How to Extract Surplus Cash from a Corporation Without Paying Taxes in Canada

In the Canadian tax system, there’s a mechanism that ensures corporate taxpayers don’t have an undue advantage over individual taxpayers. This system isn’t flawless, but it’s functional. When individual shareholders receive dividends from a corporation, the income is included and adjusted based on the type of dividends (eligible or non-eligible). This income is then taxed according to the individual’s marginal tax rates. A dividend tax credit is provided to reflect the taxes already paid at the corporate level. When individuals draw salaries or bonuses from the corporation, it’s also considered as income. Many individuals hesitate to withdraw cash from their corporations to sidestep higher personal taxes. While this might defer the tax issue, it doesn’t eliminate it. 

Note: This article isn’t a substitute for professional tax advice. Always consult with a tax professional for personalized guidance. 

Challenges with Surplus Cash in Corporations 

Holding excess cash in a corporation can lead to complications. For instance, it might make the corporation ineligible for the Qualified Small Business Corporation (QSBC) status, which is crucial for the Lifetime Capital Gain Exemption. Another concern is the potential risk from creditors. 

A common strategy to address this is using a holding corporation. In Canada, intercorporate dividends are tax-exempt due to available deductions. The holding corporation can then reinvest this cash. If you don’t already have a holding corporation, you can establish one and transfer individual-held shares to it using section 85(1) rollover. However, this method might not always ensure that the operating company qualifies as a QSBC. 

The strategy described here is particularly useful for purification for LCGE purposes. But it can also be employed to withdraw surplus cash or assets from a corporation. 

Considerations for Shareholders 

For this strategy to work, the shareholder of the operating company should be an individual, not another corporation. The nominal value is used to determine the dividend amount for individual shareholders, whereas the Fair Market Value (FMV) is used for corporate shareholders. This approach is suitable for straightforward tax situations. However, if the assets being removed from the operating company have inherent gains or if the company has multiple shareholders, it’s essential to be cautious. Additionally, if either the operating company or the new company is sold later on, this tax planning might not be effective. It’s crucial to collaborate with a corporate tax accountant and a corporate lawyer to ensure the strategy is implemented correctly.