Top 5 Strategies to Keep your Profit in your Pocket

At Tax Time and All Year Long

  Presented by:        Tim Miron, C.A

Overview

1) Effective Tax Planning 2) Income splitting options 3) Hybrid Expenses 4) Sales Tax Savings 5) Avoiding voluntary taxes

Legend / Assumptions

CRA = Currency raking associates or Canada Revenue Agency.

All examples assume we use the top tax rates:15% corporate income tax46% salary tax rate

 This information is for discussion purposes. Please speak to a tax professional for your specific planning.

1) Effective Tax Planning

• Incorporation 

• Holding companies 

• Retirement (Holding company vs RRSP) 

• Life insurance 

• SRED Credits and wages

Incorporation

Assumptions: 

Unincorporated Income of $120,000 living off of $100,000.

Extra income $20,000

46% Income Tax $9,200

Net after tax cash $10,800

Incorporation

 Income earned in a corporation. Owner paid $100,000 salary.Corporate income $20,000

Additional Costs $2,000

Net income $18,000

15% Income Tax $2,800

Net after tax cash $15,200

34% Tax on Dividends  $5,200

After Tax Cash $10,000

Incorporation

 Tax savings on incorporation:

This example assumes two things:    1) All the income is earned at the top tax rates    2) The income is all taken out in the same year

Unincorporated after-tax cash $10,800

Incorporated after-tax cash $10,000

Tax savings $-800

Incorporation

 A corporation is effective in tax planning if:        The income is taken at lower tax rates.         The income is not taken out each year (more earnings                     retained for investment)

Compounding effect of incorporation

Unincorporated After Tax Cash    $10,800Invested for 20 yearsRate of return 5% (before taxes)

Value $289,100

Annual draw    $30,000Years to draw   9.5  

IncorporatedAfter Tax Cash    $15,200 Invested for 20 yearsRate of return 5%(before corp taxes)

Value $484,300 Annual draw $30,000Years to draw 16

Holding Companies

Dividends between related companies can be paid tax free.

A holding company is a corporation in place to hold the shares and / or non-operating assets of a corporate group.  In a business with multiple families involved, family holding companies can be put in place to allow for a saver and a spender. Capital gains exemptions can be compromised with Hold Co's.

Retirement - RRSP vs Corporation

RRSP's provide for a deduction in income equal to the contribution made. 

When the income comes out it is taxed at the marginal rates.

$20,000 could be at a rate of 35% = $7,000 in tax in retirement.

RRSP's are limited to 18% of earned income or $21,000 / year

Retirement - RRSP vs Corporation

Retained earnings in the company can build up over time. 

Retained earnings are already taxed at the corporate rate. 

If no other income $35,000 / year can be paid for virtually no personal income tax. 

Retained Earnings are not limited.

Incorporation vs RRSP

Unincorporated Cash    $20,000Invested for 20 yearsRate of return 5%(no taxes)

Value $694,385Taxes on withdrawal 35% After Tax Cash $451,000

Annual draw    $30,000Years to draw   15  

IncorporatedAfter Tax Cash    $15,200 Invested for 20 yearsRate of return 5%(before corporate taxes)

Value $484,300   Annual draw $30,000Years to draw 16

Incorporation vs RRSP

Pros and Cons• Dividends can be split between any shareholders

 

• RRSP's have contribution limits where retained earnings do not.

 

• RRSP's have required withdrawals (RIF) 

• RRSP income is all taxed at the same rate as interest (the high rate)

Life Insurance

Uses for life insurance:   

• Catastrophic event protection  

• Estate Planning 

• Expedited savings

Life Insurance - Protection

In a business with 2 or more families involved, life insurance can be used to protect the families of the shareholders.

If the life insurance premiums are deducted on the tax return the proceeds flow-into the company tax free.

A capital dividend account then allows for a tax-free payment out of the company to buy-out the estate of the former partner.

  

Life Insurance - Estate Planning

  Life insurance can be used: • To pay the realized gains on death  

 • Equalization between children in / out of the business

o One child could inherit the business

o The other child could inherit the life insurance policy

  

Life Insurance - Estate Planning

  You could also purchase an insurance policy and list me as the beneficiary!

I'm worth it I promise!  

Life Insurance - Expedited savingsIn certain life insurance arrangements (Universal / Whole Life) a company can contribute investment dollars to an insurance policy. 

The contributions would grow inside the insurance policy tax free (increasing the compounding). 

The Cash Surrender value of the policy can either be withdrawn (some tax consequences) or borrowed against, to be paid off when the policy pays out. Do NOT sign up for this without speaking to your accountant!

  

SRED CreditsScientific Research and Experimental Development credits are available on a wide variety of development projects. A credit is received for costs incurred to perform SRED work. One cost is wages of specific employees. The max is 5 times the CPP max ($48,000). However bonuses are not included in these wages.

