Dividends vs Salary – Business Owner’s Dilemma

Even though they are a business sole owner, the proprietor is not authorized to dispose of its funds the way they like. By act of law, business funds are separate from the owner’s personal finances and any payments to the business owner shall be justified and documented. With dividends and salary being the most popular payments from the business to its owner, each of them influences the final tax liabilities in a different way. Let’s explore what is more profitable for the business owner. 

Dividends vs Salary
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In the article below, we will analyze the differences between the salary and the dividends and discuss the main advantages and disadvantages of each payment method for a business owner. Our calculations will be based on the Canadian laws and legislative instruments. If your business is incorporated in a different jurisdiction, you are welcome to consult the International Wealth experts and apply to International Wealth for further info. 

Salary

If you are a company director with a fixed salary, payments to you shall be treated as corporate intercompany expenses. They are used to reduce the taxable revenue of a business and decrease corporate taxes accordingly. 

The income received shall be treated as employment-related income. In Canada, where a person pays salary to themselves, they shall fill in a special T4 payment form. The latter is a summary payment document for the past fiscal year. Below, the information is listed it shall contain:

  • business and employee names
  • your personal data and total annual income
  • insurance payments and income tax withheld. 
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 If in Canada, you shall complete and submit your T4 form before February 28. To avoid tax return errors and resulting fines and/or penalties, an expert reporting advice may come invaluable. At International Wealth, we offer professional assistance with overseas and offshore reporting and accounting regardless of a business incorporation jurisdiction. 

The settlement account to credit the above payments to shall be pre-registered with the Canada Revenue Agency (CRA).  Every time your salary is credited thereto, the business shall withhold original deductibles from it, including the income tax and the Canada Pension Plan (CPP) expenses. 

The data as to the above original deductions shall be submitted to the CRA on a regular basis together with the T4 forms for salaried employees. In Canada, the above is vital for company and business owners, so please see to it that your record and account keeping stays proper. 

Paying yourself a salary is a great option to receive stable and predictable personal income. Let’s go deeper into the main advantages thereof.  

Individual retirement plans and lower taxes combined

Canada has a special individual pension plan a.k.a. Registered Retirement Savings Plan or RRSP in place. The plan supplements Old Age Security (OAS) and Canada Pension Plan (CPP) introduced by the state in Canada allowing the holder to personally manage their retirement savings plans. 

RRSP savings come with special tax incentives, i.e., contributions thereto decrease your personal income tax. Additionally, RRSP funds may be contributed to various financial programs like savings accounts or investment funds. Income from the above investments is tax-exempt and the only withholdings that exist happen with withdrawals. 

Say, an employee’s salary is CAD 60,000 per annum. After monthly tax deductions, the actual salary amount is greatly reduced. At YE, the state does tax adjustments for the year with due regard to any possible tax benefits, exemptions, and preferences, and pays back the amount overpaid to the holder. 

Where the total amount is CAD 60,000, and you have already set aside CAD 10,000 for the RRSP savings account, the state will adjust your tax liabilities accordingly using a CAD 50,000 annual taxable basis. The difference of CAD 2,965 which makes 29.65% of CAD 10,000 will be paid back to you by check. This way, you will have CAD 10,000 on your pension account plus CAD 2,965 paid back to you by the state. 

Please, remember, that the higher your annual income is the more you will receive in refunds. If your annual salary makes CAD 105,000, and you contribute CAD 10,000 to the RRSP your refund will amount to CAD 4,341. 

It does not work the same way if you only receive dividend payments from your business. In the latter case, you won’t be able to invest in the RRSP and earn extra income therefrom.   

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Canada Pension Plan

The Canada Pension Plan (a.k.a. CPP) introduced by the state is a double-edged sword for a business owner. In future, you will profit from contributions to the CPP as you will receive pension payments from the fund. At the moment, however, they remain extra expenses for both you and your business. The CPP contributions decrease your salary yet they will make for larger retirement benefits when the time comes. 

No surprises with tax payments

In case of salaries, PIT is withheld from your monthly salary and paid to the state on a monthly basis. This means, as of the tax return submission date, your PIT will have been paid already. As a result, you will avoid any unpleasant surprises with payments and invoices at the end of a fiscal year. 

As for dividends, PIT is not withheld and paid with each dividend payment. You will only pay PIT in April, when completing and submitting your tax return. Unexpected tax bills are only typical for those business owners who are new to paying themselves dividends.

If saving money is a challenge for you and you won’t be happy to receive a tax bill for over CAD 10,000 you should decide in favor of paying yourself a salary instead of dividends.

Salary makes it easier to obtain a mortgage

Banks prefer to grant mortgages to those customers who enjoy a stable income. Regular salary payments are seen as a pro argument by them while dividend payments may not be considered an argument at all even if your business is successful.  

Preoccupied with tax optimization, accountants tend to overlook it. Mind that if you are about to purchase a house within 2 years, paying yourself a salary is a better option if you are a business owner.

