As a business owner in Surrey, you’re constantly looking for ways to optimize your company’s financial health. While you’re busy growing your business, it’s easy for key financial concepts, like how to pay yourself, to be overlooked. One of the most important tools available to owners of incorporated businesses is dividend distributions.

But what exactly are dividends, and how do they fit into your overall financial plan? This article will help you navigate this important topic. Understanding how to properly use dividends can be a powerful way to manage your income and enhance your corporate tax planning, but it’s crucial to get it right to avoid costly mistakes.

What Are Dividend Distributions?

Simply put, a dividend is a payment made from a corporation’s after-tax profits to its shareholders. When your business generates profit, that money is taxed at the corporate level. The remaining funds, known as retained earnings, can be kept within the company or distributed to the owners (shareholders) as dividends.

It’s important to understand how dividends differ from a salary. A salary is a regular payment to an employee (including a business owner) that is an expense for the corporation. The company can deduct this expense from its taxable income, and the recipient pays personal income tax on it. Dividends, however, are paid from profits after the corporation has paid its own taxes. The shareholder then pays personal tax on the dividend, but Canada’s tax system is designed to provide a tax credit that accounts for the corporate tax already paid. This concept is known as “tax integration,” and the goal is to ensure the combined tax rate on the profit is similar, whether it’s paid as a salary or a dividend.

Types of Dividends Available to Business Owners

Not all dividends are treated the same way. In Canada, there are different types, each with its own tax implications.

Eligible vs. Non-Eligible Dividends

This is a key distinction. The tax treatment you receive depends on how the corporation’s income was originally taxed.

• Eligible dividends are paid from a corporation’s income that has been taxed at the higher general corporate tax rate. They receive a more favourable tax treatment for the individual shareholder through a higher dividend tax credit.
• Non-eligible dividends are paid from a corporation’s income that was taxed at the lower small business tax rate. These dividends have a lower gross-up and dividend tax credit, which means shareholders face a higher personal tax rate on them compared to eligible dividends.

Cash vs. Stock Dividends

Most of the time, dividends are paid in cash. However, a corporation can also issue a stock dividend, where new shares of the company are given to existing shareholders instead of cash. This allows the business to reward investors without affecting its cash flow.

Key Considerations Before Paying Dividends

Before you decide to pay yourself or other shareholders a dividend, there are critical steps you must take to ensure you are compliant with British Columbia corporate law.

• Solvency Test: You cannot pay a dividend if the corporation is insolvent or if the payment would make it insolvent. This means the company must be able to pay its debts as they become due, and its assets must be greater than its liabilities.
• Proper Documentation: Every dividend distribution must be properly documented. This includes a resolution from the board of directors authorizing the payment. This resolution must be kept in the corporate minute book. Without this, the distribution could be seen as an unauthorized payment, potentially leading to serious legal and tax issues.
• Tax Planning: It’s vital to consider the tax implications for both the corporation and the individual shareholders. The decision to pay a dividend or a salary is a strategic one that should be part of a comprehensive tax plan.

Benefits of Dividend Distributions for Incorporated Businesses

When done correctly, dividend distributions can be a very powerful tool.

Tax Efficiency for Owners

For many incorporated businesses in BC, especially owner-managed ones, a blend of a small salary and dividends is often the most tax-efficient way to receive income. This strategy can help you maximize personal after-tax income and manage your overall tax burden.

Flexible Income Planning

Unlike a set salary, dividends offer flexibility. You can decide when and how much to distribute based on the business’s cash flow and your personal financial needs. This is particularly useful in industries where income can fluctuate throughout the year.

Attracting and Rewarding Investors

If your business has outside investors, dividends are a way to share the company’s success and provide a return on their investment. This can help attract new shareholders and build confidence in your business.

Learn More: The Role of Legal Counsel in Strategic Planning for BC Charities and Non-Profits

Common Mistakes Business Owners Should Avoid

To protect yourself and your business, you should avoid:

• Distributing dividends without a proper resolution: It’s a simple step, but it’s easy to overlook. Without the right documentation, the payment is not a legally authorized dividend.
• Ignoring the tax implications: Misunderstanding the difference between eligible and non-eligible dividends can lead to paying more personal tax than necessary.
• Going it alone: Trying to manage these complex decisions without professional guidance is a common mistake that can have significant financial and legal consequences.

How Professional Support Simplifies Dividend Distributions

An accountant can provide tax and financial advice, and a lawyer who understands corporate law can help ensure corporate legal requirements are met.

With our local expertise, we can help ensure your documentation and filings meet the specific requirements of British Columbia. From creating and maintaining your minute book to drafting the necessary resolutions, we provide the support you need.

Final Thoughts

Dividends are a powerful and flexible tool for any Surrey incorporated business. They can provide a tax-efficient way to pay yourself, reward investors, and give you control over your income. However, they are not something you should handle without expert advice. The legal and tax risks of a do-it-yourself approach are simply too high.

For corporate guidance on dividend distributions, contact L. Johnson Law today for expert advice and professional support that keeps your business compliant and financially efficient.

Let us help you unlock the full value of your hard work.