 

2) Income Splitting

• Reduce taxes 

• Family Trusts 

• Multiplying tax savings

Income Splitting - Reducing Taxes

Income splitting only works if you have someone to split the income with.

Income Splitting - Reducing Taxes

Ideally - Income between spouses is the same

In a corporation only three ways for an individual to be paid:

• Salary

• Dividends

• Interest / Rent 

Income Splitting - Salary

CRA requires that salaries paid to related individuals must be a fair wage for services performed.

• Have a job description

• Have other staff know who your spouse is

• Have your spouse know where the office is

• Pay them on the regular payroll (not a one time bonus)

• Pay them as an employee not a sub-contractor

Income Splitting - Dividends

Dividends are paid to a class of shares of the company out of after tax earnings. • Set up different classes of shares allowing discretionary

dividends• Do not pay dividends to individuals under 18• Shares do not have to be voting• Shares either have a fixed value (cap on dividends) or grow

with the value of the company

Income Splitting - Property

A company can pay rent / interest to an individual • Rent between related parties must be at fair value

• Interest must be at market rates and on an amount loaned to the company

Income Splitting - Family Trusts

   

If you can't trust family who can you trust?

Income Splitting - Family Trusts

Shares of a company can be owned by another corporation, an individual or a family trust.

A family trust is a legal entity that can hold capital items and receive income. The income must either be paid out to individuals and taxed personally or the tax is paid by the trust.

The trust can be set up to discretionally pay income out (not consistent basis).  At the end of an inter-vivos trust's life (21yrs) the capital must be paid out.

Income Splitting - Family Trusts

Example: • A family trust could be created to hold a class of shares of

the company.

• The beneficiaries could include you and your children

• The corporation could pay dividends to the trust

• The trust could then allocate those dividends to a child in university.

• $30,000 after tax is $35,300 in income

• $30,000 personally would require $55,500 in personal income.

Income Splitting - Multiply Tax Savings

Multiple small business deductions

• Set up two separate corporations earning active income, one owned by two separate people.

 

• This would create 2 small business deductions 

• Association rules would have to be carefully considered 

• Up to date and on-going sets of books would have to be maintained.

Income Splitting - Multiply Tax Savings

Capital Gains Exemption (CGE):

• Every Canadian is entitled to one life time capital gains exemption of $750,000 on the sale of a business or shares in a business

 

• Having multiple common share holders could allow for this exemption to be used by more individuals

 

• Using a family trust with children over 18 as beneficiaries could result in many CGE's

Income Splitting - Multiply Tax Savings

Capital Gains Exemption (CGE):

• If you need one more $750,000 exemption, I have not used mine yet.

• I'm just saying . . . . 

3) Hybrid Expenses

• Home Office 

• Automobile expenses 

• Cell phones 

• Medical expenses

Home Office ExpensesIf you do not have an external office or you regularly meet clients at your home, you can deduct a percentage of the costs of your home (include HST).

Including:• mortgage interest• utilities, heat, hydro, gas, water, internet, phone• insurance• property taxes• Repairs

 

Do not include capital improvements or you could ruin the principal residence exemption.

Automobile Expenses

Company owned vehicle:• Must calculate personal portion (keep all receipts)• Taxable benefit does not decrease as the value of the

vehicle does.• Calculations are messy

Personally owned vehicle:• The driver charges the company mileage. • Only need to keep log of company driving• Tax deductible expense not taxable to driver.

Hybrid Expenses

Cell phones • Have the cell phone billed to the company• Charge back the owner for personal phone calls

 Medical Expenses  • Medical insurance is deductible to the company but not

taxable to the employee• Life and LTD insurance are taxable benefits and better paid

by the employee (or owned by the company).• Consider a Health and Welfare Trust

4) Sales Tax Savings

• Common pitfalls 

o HST on meals 

o HST on mileage

o Place of supply rules 

• Restricted ITC's  

o HST of vehicle purchases 

o HST for large companies

Sales Tax Basics

Any business with over $30,000 in sales in any one year is required to register for HST.

The HST collected on sales is offset by the HST paid on purchases. The net amount is paid or refunded.

Register early, to claim ITCs on your start-up expenses.

There is a quick method for companies with sales under $200,000. 

Sales Tax - Meals

Meals are only 50% deductible for income tax purposes.

The CRA says you needed to eat any ways.

Under the same thinking the HST paid on meals is only 50% deductible.

Extra Tip:Every business is allowed to fully deduct 6 meals a year as long as all of the staff are invited (ie. Holiday Party, Company BBQ, Throwing Tim a Birthday Party!)

Sales Tax - Mileage

HST registered companies paying mileage should also pay HST on top of the mileage rate ($0.52 + HST). 