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Subsidies and tax incentives are not an issue for salaried business owners

Canadian laws provide for a number of tax incentives and state subsidies but they are only available to those business owners who receive official salaries. Canada Workers Benefits may serve as an example of a PIT benefit. Such benefits are convenient if you are a high-ranking official in your business and your salary is way above any potential dividends. 

Dividends

Dividends are payments to shareholders made from the company’s after-tax profits. As such, they aren’t corporate expenses and do not reduce the general tax load of a business. 

On a positive note, dividends come with lower personal tax liabilities compared to a salary. It is vital for business owners that additional corporate taxes and reduced personal taxes offset each other.

Paying yourself dividends

After dividends have been declared, the corresponding funds are transferred from the company’s corporate account to a shareholder’s personal account in one or several transactions. Occasionally, shareholders simply withdraw funds from the corporate account of a business as and when necessary, with total dividends announced afterwards once a year. At the YE, the company’s accountant prepares the T5 form for all shareholders who received the dividends and submits it to a tax authority in charge. 

With dividend payments, it is challenging to calculate the dividend amount based on a particular shareholding. 

Say, a business is about to pay the dividends of CAD 100,000 to holders of its class A ordinary shares. The money shall be transferred to shareholders based on their ownership interests. A shareholder with 30% of the company’s shares will receive CAD 30,000 in dividend payments, while a member holding 70% of the above shares is authorized to receive a CAD 70,000 dividend payment. 

If all members hold shares of the same class, it may hinder distributing the company’s profits between several such shareholders.  

Advantages of dividend payments

You should keep in mind that as a business owner you may only pay yourself dividends if the business has profits. If your business is a money eater or operates at net zero, we recommend you appoint yourself at a position with the business and pay yourself a salary. Considering dividend payments makes no sense, if the business doesn’t make enough net profits or if its net profits are lower compared to its expenses and losses. 

No obligatory contributions to retirement funds

If you pay yourself dividends, you don’t have to make any contributions to the CPP. Thus, you cut your corporate and personal expenses. As of 2022, the CPP contributions per employee made up 5.7% of any salary below CAD 64,900. Remember, CPP contributions are paid by both employee and employer in equal parts, i.e., the employer will also pay 5.7% of the employee’s salary in CPP contributions. 

With salaries above CAD 64,900, the interest rate for CPP contributions is higher. Where a business owner pays themselves CAD 65,000 as a salary, their CPP contributions amount to almost CAD 7,000 (excluding possible incentives). 

The table below illustrates the above calculations: 

Salary amountCAD 64,900
Incentive amount CAD 3,500
Base amount used to calculate CPP contributionsCAD 61,400
  
CPP%5.7%
  
Company contributions to CPP CAD 3,499.80
Employee contributions to CPP  CAD 3,499.80
Total contributions to CPP CAD 6,999.60

With dividend payments, both your current expenses and retirement benefits are reduced though. It means you will have more money for the moment but less money in old age. 

It is easier to pay yourself dividends than salary

If you own a 100% stake in your business, feel free to declare dividends and transfer the company’s money to your personal account. Most often though business owners withdraw cash when and where necessary and declare total dividends once a year afterwards.

To receive your salary and make original contributions, you don’t need to register with local tax authorities. You will still have to submit the T5 form on an annual basis, which is much easier compared to submitting payroll statements.

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If you intend to transfer dividend payments to an overseas bank account, the International Wealth pros will assist you with setting it up and selecting the best jurisdiction therefor. You are welcome to contact International Wealth to learn how you can open foreign bank accounts online. Mind that you are not required to visit the bank in person to do it. 

Fewer payments are associated with fewer worries

Dividend payments are not associated with regular money transfers. Unlike them, salary payments shall be made on a strict schedule. The standard practice is to make such payments on a monthly basis. In Canada, late salary payments result in tough penalties. 

Dividend payments and late or missed payments are incompatible. Please, remember to prepare and submit your annual T5 form to the tax authority in charge on a timely basis. 

Those business owners who are not sure they can run payroll calculations and pay salaries on a timely basis should definitely decide in favor of dividends.  

Dividends come with lower employer health tax

The employer health tax is a must for companies incorporated in certain Canadian provinces (like BC, MB, and ON). The EHT is calculated on the basis of an employee salary.

It is a standard practice to apply the tax to salaries and not dividends. This means, companies may avoid paying the EHT or reduce the amount thereof by paying dividends instead of salaries to business owners.

Dividend or salary tax – which is smaller?

In early 2018, certain amendments were introduced into the Canadian legislation. Having gone into effect, they made it challenging to reduce tax deductions when choosing between salary and dividend payments. This was done on purpose so that business owners would be unable to reduce taxes by choosing this or that payment method. 

The tax concept long-established in Canada provides for an insignificant or non-existent difference between total income tax amounts in case of dividend and salary payments. Let’s see how it functions:

  • Salary payments reduce corporate taxes but create higher personal tax payments compared to dividends.
  • Dividends do not reduce corporate taxes but do reduce personal tax payments compared to salary payments.

