Letting your business do the investing
An incorporated small business pays far less tax on its profits than its owner does when those profits are taken out as income.
The difference between personal and corporate taxe rates can create a wealth-building opportunity if the company makes more money than it and the owner need in order to meet expenses.
To fully benefit, you'll want to understand how to capitalize on this opportunity, and be aware of any drawbacks.
Make use of the small-business tax rate
Suppose that, thanks to the small-business deduction, your company pays tax at a rate of just 18%. On $1,000 of earnings, that would net $820, after tax.
If you paid that $820 as a dividend to yourself as shareholder, you might have to pay as much as $250 in personal income tax. (The exact amount would depend on your province of residence and the amount of your other income.) That would leave $570 available for you to reinvest on your own.
There is another option
What if, instead of paying the net earnings out as a dividend, the company invested them? You'd be able to put $820 to work, not just $570. The $250 difference remains taxable, but only when withdrawn from the company. That might be many years away, and in the meantime that $250 can grow.
Remember, you'll be taxed personally only when the money is taken out of the company, providing another potential advantage. You get to control the timing of the payout and also whether it's taken as salary or as a tax-advantaged dividend.
Proceed with caution
There are potential pitfalls, for example:
- If the investments held by your business grow too large, they may compromise your ability to qualify for the special lifetime capital gains exemption that's available when shares of a Qualified Small Business Corporation are sold or transferred.
- This money would also be vulnerable to seizure by corporate creditors unless you take steps beforehand to shield it. This might be achieved by interposing an investment holding company or trust between you and the corporation, and transferring investment assets into it by way of a dividend, but it's a complex matter requiring professional advice.
- Because companies face very high tax rates on income derived from investments rather than business operations, there could be tax consequences.
Focus on investments that appreciate in value, not those that pay out income. There's no advantage to investing in an interest-bearing Guaranteed Investment Certificate – the company would be likely to pay more tax on the interest than you would yourself.
But there might be an advantage from investments such as equity mutual funds, corporate-class mutual funds, and growth stocks that can grow in value while making few or no taxable payouts.
Seek advice before investing
For incorporated small-business owners who hold investments personally, investing through their company is one of many strategies that might be beneficial. Seek professional financial and tax advice regarding your specific circumstances.