Should a Canadian Small Business Owner Take Dividends?

Deciding whether a Canadian small business owner should take dividends is a strategic financial decision that depends on various factors, including the owner's personal financial situation, the business's financial health, and tax considerations. Here's a comprehensive guide to help you understand the benefits and considerations of taking dividends as a small business owner in Canada.

Advantages of Taking Dividends

1. Tax Efficiency:

   • Lower Tax Rate: Dividends are typically taxed at a lower rate than salary because of the dividend tax credit. This can result in significant tax savings, especially for higher-income individuals.

   • No CPP Contributions: Dividends do not require contributions to the Canada Pension Plan (CPP), which can be a cost-saving advantage compared to taking a salary.

2. Flexibility:

   • Timing: Dividends can be declared at the discretion of the business, providing flexibility in timing to align with personal financial needs or tax planning strategies.

   • Income Splitting: Dividends can be paid to shareholders, including family members, which can facilitate income splitting and potentially lower the overall family tax burden, subject to tax on split income (TOSI) rules.

3. Retained Earnings:

   • Business Growth: By taking dividends, business owners can leave more funds within the company to reinvest in growth opportunities, expansion, or to buffer against future financial uncertainties.

Considerations Before Taking Dividends

1. Personal Financial Needs:

   • Steady Income: Unlike salaries, dividends are not guaranteed and may fluctuate based on the business's profitability and cash flow. Business owners relying on a steady income may prefer a regular salary.

2. CPP Contributions and Benefits:

   • Retirement Benefits: While dividends do not require CPP contributions, they also do not contribute to future CPP benefits. Business owners should consider how this affects their retirement planning and whether additional personal savings or investments will be needed to compensate.

3. Corporate Earnings:

   • Profitability: Dividends can only be paid out of retained earnings or current year profits. If the business is not consistently profitable, dividends may not be a reliable source of income.

4. Tax Implications:

   • Integration Principle: The Canadian tax system aims to integrate corporate and personal taxes so that, in theory, there should be no significant tax advantage or disadvantage to taking income as dividends versus salary. However, the actual tax implications can vary based on individual circumstances and should be carefully analyzed.

5. Tax on Split Income (TOSI) Rules:

   • Restrictions: The TOSI rules restrict the ability to income split with family members who are shareholders, potentially limiting the tax benefits of paying dividends to them.

Combining Salary and Dividends

Many small business owners choose a combination of salary and dividends to balance the benefits and mitigate the drawbacks of each. For example:

• Salary: Provides a steady income, contributes to CPP, and allows for RRSP contributions.

• Dividends: Offers tax efficiency and flexibility, and helps retain more earnings within the business.

Consulting a Professional

Given the complexity of tax rules and the need for strategic planning, it's advisable to consult with a tax professional or accountant who can provide personalized advice based on your specific situation. They can help you determine the optimal mix of salary and dividends to meet your financial goals and minimize your tax liability.

Conclusion

Taking dividends can offer significant tax advantages and financial flexibility for Canadian small business owners, but it also comes with considerations that must be carefully weighed. By understanding the benefits and potential drawbacks, and seeking expert advice, business owners can make informed decisions that align with their personal and business financial objectives.