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Salary or Dividends


A theoretical case study addressing the dividend versus salary debate yielded interesting results and conclusions. The debate centers around whether a business owner should take their income as a dividend or salary.

Although dividend income will most likely provide a individual tax savings opportunity, it could come at the expense of wealth generation for years to come. The gains you make on individual tax saving come at the expense of increased taxes on the business.

It can be shown that maximizing individual tax savings will deprive the business of retained earnings that could be reinvested at a higher rate of return. Over the years, these reinvestments compound on themselves thereby generating real wealth for business owners when it comes time to exit.

Couple this with the capital gains deductions for Canadian Controlled Private Corporations, starving the company of retained earnings and limiting growth throughout the business’s life, could significantly limit the exit value of the company.

Business owners need to balance the risk of “keeping money in the business to fuel growth”, or “take the money and run”, now.

Case Study Introduction

A theoretical case study was developed to study the effects of a company paying its owner through a salary and comparing it to the options of paying the owner through dividends or a combination of both. Using Excel and Profile Tax software, three scenarios were studied, 1) 100% salary, 2) 100% dividend, and 3) 50% salary & 50% dividend. In Excel, a model was developed to provide Balance Sheets and Income Statements and modified only for changes in payment types (Salary v Dividends). With salary, we also included the company portion of CPP expenses. The Profile Tax software was used to develop the Tax returns for the company and the individual.

The case is about Howard Cunningham, a Canadian citizen, who owns 100% of a Communications Technology Reseller Business which he launched on January 1, 2020 for $300,000. Howard is married to Marian who does not work in the business but works at two part time jobs (mornings for one firm, afternoons for another) as a law clerk.

Howard opened the business knowing an opportunity was ripe given the recent shut-down of a local reseller. Howard had worked for that business, but it closed its doors due to unforeseen events. Howard knows the industry and he knows the customer base.

Howard invested $75,000 of his own money and borrowed $225,000 from a bank. Howard has offered his house of 26 years as collateral. The house was mortgage free and is assessed at a value of $565,000. Loan to Value ratio is 40% which is well within the banks lending policy.

In the first year, Howards business pulled in $1.5 million in equipment sales and $2.78 million in services. The business was able to hire the staff from the previous business so the ramping up of revenue was an easy task for them.

During the year, Howards business acquired $357,500 in assets of which $25,000 was for furniture and fixtures, $125,000 in equipment, $140,000 for four vehicles, and $67,500 for computer hardware and software.

Howard’s business made $145,620 net income in the first year. This included paying himself a salary of $250,000 in the first year.

For tax purposes, the business is considered a Canadian Controlled Private Corporation or CCPC. CCPC’s are eligible for a Small Business Deduction (SBD) which is equal to 19% of Taxable Net Income. As a result of the SBD, the company only pays 12.2% on taxable net income. Dividends that are paid from income that has been subject to the SBD are designated as ‘non-eligible dividend’s’. Dividends that are paid from income that has not been subject to the SBD are designated as ‘eligible dividend’s’. Currently, Howard’s company only issue non-eligible dividends.

The question, and focus of this case study, is: Should Howard take his income as dividends or salary?

Tax Integration (in theory)

The Canadian income taxation system is set up in such a way as to achieve “tax integration”. Tax integration is achieved when income is subject to the same (or as close to the same as possible) total tax once it reaches the individual taxpayer. This tax integration should hold true regardless of the number of corporate tiers the income has passed. The objective of tax integration is to eliminate any duplication of Canadian taxes paid by the ultimate tax payor.

If an individual receives a salary, the company deducts that salary from income and does not have to pay tax on those amounts. The individual receiving the salary will receive a T4 at the end of the year and will pay taxes on the amounts as ‘earned income’.

However, if an individual receives a dividend, the company pays those dividends out of after-tax income, so there has been income tax paid on the business earnings that were distributed. The individual receiving the dividend will receive a T5 Statement of Investment Income at the end of the year.

As an example, considers the pure effects of taking additional income as a 1) salary or 2) dividend. If tax integration works perfectly, then we should see very little difference in taxes paid, if at all, between these two scenarios.

