When deciding whether to invest within your corporation or to do so personally, there are a few factors to consider:
By keeping a larger portion of the original capital and paying less in tax out of the gates, your investment can grow larger, more quickly because of the size of your original investment. If you keep your profit within your corporation and invest it here, you will retain a large portion of the original capital to invest.
This is due to low small business corporate tax rates for active business income. If you take the money out personally and invest it there, you would normally pay a higher tax rate (essentially your marginal rate, which will depend on your income level). Most personal rates are higher than corporate rates, so you would pay more in tax and have less in original capital to invest.
That might be the end of the story, except that, personally, you have access to Register Retirement Savings Plans (RRSPs). RRSPs allow you to retain 100% of the original capital, which is a bigger benefit than investing within the corporation.
There are limitations here as you must have enough contribution room to make use of this legal tax shelter and can only create room with earned income (mainly salary rather than dividends).
In short, it can depend on which method will allow you to retain more of your original capital, but it's a big item to consider.
Unfortunately, those low small business corporate tax rates are for active business income, not investment income. Investment income is taxed at a much higher rate than your usual business income.
Rates vary by province, but investment income tax rates can be higher than top personal tax rates. Fortunately, some of that tax is refunded to the corporation when dividends are finally paid to the owner for their personal income.
The next result is that overall rates are similar whether you are investing within a corporation or doing so personally; however, you can pay a higher tax rate inside the corporation temporarily.
If you are looking for short-term investing of excess cash within the business, but expect to need that money inside the business within the next year, investing inside the corporation makes sense. You will retain much of the original operating profit due to low corporate tax rates and have the money at the ready when needed.
If you are looking for longer term, person-related savings, it makes sense to use your RRSP contribution room and not invest inside the company. By using your RRSPs, you retain 100% of the original profit for growth and subsequent growth happens tax-free. You will only be taxed when you start to withdraw those funds from your RRSP.
If you are holding passive assets inside your operating company, it's useful to evaluate the risk involved. If you have some risk of being sued in the normal course of your business, the plaintiff may have access to these assets if the lawsuit is successful as recourse.
Having a holding company is a way around this, but is not 100% foolproof. The same can be said for holding the assets personally, but holding the assets outside the operating company does add a layer of legal protection for these assets.
There are limits to the amount of investment income you can produce inside a corporation before it starts to have detrimental effects on the taxation of your active business. If you have more than $50,000 in investment income produced in your corporation, you start to claw back your small business deduction ( which creates your lower corporate tax rate) and will pay a higher corporate tax rate on your active income as well. The clawback is complete when you hit $150,000 in investment income and should be avoided.
For most cases, you can use the earnings of the corporation to invest, but generally we want to avoid creating a lot of savings inside your corporation. If you are investing for the long-term, it makes sense to pay yourself a salary and create RRSP contribution room.
You can then invest within the RRSP and retain all of your original capital, plus the earnings will be tax-free as long as the investments are held there. Secondarily, we would look at investing within a Tax Free Savings Account (TFSA).
One important consideration that most people miss is re-investing into the business itself. By investing back into your business through new hires, upgraded products or services or streamlined processes, you are building more value right into your business, which make it more saleable later.
If you are a business owner and looking to build a business that is truly valuable (gives you time, money and purpose) and are looking for an accounting firm that truly wants to help you get there, reach out! We love this stuff!