David Rotfleisch is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law firm
We all have to pay our fair share of taxes, but we shouldn’t pay more than we are legally obligated to. The Canadian tax system is byzantine and the way in which you carry out a transaction or structure your business affairs can cause you to pay excess taxes.
Here are tax tips for Canadians starting a business:
Startup losses can reduce your taxes
If you are starting a new business, losses can be deducted against all of your other sources of income, such as employment or investment income. Those losses can be carried back three years to reduce past income, or carried forward to reduce income in the next 20 years. But not if you incorporated. If you incorporate too early, those losses would be trapped in the corporation.
So, you start out unincorporated because you anticipate startup losses and incorporate your business once it becomes profitable. Excellent tax planning!
You then transfer your assets, including goodwill from your proprietorship to your corporation. Oops. You’ve just created a personal tax liability due to the disposition of the assets to your corporation.
Avoid taxes on the transfer of assets into the corporation. Even though you own the corporation, it is a separate “legal person” and you carried out a taxable transaction. That’s unless you consulted with a Canadian tax lawyer who advised you to do the transfer under the provisions of Section 85 of the Income Tax Act, which allows for a tax-deferred transfer of assets by an individual into a corporation. This will avoid any taxes on the transfer into the corporation.
Once profitable, incorporate
Incorporating your business, once you are profitable, has distinct tax advantages.
Your corporation is entitled to a low rate of tax on the first $500,000 of active business income. Recent tax changes will reduce this amount if the corporation earns passive (or investment income) in excess of $50,000 annually. Active income that is left in the corporation is taxed at a much lower rate than if that same income were earned personally. However, once you withdraw that income from the corporation by way of dividends, the overall amount of taxes will be approximately the same as if you had earned the income personally.
RRSPs, private pension plans
If you are unincorporated, you can contribute to a registered retirement savings plan to reduce your taxable income. Owner-managers of corporations can set up private pension plans that allow for greater tax savings and contributions than through an RRSP.
In some circumstances, you may still be able to do some income-splitting with your spouse or adult children, but these rules were tightened up last year by the federal Liberal government.
Lifetime capital gains exemption
At the other end of the business cycle, when you are ready to retire, you can benefit from the lifetime capital gains exemption, which is indexed annually and is about $866,000 for 2019.
Furthermore, if your spouse or adult children are also shareholders, they may each be entitled to the same lifetime capital gains exemption. However, there are very rigid rules to qualify for this exemption and there are separate tests for the previous 24 months and for the time of sale. At least 50 per cent of the corporation’s assets must have been used as part of an active business for the 24 months prior to the sale, and at least 90 per cent of the assets must have been used in that active business at the time of sale. Investment assets do not qualify. There are other qualifying tests as well, including holding periods for the shares.
Has your corporation disposed of capital assets and earned a capital gain?
If so, one half of this amount can be paid out to you on a tax-free basis as a capital dividend. There are Canada Revenue Agency hoops to jump through, so make sure that you consult with a Canadian tax lawyer to get it right.
Life insurance premiums are not typically deductible by a corporation
Surprise! There are exceptions. If the life insurance is a requirement of a bank loan, then the premiums are deductible. Consulting with a bank and structuring your loan appropriately may yield large tax savings.
Stay ahead in your career. We have a weekly Careers newsletter to give you guidance and tips on career management, leadership, business education and more. Sign up today.