A corporate structure can provide many tax benefits, including the ability to defer taxes and the flexibility to determine a remuneration strategy that fits your needs. However, the corporate structure is more costly to maintain as it is a separate legal entity that has its own filing obligations. Ensuring that you can maximize the tax benefits available to you is a crucial planning point when deciding to incorporate. Understanding the concept of integration will assist you in making this decision.
Integration means that income should be subject to the same overall tax rate regardless of whether it is received directly by an individual, or if is received by a corporation and subsequently paid out as a dividend to the individual. The goal of integration is to eliminate any tax cost or benefit of choosing one structure over another which ensures that income is not subject to double taxation. In practice, perfect integration is near impossible to achieve. There may be a tax cost or benefit of using a corporation, and this may change along with tax rates each year. The shifting nature of integration creates planning opportunities that should be regularly assessed.
As an example, consider an individual resident in Ontario who is earning business income subject to the top tax rate of 53.53% based on 2021 tax rates. The same earnings would be subject to corporation income tax at the general corporate rate of 26.5%, or 12.2% if the earnings are eligible for the small business deduction (SBD). The table below summarizes how integration would apply to these earnings.
SBD rate General rate
Income $ 100,000 $ 100,000
Corporation tax 12.20% (12,200) 26.50% (26,500)
Dividend paid 87,800 73,500
Personal tax 47.74% (41,916) 39.34% (28,915)
Cash in hand $ 45,884 $ 44,585
Salary paid $ 100,000 $ 100,000
Personal tax 53.53% (53,530) 53.53% (53,530)
Cash in hand $ 46,470 $ 46,470
Tax cost using $ (586) $ (1,885) corporation
Based on these calculations, an individual will pay more in combined taxes if they earn income through a corporation and distribute the entire amount as a dividend in the same year. This applies for earnings taxed at either the small business rate or the general rate. There are other considerations that need to be factored into this simplified analysis. Most importantly, this analysis does not consider the potential benefits of tax deferral as it assumes all earnings are distributed to the individual in the year earned. If earnings are retained by the corporation, the upfront corporate taxes are significantly less which allows for compound growth on the tax deferral. It also allows for flexibility in the timing of withdrawals. You may be able to withdraw earnings in a future year when your personal income is below the top tax bracket assumed above.
Integration also applies to investment income earned within a corporation. Integration varies depending on the type of investment income earned as dividends, capital gains and other investment income are each taxed in a different manner. Dividends are subject to a fully refundable tax which gets refunded to the corporation when dividends are paid out to the shareholders. As a result, near perfect integration can be achieved. Capital gains and other investment income may also be subject to refundable taxes when earned by a Canadian-Controlled Private Corporation (CCPC). These refundable taxes are assessed to approximate the highest marginal rate that an individual would be required to pay on the same income. This system reduces the benefit of the tax deferral on investment income and incentivizes the shareholders to declare dividends to recover the refundable taxes paid. The table below summarizes how integration applies to investment income earned by a CCPC for an individual resident in Ontario and paying tax at the top rate.
Other Eligible Non-eligible Capital investment dividends dividends gains
Income $ 100,000 $ 100,000 $ 100,000 $ 100,000
Corporation tax (50,167) (38,330) (38,330) (25,083)
49,833 61,670 61,670 74,917
Dividend refund 30,667 38,330 38,330 15,333
Dividend paid 80,500 100,000 100,000 90,250
Personal tax (38,431) (39,340) (47,740) (19,215)
Cash in hand $ 42,069 $ 60,660 $ 52,260 $ 71,035
Income $ 100,000 $ 100,000 $ 100,000 $ 100,000
Personal tax (53,530) (39,340) (47,740) (26,765)
Cash in hand $ 46,470 $ 60,660 $ 60,660 $ 73,235
Tax cost using $ (4,401) $ nil $ nil $ (2,200) corporation
As with business income, there is currently a tax cost to earning capital gains and other investment income within a corporation. Unlike business income, the corporation does not significantly benefit from a tax deferral due to the refundable taxes that are assessed. This imposes restrictions on the ability to benefit from earning investment income within a corporation, but benefits can still be obtained with proper planning. It may be possible to split income with shareholders in a lower tax bracket and therefore reduce the overall tax cost.
Integration is a simple concept at surface level, but the mechanisms used to achieve it can be very complex. It needs to be analyzed fully and regularly to ensure you are reaping full benefits of your corporate structure. Many other factors also need to be assessed as part of your decision to incorporate and your annual remuneration strategy.
For more information, please contact firstname.lastname@example.org or 1 844-GYTD-CPA