With the introduction of stock options to many corporate structures, it’s no surprise that the amount of shareholders is growing in Canada – and with them comes a lot of questions about the potential tax implications.
When shareholders receive a monetary “due” from a corporation the payment may have implications for both the paying corporation and the recipient shareholder. To ensure compliance with Canadian tax law for such payments, it is important to understand what type of payment is being made and any potential associated implications. The purpose of this guide is to provide a brief overview of types of payments that may be considered “due from shareholders” and their potential tax implications in Canada.
The overview
In Canada, shareholders are subject to dividend taxation. This taxation is based on the number of dividends that each shareholder receives. The amount of taxes paid will depend on a variety of factors, including the size and type of the business, and which province or territory a shareholder resides in.
For most companies located in Canada, it’s important to know how shareholder dividends are taxed before issuing any payments. Corporations should be aware that these tax rules do not necessarily apply to Canadian-controlled private corporations (CCPC), as these entities may have different forms of dividend taxation.
A dividend received by a Canadian resident from a Canadian corporation is generally subject to non-refundable personal income taxes in the hands of the recipient as regular taxable income when it is declared by the company.
In some cases, certain provinces or territories may also apply additional taxes on certain types of dividends paid to its residents – such as provincial surtax or health premium – so it’s important for shareholders to check with their provincial government for additional information regarding these taxes before payment is issued from the corporation.
Benefits of Receiving Dividends from a Shareholder
Receiving dividends from a shareholder can have some beneficial impacts on a Canadian business. Dividend payments from Canadian-controlled private corporations (CCPCs) to their shareholders may qualify for the small business dividend tax credit (SBDTC), allowing the shareholder to reduce their total income tax due. The SBDTC is also applicable to eligible dividends, so corporations wishing to transfer funds between family members via dividends can do so with minimal income implications.
In addition, depending on the level of profit retained in a CCPC each year and the number of dividends paid out, a significant portion of each dividend payment can qualify as capital gains when flowing through to individual shareholders.
This is beneficial as one-half of capital gains are taxable after accounting for further deductions, such as eligible donations or RRSP contributions. This means that receiving donor-allowed corporate surpluses via dividends can result in greater overall savings for shareholders than if those surpluses were simply reinvested by the corporation and not reported as income until sold.
Of course, all forms of passive income received from CCPC shares are subject to federal and provincial taxes; however, there are ways for investors to mitigate their risk with this type of investment by setting up strategies such as an advance family trust (AFT).
Potential Tax Implications
Receiving dividends from a shareholder in Canada may have some potential tax implications for the recipient, as well as for the Canadian company paying them, depending on factors such as whether or not the company is paid both a corporate and personal tax rate on the payments. Understanding these taxes will help both parties properly manage their fiscal responsibilities.
In general, the Canada Revenue Agency (CRA) will consider dividends to be either “eligible” or “non-eligible.” Eligible dividends are taxed at a lower effective rate than non-eligible dividends and are paid out of after-tax income that has been subjected to both corporate and personal income taxes. Non-eligible dividends are attracted at higher effective rates and represent profits that have been taxed only at the corporate level.
The shareholder providing dividends may be subject to a variety of different taxes, depending on whether they are a corporation or a natural person (i.e., an individual). Corporations may be liable for federal and provincial income tax, capital gains tax, and dividend withholding tax, while individuals must pay federal and/or provincial personal income tax on any eligible and non-eligible dividend amounts they receive from their retained earnings or surplus account balances within their companies.
Both parties should also discuss other issues such as treating ineligible dividends as loan repayments, arranging advance payments of the dividend before it accrues to ensure preferential capital gains status is obtained on any distributions afterward, noting when foreign restrictions apply (if applicable), managing required withholdings, tracking regular revenue versus non-recurring flows, planning around long term debt reclassification rules (if applicable), etc., in order to mitigate potential tax problems ahead of time.
Strategies to Minimize Tax Implications
For individuals, it’s important to make sure that dividend income is reported accurately for the purposes of taxation. Dividends are taxed differently than other types of income, as they are not eligible for deductions or credits. Therefore, make sure to record all payments from shareholders and report them accurately on your tax return.
Additionally, individuals may be able to defer or spread out their taxable dividend incomes by using certain strategies such as “spreading” the receipt of dividends over multiple years or reinvesting in a corporation or individual retirement plan (RRSP).
For corporations, there are also strategies available to reduce tax liabilities associated with receiving dividends from a shareholder. For example, corporations may be able to benefit from a “dividend skimmed exemption” which reduces the amount of taxable dividend income by up to $500,000 CAD per year over two years.
Corporations may also be eligible for the Small Business Deduction which allows them to pay less corporate income tax on profits up to $500k CAD per year. In addition, companies may exercise stock options at different times throughout the year so that only a portion of taxable dividend income is attributed to one particular year.
In summary, there are several strategies that both individuals and corporations can use in order to minimize the amount of taxes associated with receiving dividends from a shareholder. It is important for all taxpayers to familiarize themselves with these strategies so they can make informed decisions on how best to manage their taxation responsibilities while minimizing tax liabilities where possible.
Conclusion
To conclude, due from a shareholder can create a number of issues for a business in Canada. The payment can create an issue with CRA should the shareholder choose not to repay the loan on time. It may also be subject to other rules and regulations imposed by provincial or federal governments in Canada.
Business owners should take the time to research all applicable rules and regulations before entering into an agreement with a shareholder for a loan or investment. They should also speak with an accountant about any potential tax implications for the business before entering into such agreements.
