Tax Efficient Ways to Invest Through your Corporation
Many times business owners ask their accountants or financial advisors if they should invest their extra money inside their corporation, or if they should take it out (pay personal tax) and invest it personally. Here are some things to consider;
First and foremost, any extra money a business owner takes out of his corporation he/she pays extra personal income tax on. Once that tax is paid, it can be placed and invested in many different areas. RSP’s are a place many people use to place their investments, however, for a business owner this might not make the most sense. The business owner takes extra money out of the corporation, places into an RSP and then gets a tax deduction to only pay full tax later on down the road when the money is pulled out. Along the way, the money does grow tax sheltered, but all the fees associated with the investments are usually hidden and not tax deductible.
Tax Free Savings accounts are great ways to investment personal assets, and many different options as to what the investment could be placed in, everything from Public Stock Market, to Real Estate to Private Companies. The downside is that only $5,500 a year is available to be placed in here once your past TFSA room is all used up. For business owners and wealthier individuals, there is little amounts they can grow personally tax free.
Non Registered investments are an option as well personally. They are taxed at much more preferable rate (Capital Gains tax), and have no limits on how much is invested. A downside to Non Registered investments is the money doesn’t grow in a tax shelter and tax is paid every year based on the growth of the assets.
Now what about if you choose to invest through your corporation instead of taking the money out personally. Right off the bat, there is more money to invest, because less money has had to go to tax. With Alberta having a small business tax rate of 14%, more money can go towards the investment.
The downside here however is something CRA calls “Passive Income Investment”. This is triggered when revenue is generated from investments that aren’t related to the day to day operations of the business. An example would be a Doctor who investments money into Real Estate. The Doctor isn’t in the business to make revenue from Real Estate. This triggers the Passive Income Rate tax of 50.67%. This can deplete any returns that are generated. On top of that, once the money comes out of the corporation, personal tax is paid on the assets, either in form of a dividend or Salary.
From the surface, it seems to take the money out and invest personally makes more sense…. Or does it?
What if I told you there are ways that money can be invested through your corporation into vehicles like a Tax Free Savings Account and like an RSP, but have more options and greater limits and even protect the business and the business owner from other risks.
The first option is having your corporation own and pay for a permanent life insurance policy. The business is protected if the business owner passes away, as well the insurance proceeds can flow out the Capital Dividend Account in a tax efficient manner to the deceased beneficiaries. However, the business can also put in extra money into this policy. This extra money grows inside the policy TAX FREE (as long as it stays within what CRA calls a Maximum Tax Actuarial Reserve (MTAR). Fancy name for saying if you put too much money into the policy, we will tax you on the excess amount. The assets inside these policies can be creditor proof as well. CRA is making tax changes coming Jan 1, 2017. They are decreasing the MTAR room on new policies being put in place, but any policies completed this calendar year, get grandfathered the room their policies have. Now is the time to get your policies either reviewed or look to see if this is an option for you and your business. Not all advisors are familiar with Corporately owned policies and how they should be set up. Make sure you are working with a firm or an advisor who is well versed in that area.
Another option is an Individual Pension Plan. This is when a business creates a pension for its Key People or Shareholders. The idea behind it is almost an RSP on steroids and really starts making sense for business owners over the age of 40 years old. The business makes contributions to the pension, which are 100% tax deductible to the corporation. The assets are invested, usually with a portfolio manager. CRA states that a pension style investment should make 7.5% return on an annual basis. If the assets don’t make that return, the business can top up the pension to that amount and deduct that contribution as well. The contribution room business owners can contribute to their pension is vastly greater than what they can contribute to their RSP’s. The growth on the investment is tax sheltered and not exposed to the high passive income tax rates which makes this an attractive option to look at when planning as well.
When the money does come out in terms of receiving your pension, it does come out as income, but the tax sheltering and using a full non taxed corporate dollar to fund it, makes it worth it.
In summary, every business owner is different and their needs are different, however, make sure to get educated on options that exist and see what is out there. There are many ways that business owners can create more tax efficiency personally and corporately. Life Insurance is one of them if done properly.
If you would like a free consultation and educational session, please reach out to me at 780 966 5084 or cboyle@legacyfg.ca