With the increased tax burden on small businesses that generate too much passive income, the need for tax-efficient investment strategies has never been more important. As of 2018, any small business with $50,000 or greater of passive income per year, would face a $5 reduction on the small business deduction for every $1 in passive income earned. As a result, the small business deduction will be completely eliminated if the passive investment income for the preceding year was in excess of $150,000. Passive income includes income from rent, interest, royalties, dividends from portfolios & taxable capital gains etc. In order to help offset some of those potential higher taxes, here are some strategies to consider implementing inside your corporation

.

Corporate Owned Whole Life Insurance

Often referred to as a ” No Limit Corporate TFSA”, tax-exempt corporately-owned life insurance can allow for the accumulation of capital without impacting the limits on passive income. As a tax-sheltered investment vehicle, life insurance is becoming increasingly important for shareholders of private corporations. Since the accumulation of funds from the underlying life insurance policy is not included in the corporation’s income on an annual basis, it will not be considered as passive income. In other words, permanent life insurance may be a great alternative investment solution for business owners to consider where there is a life insurance need as well as a concern for the corporation’s passive income levels. Permanent life insurance policies, in particular participating whole life policies, also have a long track record of stable returns with lower risk as compared to other asset classes. Funds may also be withdrawn tax-free from accumulated cash values using advanced leveraging strategies and can eventually be passed down 100% tax free using corporate CDA credits. The use of such corporately held policies, should be integrated as a complement to your financial plan and not to fully replace other more traditional investments.

Withdrawing Excess Funds to Max out RRSP & TFSA Contributions

With the tax benefits offered by both the TFSA & RRSP, withdrawing excess capital to invest in your personal RRSP and TFSA will prove to be beneficial long-term. Since all forms of growth ( dividends, capital gains, interest) accumulate tax-free in these two accounts, they will often outperform similar investments held in a corporate investment account over the long-term. Withdrawing funds that would otherwise be invested within the corporation could also help reduce future passive income. This is another reason to consider withdrawing a sufficient salary or dividends from your corporation to maximize contributions to RRSPs and TFSA’s. As an example, drawing a salary of at least $171,000 by December 31, 2022 would have allowed for the maximum RRSP contribution of $30,780 in 2023. Furthermore, $6,500 of additional TFSA room was granted in 2023 ( lifetime limit of up to $88,000).

Use of Corporate Class funds & Capital Growth funds

Having a portfolio of marketable securities ( Mutual Funds, ETF’S, Stocks etc.), is one of the most common ways to grow investments inside your corporation. However, paying attention to the construction of your corporate portfolio can result in significant tax savings. Consider using corporate class funds where taxes can be deferred or minimized given the ”pooled” structure of the funds held with a corporate class entity. In addition to corporate class funds, it may be wise to consider investing in funds that focus on capital growth and less on dividends and income. This will eliminate the annual passive income earned on distributions.

Split-Dollar Critical Illness Insurance

Sometimes known as a ” Shared-Ownership” critical illness, this strategy combines providing much needed insurance coverage with the ability to withdraw funds from the corporation in a tax-effective manner. The insurance coverage that protects against 26 major illnesses ( cancer, heart attack stroke etc.) will be funded by the corporation and represents the larger portion of the annual cost. The optional return of premium rider (ROP), provides a 100% refund of all premiums after 15 years, this is funded by the insured ( individual). As the individual is paying the ROP and owns that portion, and if they do not claim under the policy, the 100% ROP will be paid back personally resulting in a non-taxable dividend from the corporation. As this is treated as a return of capital, there is no impact on passive income and is exempt from passive income rules. When using this strategy, it is important to consult your tax expert / advisor to ensure the policy has been properly set up correctly to ensure it is within the tax guidelines.

IPP- Individual Pension Plans

Have you dreamed of replicating an RRSP inside of your corporation? The IPP might be the solution. The IPP is an individual pension plan allowing for a corporation to make large deposits for the benefit of it’s shareholder. With tax-deductible deposits, tax-deferred benefits and no impact to passive income limits the IPP may be worth considering. Furthermore, with deposit limits that can be 65% higher than current RRSP limits you will see your capital grow faster and more efficiently. While the tax benefits can be significant, all calculations must be performed by an actuary and are based on past years of service. The administrative costs to set up & maintain can be significant so it is therefore important to ensure the tax benefits outweigh those costs.

Claim all Appropriate Expenses and Deductions

As a business owner, you are entitled to claim any expenses as deductions that are directly linked to your business activities. In other words, any reasonable expense that is used to generate revenue for the business can be claimed as an expense. Examples of such expenses can be salaries & wages, travel expenses, management & administrative fees, bank and interest charges, overhead expenses, supplies etc. It is important to understand what qualifies as an acceptable expense and what may be refused. We recommend sitting down with your accountant & financial planner to identify all eligible expenses to help reduce that final tax burden.

Want to know more?

To find out more about any of these strategies and how they can help you reach out to your Oberoi Financial advisor at any time. Our team of professionals is always available to help answer any questions you may have and discuss your specific situation.