In the table “Small Business Tax & Dividend Tax Credit”, we see that $100.00 of income is taxed for $12.20. The after-tax amounts are paid out as a dividend of $87.80. In the hands of the tax payor, this dividend received is grossed-up 15% to $100.97 and is called a Taxable Dividend; which represents the pre-tax earnings that were received i.e.: $100.00. A Dividend Tax Credit (DTC) of $12.13 is offered to the tax payor. The DTC is equal to approximately 12% of the Taxable Dividend and represents the taxes paid by the business (DTC of $12.13 v tax of $12.20) and tax integration is achieved - well, almost.

Let us assume, with $250,000 of income, Howard’s income is being taxed at the highest marginal tax rate of 53.53%; however, his current overall tax rate is 38%. As stated above Howard only receives non-eligible dividends.

In the hands of the individual, non-eligible dividends are grossed up by 15% to arrive at the Taxable Dividend. The individual is then allowed a Dividend Tax Credit equal to ~12% (for 2020: Federal 9.0301% + Ontario 2.9863%) of the Taxable Dividend received.

In the table to the left, the company earns an additional $11,390, then taxed at 12.2% for taxes owing of $1,390. The remaining income of $10,000 is issued to Howard as a $10,000 non-eligible dividend.

The dividend is grossed up 15% to $11,500. The dividend tax credit is calculated to be $1,382 ($11,500 x 12.0164%) which is almost the same amount of tax the company paid; so, the individual is given a tax credit approximately equal to the taxes paid on the dividends declared.

We observe that the total combined taxes paid is slightly higher by $641, which is made up from $1,220 extra taxes paid by the company by not paying a salary, offset by the individual savings of $579 by taking income in as a dividend versus salary.

Conclusion: Tax integration works in that it allows individuals to receive a tax credit equal to the amount of taxes paid on the income that led to the dividend declared.

Observation: The total taxes paid by the company and the individual through dividends appears to be greater than the total taxes paid through taking income as a salary.

Case Study Analysis

The best scenario for tax minimization is somewhat mixed. It depends on how you want to measure the savings and from what perspective one wants to consider tax savings. Company interests are often at odds with owner interests. There are multiple perspectives to consider: 1) Company, 2) Individual, and 3) Combined individual & company. The ways of measuring taxation of each perspective are 1) Taxes Paid, 2) Tax Rates, and 3) Earnings Retained. Each perspective is studied across each way of measuring taxation below.

A company would want to undertake a tax strategy that would maximize its retained earnings. Retained earnings allow the company to reinvest for future growth which in turn creates more shareholder value and wealth.

Individuals want to minimize taxes paid or maximize their individual earnings retained. Many financial planners focus on investible assets for their clients. Many tax practitioners may not prepare corporate taxes and therefore focus on individual tax planning for their clients. In both cases, consideration for what could be a client’s largest assets, is a missed opportunity.

Equity from individual and corporate sources represent the owner’s total net worth, so strategies to maximize total net worth would mean maximizing all sources of retained earnings. The holistic approach provides us with the ability to trade off wealth growth in the business versus individual wealth growth.

Taxes Paid

We observed that as the company shifts from paying salary toward paying dividends, 1) taxes paid by the company rises, and 2) taxes paid by the individual declines.

In the case study, the total tax disadvantage in shifting from Salary to Dividends is $17,282 is made up of an increase of $30,853 ($250K x 12.2%) in company individual taxes paid, offset by a decrease of $13,571 ((32.6%-38%) x $250,000) in individual taxes paid. The individuals net tax after applying credits was lower with dividends versus salary.

Tax Rates

Considering only the individual and corporate tax rate paid on taxable income, we see that corporate tax rates remain constant at 12.2%. (The company

will lose access to the 19% small business deduction for taxable net income over $500,000.) We also observe that the total individual tax rate declines as income is shifted from salary to dividends. This total rate drop is the result of the increased effect of Tax Integration (reducing double taxation) where we realize more of an individual tax credit-based equivalent to the income tax paid by the company on the distribution of those after-tax dividends.

Earnings Retained

Earnings retained is important because it represents the amount of cash that becomes available for investing purposes. Holistically speaking, investment opportunities have two sources.

