Most small business owners lack understanding in the area of taxation. And hence when they are operating a corporation they often get confused whether to get dividend or salary or both from the company. What is beneficial for them? What would be the right strategy to save taxes?

Here, I am trying to explain everything in the layman language.

Let’s discuss Salary and Dividend one by one:

Salary
If you are taking a regular salary from your company, it will become an expense for the company. The company can take deductions from the taxable income. The benefits of taking regular salary income from the company:

CPP Contribution – When you take salary from the company it is mandatory on company’s part to deduct the CPP from the gross salary and the company will also contribute the equal amount on your behalf and remit it to CRA. The more contribution you make towards CPP; the more pension you will get at the time of your retirement. So, it works like an Indirect Investment.

RRSP – RRSP contribution reduces your tax liability. The contribution room Is available only when you are paying salary to yourself. When you take Dividend, the RRSP contribution room is not available.

Bank Mortgage – Some banks prefer regular income over lump sum amounts. When you take a salary on a regular basis, it gets deposited in your bank on a regular basis and it increases the lender’s confidence in your ability to pay the mortgage back. Although some lenders also consider dividend as a legitimate income source, it’s better to be safe if you are planning to buy a property in future.

Dividend
The company pays dividend to its shareholders from it’s after tax retained earnings. So, it is not going to be considered an expense for the company and it will not help the company to reduce its tax liability. On the other side dividends carry less tax liability in personal taxes in comparison to salaries because it comes with dividend tax credit.

What are the benefits of choosing dividends over salary?

No Interest / Penalty on Late Payroll Tax Liabilities – Entrepreneurs are really busy in running their operations. Quite often they miss the tax deadlines. If they are getting monthly compensation in the form of salary then they would need to pay payroll tax liabilities before 15th of every month and if they miss any of the due dates, they will have to pay interest and / or penalties on late payments. On the other hand, if they are only getting dividends from the company then there is no such monthly payment requirement.

No Complexities – When the company is owned by a single owner then getting compensation from the company in the form of dividend always helps to keep the operations simple. When the owner gets compensation in the form of salary then it is required for the company to be registered with CRA’s Payroll Account. And then there are other compliance requirements. So, if the entrepreneurs want to keep simplicity in their operations then it is better for them to get dividends.

So now the question is, which method should the business owner choose to reduce taxes?

The answer is, IT DEPENDS..!!!!

To choose one method or the other or both depend upon various scenarios. Apart from that the accountant needs to run numbers in their tax software to determine the total tax the business owner would pay by choosing one or both the methods. Apart from that there are other scenarios like,

If the owner wants to get parental or maternity benefits, then it’s better to get paid via salary to qualify for that

If the owner wants to get qualified for a mortgage, then banks would prefer to see salary amounts getting deposited on a regular basis.

If the net income for the year is very low, then it’s better to get a small salary from the company to get qualified for Working Income Tax Benefit.

WANT TO KNOW MORE?

Please get in touch with us, we will be more than happy to guide you in choosing the best method which suits your requirements.