Salary vs. Dividends

As discussed in other topics, a corporation is a separate legal entity. In order to extract the money or income earned from the corporation, the owners must either receive a dividend or salary from the corporation

There is truly no correct answer to this question, despite popular belief that one or the other is more beneficial. The CRA has actually developed a theory or system to eliminate any advantage between paying salaries or dividends. Our tax system is designed in a manner that business owners should be indifferent between taking salaries or dividends. This is often referred to as integration.

Our tax system is constantly being revised and tweaked to try and attain integration. In a perfectly integrated tax system, an owner would pay the same amount of tax regardless of whether they were paid salaries or dividends. However our system is not perfect and there are usually opportunities to reduce taxes by adjusting the amount of salaries and bonuses paid. This is often largely attributed to tax rates varying between different provinces. Very careful analysis is required to calculate the mix of salaries and dividends for your corporation’s specific circumstances.

Salary alternative

Generally speaking the payment of a salary is deductible to your corporation, while dividends are paid from after-tax corporate profits. Note as a general rule, the CRA does not allow the deduction of salary (or bonuses) without justification. So if the owner is not involved in the business (or their involvement is limited) then providing salaries or bonuses cannot be justified, and will not be deductible. Another consideration for salaries is that you will have to (or get to) make Canadian Pension Plan (CPP) and Employment Insurance (EI contributions). Paying salaries will also allow the owners to be earning income which can increased their allowed participation in Registered Retirement Savings Program (increasing their allowable annual RRSP contribution).

Dividend alternative

Although dividends will not be deductible by the corporation to reduce corporate tax payable, our integrated system makes up for the lost deduction by reducing the personal tax paid through a dividend tax credit. Basically this is a reduction in the tax paid at the personal level as the income was already taxed at the corporate level. Again, there are a number of considerations that must be analyzed and this is often an excellent opportunity to consult a professional who has the experience and expertise to advise the best strategy.