This is an extra 13% in the individuals pocket that is refundable to the company.  For every 2,000km that is an extra $135! WIN WIN!

If the company pays auto expenses and a taxable benefit to the individual then HST should be added to the taxable benefit. 

Sales Tax - Place of Supply

Place of supply rules determine what rate of GST / HST to charge.

There are some specific rules.

Otherwise the rate to charge is the rate in the province the goods / services are being delivered to.

Sales to the US are zero rated (but must be included on HST return).

Sales Tax - Place of Supply

Actual General Rule: If a supply of a service is made and, in the normal course of business, the suppler obtains a particular address of the recipient that is (a) a home or business address in Canada of the recipient, (b) where the supplier obtains more than one home or business address in Canada of the recipient, the home or business address that is most closely connected with the supply, or (c) where the supplier does not obtain a home or business address in Canada of the recipient, but obtains another Canadian address that is most closely connected with the supply, the supply will be regarded as made in the province which the particular address is situated.

Restricted ITCs on Autos

Passenger vehicles are limited to $30,000 plus tax.

HST credit on passenger vehicles is also limited.

This limit is not indexed to inflation.

Restricted ITCs on Autos

Why do you need such an expensive car?

Restricted ITCs on Autos

That's OK! Tim told me to pay mileage instead!

Restricted ITCs for Large companies

For companies with over $10 million in sales some HST ITCs are restricted.

The restriction applies to:• Costs related to vehicles under 3,000 kg• Energy for overhead (not in manufacturing)• Telephone, satellite TV but not internet• Meals 

Restricted ITCs for Large companies

Restriction is currently 100% of provincial portion     of HST (8%). 

Phasing out between July 1, 2015 and 2018

HST returns must show HST paid and HST restricted     separately.

Restricted ITCs for Large companies

Is there any good news?

Restricted ITCs for Large companies

Good News:

• Only required for large companies

• Large companies can afford to pay their accountant extra to sort it out.

Restricted ITCs for Large companies

I actually like this rule!

Voluntary Taxes

5) Avoiding Voluntary Taxes

• Interest and penalties 

• Late filing 

• Filing Thresholds  

• Employment insurance

• Canada Pension Plan 

• Employer Health Tax 

• Separate wills

Interest and penalties

Interest and penalties are non-deductible.

Interest is charged at CRA plus 4%.

Currently that rate is 5%

That is the equivalent of 6% pre-tax interest

Late Filing Penalties

Late filing penalties are Nasty!

Penalties

Standard Penalties start at 10% of the tax owing. 

The percentage can increase (double) for repeat offenders.

T4 and T5 penalties are $25 per day up to $2500

SRED claims are not allowed if filed 18 months after year end.

There is no penalty for filing on time but not paying.

Filing Thresholds - GST

It is the company's responsibility to inform the government of a change in filing frequency.

Annual Taxable Supplies

Assigned reporting period

Optional reporting period

$1,500,000 or less Annual Monthly or Quarterly

More than $1,500,000 up to $6,000,000

Quarterly Monthly

More than $6,000,000 Monthly Nil

Filing Thresholds - Source DeductionsIt is the company's responsibility to inform the government of a change in filing frequency.  AMWA - Average Monthly Withholding Amount< $3,000 = Quarterly *$3,000 - 15,000 = Monthly on the 15th$15000 - 50000 = twice a month$50,000 + = 4 times a month

To file quarterly you must have 12 months of perfect compliance history.

Employment Insurance

Employment insurance is not required on directors / officers of a corporation. 

Also exempt are relatives of directors.

This could save an employee $800 / year and the company $1,120 per year.

Consider paying EI for family that might take a parental leave.

Employment Insurance

Why is family exempt from Employment Insurance?

Employment Insurance

Because you could not fire them even if you wanted to!

Voluntary Taxes - CPP

Cannot opt out of CPP.

CPP is paid on wages (not dividends)

CPP is based on best 85% of years.

Consider switching to dividends when near retirement.

Saving $4,000 per year.

New CPP rules starting in 2012!

Avoiding Voluntary Taxes - EHT

 

Employer Health Tax is 1.95% on any wages paid in Ontario over $400,000 (no exemption for owners).

Consider paying shareholders not through wages:

- Rent- Interest on shareholder loan- Dividends

 

Voluntary Taxes - Separate Wills

Probate is the administrative fee (not a tax) on an estate.

$5 per $1,000 on first $50,000$15 per $1,000 afterwards

Most entrepreneurs largest asset is their company.

A separate will can exclude your company from probate.

Voluntary Taxes - Separate Wills

Quick Someone call a lawyer!

Questions?

Thank you!

Tim Miron, C.A.Beckett Lowden Read, LLP Burlington / Waterdown905-333-5066tim@blrca.ca       @TJMiron