Thursday, May 3

The Dividend Project - Taxation

Warning up front: this is not purely about dividends...

I met with my accountant today to discuss my adventures in investing and the best way to structure them. The short version of the meeting was: Put everything in the corporation.

Interesting highlights include:

  • For corporate taxation, foreign dividends are just as favourable as Canadian dividends and this is the best kind of income for corporate (as we know it is for personal)
  • Interest income is taxed more gently while it remains proportionately small compared to corporate revenue (under 50%)
  • Upcoming/phased changes in the tax laws may make investing within a corporation even more attractive by 2010
  • Both corporate and personal capital gains are only 50% taxable. This means that your tax rate is effectively cut in half. However, for corporate it is taxed at the high rate, so the 50% deduction basically puts it back into the low rate.
  • The 50% of corporate capital gains that are not taxable are also tax free when you take them out of the corporation

We also talked about my mortgage and she was very much in favour of paying it down, although the rental income I receive from the basement suite makes this less urgent. We may look at a 5 year plan for this.

Another interesting surprise: I discussed the concept of borrowing to invest and she said that even that should happen inside the corporation.

So my two grand conclusions are:

  • Put it all in the corporation and let the accountants figure out the taxation.
  • Dividends are great.

The last thing she said to me was perhaps the best advice: Make sure you are doing good investing and making money rather than simply structuring for tax effectiveness.

You can say that again!

6 comments:

J W said...

Interesting ideas.

If you put everything in your corporation, how do you ever get it out?

How is interest income taxed "gently"? I thought it was taxed at around 50%, no matter what.

the money diva said...

jw,

You take it out as dividends, mostly, although it could also go out as shareholder loans or salary. But even if it draws tax at that time, paying tax later is better than paying tax now, for the purposes of investment growth.

From my simplified understanding, there is a high corporate tax rate and a low corporate tax rate. Smaller amounts of interest are "incidental income" and are taxed at the lower rate, while larger amounts are investment income and taxed at the higher rate.

Keeping in mind that I'm not a tax expert. :)

MD

Thicken My Wallet said...

Good Post.

I believe what your accountant was taking about is active vs. passive income. In Canada, active income is taxed at a low corporate tax rate (assuming you meet some rules) while passive income, such as rental income and dividends, is taxed at the highest marginal tax rate.

Just be careful, if you mingle active and passive income in a corporation, you may get taxed at the passive income rate.

Looking forward to your next post.

the money diva said...

TMW,

Thanks for your comment! I think your distinction between active and passive income really makes things clearer for me. Accountants don't always realize that we may be missing some basics so this term never came up in my discussion.

From what my accountant told me, it sounds like by 2010 it may be advantageous to opt into the higher corporate tax rate if you have lots of passive income. I'm afraid that I can't provide any more detail than that, othen than it has something to do with how dividends get taxed when they are finally disbursed to the shareholder.

This is an area that I am very weak in and I really would like to grow my understanding of it. Thanks again for your input!

MD

Thicken My Wallet said...

Thanks MD.

I have blogged on your post to provide some clarification; you'll have to wait until Tuesday morning to read it though!

I hope my post will shed some light. I am not sure about the 2010 comment but I'll look into it.

Anonymous said...

MD, I am an accountant and my only comment to you is "if YOU don't understand it, don't do it!". Your accountant should be willing and able to explain this to you in terms you understand. It sounds like she is good and helpful so that shouldn't be a problem. But remember, it is YOUR money and as she said, tax effectiveness is only one criteria for planning.