Historically, shareholders could avoid the integration issue and save money on taxes. Therefor, the method known as dividend sprinkling was used. Tax deductions were reduced by distributing dividend payments between the shareholder and their spouse or adult family member with lower income. Due to the said spouse or family member having a lower tax category compared to that of the business or company owner, the resulting personal dividend tax is lower. 

The state currently monitors tax payments closely, and it is getting ever more challenging to pull a stunt like this.  This is the reason why business owners tend to change their tax residency to reduce tax payments preferring the jurisdictions with neither personal nor corporate income and/or profit taxes.  

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Feel free to approach International Wealth for free initial consultations that will make it easier for you to select the best tax residence jurisdiction and terms. Assisted by the industry’s best, you will seamlessly obtain a tax residence certificate and reduce your tax load. The option is right for you if you frequently change your state of residence. 

Tax liabilities – calculation and comparison

Although you are likely to save less this way compared to the times before 2018, here are some calculations for you to select the most profitable option. As a business owner, you are free to choose between salary and dividend payments to profit therefrom. 

Below, we will exemplify tax calculations for dividend payments and compare these with general salary payments.  

Payment to business owner – CAD 100,000
SalaryDividends
Corporate tax savingsCorporate tax savings
Salary amount                                             
CAD 100,000
Dividend amount                                       
CAD 100,000
Corporate tax rate 11% 
Savings on salary expenses
CAD 11,000
Corporate tax deductions
CAD 0.00
  
Personal tax deductionsPersonal tax deductions
Regional PIT
CAD 6,140
Regional PIT
CAD 9,073
Federal PIT
CAD 14,693
Federal PIT
CAD 5,988
Total PIT:
CAD 20,833
Total PIT:                         
CAD 15,061
  
CPP contributionsCPP contributions
Business contributions                                
CAD 3,499.80
                                                                                    CAD 0.00
Employee contributions                              
CAD 3,499.80
                                                                                    CAD 0.00
Total:                                                               CAD 6,999.60Total:                                                                       CAD 0.00
  
Total, payroll tax:                                 
CAD 16,832.60
Total, dividend tax:                                
CAD 15,061.00

As you can see, if payments to a business owner amount to CAD 100,000, dividends are a better and more profitable payment option to choose. Let’s run the analysis again for a different payment amount. 

Payment to business owner – CAD 150,000
SalaryDividends
Corporate tax savingsCorporate tax savings
Salary amount                                              CAD 150,000Dividend amount                                        CAD 150,000
Corporate tax rate                                   
11%
 
Savings on salary expenses
CAD 16,500
Corporate tax deduction
CAD 0.00
  
Personal tax deductionsPersonal tax deductions
Regional PIT 
CAD 12,995
Regional PIT
CAD 13,394
Federal PIT
CAD 27,646
Federal PIT
CAD 19,402
Total PIT: CAD 40,641Total PIT: CAD 32,796
  
CPP contributionsCPP contributions
Company contributions                                
CAD 3,499.80
                                                                                    CAD 0.00
Employee contributions                              
CAD 3,499.80
                                                                                    CAD 0.00
Total:                                                               CAD 6,999.60Total:                                                                       CAD 0.00
  
Total, payroll tax:                                 
CAD 31,140.60
Total, dividend tax:                                
CAD 32,796.00

In the 2nd case with the CAD 150,000 payment to a business owner, the business owner’s salary is less costly compared to dividend payments. 

FYI: the above examples are general and they do not account for many important details. Please, do not apply them to your particular business situation for no special reason. Remember, the result may be influenced by other factors that are not analyzed here. 

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When in need of detailed info on the subject, you are welcome to contact the International Wealth experts. With a variety of both free and fee-based business consulting services on tax planning, business incorporation, financing, asset protection, and capital growth issues offered, you are sure to find a plausible solution to any issue at stake.

General recommendations for business owners

Below, you will find several recommendations from International Wealth that will come handy when choosing between salary and dividend payments for business owners:

  • If timely frequent payments are inconvenient for your business, consider paying yourself dividends. It is much easier and comes with lower expenses. Salary payments are associated with guaranteed regular money transfers and contributions, and if you miss a payment or are late to make it, the tax agency in charge may penalize your business with a fine.
  • Where you are about to purchase real estate in the near future and receive a mortgage therefor, you’d better pay yourself a salary. Banks like stability better than sporadic dividend payments.
  • If you plan to start a family and receive maternity and/or childcare benefits, do decide in favor of a salary. With unemployment insurance contributions deducted from your salary, you’ll be authorized to receive parental allowances in the future.
  • Tax payments may be reduced or postponed by paying bonus salaries. The procedure is relatively complex for business owners and it is impossible to apply it in every case, yet you should know the opportunity does exist.
  • In Canada, you will find a special employment benefits scheme a.k.a. refundable tax credit. Thereunder, employees and low-income families may obtain tax benefits. To be able to use the option and cut your personal taxes, you may pay yourself a small salary. Please, keep it in mind, if your net annual personal or family income is low.

For any questions you may have left or if you require any further info, do not hesitate to contact the International Wealth experts at info@offshore-pro.info. We are here to make your life cloudless.

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