As the personal tax rates have increased to 53.53%, the tax spread between dividend income and capital gains has widened significantly. As a result, planning has evolved whereby a taxpayer creates a capital gain as a means of extracting corporate funds instead of paying themselves a dividend, which would be taxable at a higher rate. For example, if an individual taxpayer where to extract $1,000,000 of corporate funds as a capital gain instead of paying a non-eligible dividend, the tax savings would be $210,200. This spread has led many taxpayers to deliberately create capital gains as a form of remuneration from their company.
On March 19th the 2019 Federal Budget will be released. Each year, around this time, tax practitioners become concerned that the anticipated Budget will contain new legislation that will target this type of planning. The possibility of unfavorable legislation being introduced causes many taxpayers to implement these types of transactions prior to the Budget date, which in this case is March 19th.
Illustration of Tax Savings
|Capital Gain||Eligible Dividend||Non-Eligible Dividend|
|Amount to be distributed||$1,000,000||$1,000,000||$1,000,000|
|Amount received by individual||$732,400||$606,600||$522,200|
This planning can be particularly effective where (1) a taxpayer has a large shareholder loan balance owing to the company that needs to be repaid to avoid an income inclusion, (2) a taxpayer anticipates significant corporate draws to fund personal cash needs in the near future.
Although the tax savings illustrated above are attractive, a word of caution is warranted. This type of planning is very technical and not completely free of CRA risk. Although the case law that has evolved in this area over time has generally been in favour of taxpayers, there are number of technical mishaps that could occur that could result in CRA challenge.