There are volumes of business literature on the subject of payments to shareholders because it is indeed complex. The primary consideration for the design and implementation of a payment strategy in Canada is the Income Tax Act. It should be noted that these comments are very general in nature and are prepared as a starting point for you to consult your tax and accounting professionals for assistance and specific recommendations.
There are 3 types of payments that can be made to the shareholders of private corporations.
- Loan repayments - If the shareholder has lent money to their corporation in the past, these are repayments of the money lent to the company. This happens when cash is advanced to cover company purchases, or if the shareholder transfers assets to the company for payment at a later date. There are no tax consequences here because the shareholder would have advanced money on which tax has already been paid.
- Salary and wages - Salary and wages are payments made by the corporation for services provided to the corporation. This is employment income to the shareholder, and a payroll expense to the corporation. Payroll taxes are triggered as a result, and the corporation must deduct and withhold income tax and Canada Pension Plan contributions from the gross amount of pay, and remit these to the government. The payment of salary and wages can also trigger other sorts of expenses like payments for Worker's Compensation and Employer Health Tax (in Ontario). Salary and wages is chosen as a payment method if the shareholder would like to contribute to the Canada Pension Plan, or if the taxable earnings of the corporation exceed the small business taxable income limit, among other reasons.
- Dividends - Dividends are distributions of after-tax corporate earnings to the shareholders, which is a return on their investment essentially. In Canada, corporate and personal taxable income is integrated through dividends, in theory, so that when the dividends are paid to the shareholder, the income is taxed at the shareholders' personal rate of tax. The dividend taxed to the shareholder is the amount of income earned by the corporation before tax, which is the reason for the dividend gross up amount. This amount is used for the individual tax calculation when added to their other sources of income. Finally, the individual gets credit for the taxes already paid by the corporation. So in simple terms, a $100 dividend from a Canadian controlled private corporation is taxed at $115 to the individual at whatever their tax rate is (let's say 40% in this case, which happens for income over $90,000 - that tax is $46), and then the individual gets credit for the tax already paid by the corporation, or $15. In this case, the individual would have to pay the $31 difference when they file their personal return. There is no effect to the corporation, other than requiring the minute books to be updated for the dividends. It is also important to note that all of the shareholders of a class of shares are entitled to the same dividends. Dividends must be paid in those proportions to everyone. You may have issued different classes of shares to each of the shareholders, in which case each class can receive amounts independent of the others. This is where there are many considerations in establishing a strategy for shareholder payments, and it is advisable to consult with your professional on this. For one thing, the integration theory is not perfect, as it attempts to be appropriate for all situations. But with constant changes to the Income Tax Act, different gross up amounts for publicly traded corporations, and various provincial Income Tax schemes, there are situations where the total tax paid is different from what the individual would have made if they earned the income themselves.