Managing business profits for tax advantages

Using tax savings to grow your business

Tax assessments on businesses are significantly different than those individuals are subject to. And there is an array of techniques available to help you optimize your business tax strategy. Knowing how to use these tools to create tax savings can help power greater growth and investment opportunities for you and the business.

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 tax rates can create a wealth-building opportunity if the company makes more money than it, and the owner, need to meet expenses.

To fully benefit, you'll want to understand how to capitalize on this opportunity, but also be aware of any drawbacks.

Make use of the small-business tax rate

In British Columbia, there are two rates for corporate income tax; small businesses with up to $500,000 in income pay a lesser rate. This creates a tax-savings and investment opportunity for small business owners.

If your company pays an 18% small business tax rate, then $1,000 in earnings would net $820 after tax. If you paid that $820 as a dividend to yourself as a shareholder, you might have to pay as much as $250 in personal income tax (the exact amount may vary on factors such as other income). That leaves $570 available for you to reinvest on your own.

Investing tax savings

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 The $250 difference remains taxable, but only when withdrawn from the company.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 could be years away, but in the meantime that $250 can be used for growth.

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

Of course, nothing to do with taxes is ever free from complications, and there are potential pitfalls to be aware of. Here are a few.

• 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. You could consider setting up a holding company or trust between you and the corporation, and transfer investment assets into it by way of a dividend, but this is a complex matter requiring professional legal, accounting, and financial advice.
• Because companies face high tax rates on income derived from investments rather than business operations, there may be tax consequences down the road.

Focus on investments that appreciate in value, not those that pay out income. For example, interest-bearing term deposits or GICs may cost the company more in tax than you would pay personally. Whereas corporate class mutual funds and other equities may incur a lower tax burden even while they grow in value.

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.