With a top personal tax rate in Ontario of 53.53%, the tax spread between dividend income and capital gains is significant. As a result, planning has evolved over the last number of years whereby a taxpayer creates a capital gain as a means of extracting corporate funds in lieu of or in combination with paying themselves a dividend/salary, which would be taxable at a higher rate. For example, if an individual taxpayer were 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 April 7, 2022, the 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 and possiblity eliminate 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.
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 has become generally accepted by tax practitioners as a low risk strategy, although it remains very technical and subject to various tax traps for the inexperienced. The case law that has evolved in this area over time has generally been in favour of taxpayers, alhtough there are number of technical mishaps that could occur that could result in CRA challenge.