So you’re Lucky Enough To Have Some Extra Funds to Play with. Now What do you Do?

If you are the owner-manager of a private Canadian corporation and have surplus cash accumulating in your company, you may be wondering whether to retain the funds in the company or withdraw them while paying as little tax as possible. If so, there are a number of questions you should consider before you take action.

Is there a business need for the cash?
When you realize that you have surplus cash in your corporation, ask yourself if you will need it for business purposes in the short term. Will you need to use the cash to pay installments of income tax or HST? Does your business experience seasonal slow periods when cash fl ow will need or make any major purchases in the near future. If you have excess cash that won’t be used for business purposes, the investment income earned on this surplus cash may be taxed at the corporate investment tax rates, which are slightly higher than the top personal tax rates.

Do you need the surplus cash for personal purposes?
Do you have personal expenses coming up, such as income tax installments that must be paid on time? You may also be considering a major purchase like a vacation property or planning to help out with a family member’s education costs, wedding expenses or house down payment. If you know you will need to withdraw surplus funds from the corporation to meet these personal expenses, consider when you will need the funds. It’s important to understand the tax consequences of making the withdrawal and whether it will be possible to make several withdrawals over a period of time to minimize tax costs. Did you know that there are ways to structure withdrawals from a corporation that enable income splitting and maximize tax deferral?

What are the funds going to be used for?
If you don’t need the surplus funds immediately for business or personal purposes, what are your reasons for moving funds out of the corporation? A good starting point is to analyze your longer-term goals, which could include:
Planning for retirement – are you going to use the funds for your retirement by contributing to a registered Retirement Savings Plan (RSP), Individual Pension Plan (IPP) or Retirement Compensation Arrangement (RCA)? If so, did you know there can be tax advantages for business owners setting up pension plans or investing cash in their companies?

Estate planning – do you want to enhance the value of the estate you will pass on to your family? If so, did you know that many potentially effective estate-planning strategies involve insurance-based solutions? The funds may grow on a tax-sheltered basis and may be accessed at retirement to supplement retirement income and/or paid out tax-free on death.

Asset preservation – Did you know that if you want to mitigate the risk of funds being subject to claims from corporate creditors, you could consider transferring excess cash to a holding company. There are various ways to accomplish this.

Note that keeping excess investments or an insurance policy in a corporation may mean it is not recognized as a Qualified Small Business Corporation (QSBC). A business needs to be a QSBC to be eligible for the capital gains exemption. One alternative is to implement these strategies within a properly structured holding company. A holding company can be used for investments, while an operating company can still qualify as a small business for capital gains purposes. This planning needs to be done sooner rather than later so that the small business is eligible for the capital gains exemption.

Withdrawing funds from the corporation
If you decide to take funds out of your corporation, consider potential strategies that will help you make the withdrawal and minimize the tax consequences.