Dividend pays better than salary

By Vikram Barhat | October 20, 2010 | Last updated on October 20, 2010
2 min read

Small business owners would do well to invest surplus funds within the company instead of increasing their salary to maximize RRSP contributions, says a report from CIBC.

The report Rethinking RRSPs for Business Owners: Why taking a salary may not make sense is based on research headed by Jamie Golombek, CIBC’s managing director of tax and estate planning. It takes a fresh look at the age-old maxim that Canadian small-business owners should always pay themselves enough salary or bonus to ensure that they can maximize their RRSP contributions each year regardless of whether they actually need the cash.

“Absolute tax savings can be realized by having income taxed inside the corporation at the small-business tax rate and then paid out as a dividend, rather than having the corporation pay a tax-deductible salary to be taxed in the hands of the individual,” says Golombek.

He contends that the amount of cash business owners need personally could preferably be withdrawn from their business as dividends while foregoing the RRSP contribution. A significant tax deferral, he says, can be achieved by simply leaving the money inside the corporation and investing the funds within the corporation instead of paying them out as a salary to be taxed and investing the cash in RRSPs and non-registered personal accounts.

“Business owners may end up with more money after tax by funding their personal living requirements with dividends and leaving the excess cash in the company, as opposed to paying the salary required to maximize the RRSP contribution,” he says. “The basic premise is that the amount the owner-manager would have contributed to an RRSP is instead left inside the company and invested in the same manner as an RRSP.”

Instead of withdrawing funds from an RRSP or RRIF to live on in retirement, the business owner can sell corporately held investments and get the after-tax proceeds as a dividend.

The report says there is simply less tax paid by having the income taxed inside the corporation and flowing it to the shareholder as a dividend. There is more money to invest in the corporation when personal tax is not paid immediately on cash not needed currently by the owner. The preferred tax treatment afforded to capital gains and Canadian portfolio dividends is not available when the investments are in an RRSP, the report concludes.

Golombek also questions the theory that promotes paying enough salary to maximize Canada Pension Plan entitlements as one of the benefits of salary over dividends. He notes that it’s questionable whether, over the course of a 40-year career, the premium savings could not be independently invested in a diversified portfolio to ultimately produce a larger pension income.

Read the full report here.


Vikram Barhat