  1. Reinvest company profits into the business to grow income, and

  2. The business owner invests their excess individual earnings, from the company, into investments with their financial planner

Upon examination, we determine that increasing our retained earnings individually, is done so at the expense of decreasing retained earnings in the business. In our case study we revealed that the benefit to individual earnings retained is $13,571 ($250,000 x (38.0% - 32.6%)) primarily driven by tax integration savings (Dividend Tax Credit), is achieved by foregoing business retained earnings of $30,853 ($250,000 x 12.2%). This represents a net wealth loss of $17,282. Do this over 20 years, and this adds up to $345,000; money that could have generated additional returns.

Other Observations and Considerations

Registered Retirement Savings Plans (RRSP) are a tool that financial planners use as an individual tax and retirement savings strategy. RRSP’s can be used as a deduction from earned income that will translate to immediate tax savings. Individuals can contribute up to 18% of earned income up to a maximum of $26,500 (for 2020). These deductions will reduce your taxes payable at the highest marginal tax rates. This reduced income could result in a tax payor dropping to a lower tax rate and save more on paying taxes.

Unfortunately, RRSP contributions are not available to those who choose to take their income as dividends. RRSP contributions can only be deducted against earned income. In our case study, where salary is a source of income, RRSP limits are available; however, in the case where income is made up from 100% dividend, no RRSP limits is available.

Business owners can utilize an ‘Individual Pension Plan’ which is a registered pension plan (RPP) typically set up for one individual - the owner-manager of a private corporation. Contributions and administrative costs to an IPP are tax-deductible to the company. To take advantage of an IPP, the owner must earn “T4 income”. There are many other advantages (and rules) to IPP’s which should be discussed with a financial planner or tax accountant. Options on how a business owner should take their income, depends on the type of owner.

Going Concern Versus Lifestyle Business Owners

There are two main categories of business owners:

  1. Going concern – is usually focused on business growth and embraces long term planning, and

  2. Life-style business – is usually focused on maximizing business cashflow and to pull as much cash out of the business for individual purposes.

Going concern businesses are often characterized by owners who are willing to invest in assets and marketing with a focus on long-term business growth. For these types of businesses, new owners would be able to run the company with little additional effort or investment.

Owners of going-concern businesses approach wealth planning as an equation; Individual Net Worth plus Business Valuation = Personal Net Worth. These owners accept the trade-offs between Individual and Business financial wellness.

Life-style business are usually a business with older equipment, constrained market, and sales are usually completed by the business owner; the owner is the business. For these types of businesses, new owners would be faced with heavy investment costs in equipment and would require the previous owner to hang around for a few years as part of the acquisition deal.

For lifestyle business owners, considerable thought should be placed on individual long term financial planning. Since business exit valuation is not of consequence, a portion the funds withdrawn annually should be directed to a retirement savings plan in the amounts sufficient to fund retirement.


The best advice for business owners is to develop their goals and objectives for themselves and their business first. Business decisions should be justified based on meeting compliance, return on investment, and strategic interests; then determine which tax treatment is most favourable in meeting the objectives.

As a business owner, trying to figure out the most favourable tax position involves trade-offs. Minimizing individual taxes payable could cost your business more than you are saving.

From the perspective of the Company, we see that taking salary only, provides for the lowest taxes paid and best at maximizing retained earnings. (Until the company surpasses $500,000 of taxable active income, the tax rate remains constant.)

From the perspective of Individuals, we see that taking dividends only, provides for the lowest taxes paid, lowest tax rates, and best at earnings retainment.

From the perspective of the Combined (individual and company), we see that taking salary only, provides for the lowest taxes paid, and best at earnings retainment. This is because the taxes saved by to company providing a salary is higher than the taxes saved by an individual taking dividends.

Many owners look to their business to provide for their retirement. Ensuring their company has the cash resources to grow may mean taking a salary and reinvesting profits back into the business.

In other cases, owners have taken most profits out of the company earlier with little expectation that they would be able to sell their business upon exit. Often, in these cases, the assets are sold off at ‘liquidated’ value which is less than their ‘in-use’ value.

Owners need to determine what they need from their company on a individual perspective. There is risk in leaving money in the business and there is risk in investing in the stock market. As owners how the next $1,000 gets invested means trading off risk in investing in their company versus the opportunity and return of investing that money elsewhere.

If an owner feels their business is risky and spreading the risk across a diverse portfolio is more acceptable, then perhaps taking as much out through dividends is the best solution.

The full case study is available for download if you are interested.

Salary Dividend Case Study
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