate may continue to be better off to accumulate wealth within their
corporation, by retaining and reinvesting the excess funds in a diversified portfolio and extracting these
funds from the corporation as dividends when income is needed, before and during retirement. The
rationale for this view is that a tax deferral is achieved by retaining and reinvesting funds in the
corporation since the small business tax rates on active business income in all provinces are
significantly lower than the highest personal marginal tax rate in the corresponding provinces. In
addition, there may be small tax savings in some provinces from paying dividends (from a corporation
subject to the small business tax rate) over salaries to an owner-manager shareholder. Accordingly, the
dividend-paying strategy may continue to be more beneficial, where pre-salary corporate income is
eligible for the small business tax rate.
Similarly, as a result of the tax changes noted above, in respect of active business income subject to
the high general corporate tax rate, owner-managers in all provinces may find it more beneficial to
retain income to be taxed in the corporation so as to achieve tax deferral, and only to pay a dividend to
themselves to accommodate their personal needs as required. This is despite the fact that there may
be small tax costs associated with paying a dividend over a salary in some provinces.
Other factors to be considered in the determination of an appropriate
remuneration strategy
In addition to the income tax implications described above, other factors should be considered when
deciding whether owner-managers should pay themselves a salary or dividend. The following table
discusses some of these considerations:
Control of
Timing of
Payment
Salary
Dividend / Retain Income in Corporation
Mandatory minimum withdrawals from an RIF
(after an RSP matures, i.e., after age 71).
Greater ability to control the timing of
dividends to be received since there are no
mandatory withdrawals.
Tax rules require RSP accounts to be wound up
by the end of the year a taxpayer reaches age
71.
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Owner-Manager Remuneration
Salary
Dividend / Retain Income in Corporation
Control of
Amount
Payment of a salary and/or bonus to an active
owner-manager shareholder of a corporation
must generally be reasonable based on the
services rendered to the corporation.
Dividends can be paid at the discretion of
the owner-manager shareholder, but
subject to the share attributes and
provisions/terms as set out in any
shareholders’ agreement or imposed by a
lending financial institution.
Creditor
Protection
RSPs as personal assets generally have greater
protection from business creditors than
corporate assets.
Corporate income retained in a corporation
has less protection from business creditors
than RSPs held personally.
Tax
Treatment for
an Individual
Shareholder
A salary is fully taxable but creates RSP
contribution room. Contributions to an RSP in
the calendar year or within 60 days after yearend are tax deductible, subject to the
contribution room available.
A dividend does not create RSP
contribution room for the owner-manager.
The preferential tax treatment of capital gains
(only 50% taxable) and Canadian portfolio
dividends (eligible for the dividend tax credit) is
not available when capital gains or dividends
are earned inside an RSP or RIF. Upon
withdrawal, all income is fully taxed at the same
rate as interest income. Capital gains and
dividends do not retain their income character
when paid out of an RSP or RIF.
Certain RSP and RIF income qualify for pension
income splitting and the pension income credit
(subject to age requirements), but dividend
income does not.
Tax
Treatment for
a Corporation
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A salary is tax deductible to a corporation. A
bonus accrued at the end of the corporation's
taxation year and paid within 179 days of the
corporation's year end are tax deductible to the
corporation in the year of accrual.
Refer to the section on Eligible Dividends
and Non-Eligible Dividends for a discussion
on the tax treatment.
Dividend income may decrease the
cumulative net investment balance and may
therefore increase the enhanced capital
gains exemption claim. However, alternative
minimum tax may apply in respect of
dividend income.
Income splitting can be achieved for a
family business by having certain family
members subscribe for shares of the
corporation and receive income from the
corporation as dividends.
A dividend is not tax deductible to a
corporation.
Owner-Manager Remuneration
Additional
Costs
Capital Gains
Exemption
Salary
Dividend / Retain Income in Corporation
There are additional payroll costs to a
corporation associated with paying a salary to
an owner-manager. These may include CPP,
EI, and various health and workers
compensation levies (e.g., EHT and WSIB in
Ontario). However, these payroll costs may be
deductible for income tax purposes by the
corporation.
There are no payroll costs to a corporation
associated with paying a dividend to an
owner-manager or retaining income inside
the corporation.
The shares of a CCPC may not qualify as
Qualified Small Business Corporation
(QSBC) Shares if, among other conditions,
10% or more of the corporation’s assets are
not used principally in carrying on an active
business primarily in Canada.
Accordingly, the accumulation of substantial
investment assets by a corporation needs to
be monitored. Where an owner-manager
sells his/her shares of the corporation but
the shares are not considered QSBC
shares, the $800,000 enhanced capital
gains exemption will not be available to the
owner-manager. This would result in greater
personal tax payable by the ownermanager on the sale of the shares.
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reliable. Where such statements are based in whole or in part on information provided by third parties, they are not guaranteed to be accurate or complete. Graphs and
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