Ideas to preserve the SBD in 2022

Michael Bronstine

Assuming that a corporation is nearing or exceeding the $50,000 threshold for passive income, here are some strategies to consider reducing the impact to the SBD Limit.

Withdrawals to permit RRSP or TFSA contributions

Given current tax rates, where you are a business owner who wants to get the most from your investments over the long run and your portfolio earns a combination of interest, eligible dividends, and capital gains, consider withdrawing sufficient corporate funds to maximize your RRSP and TFSA contributions, rather than leaving the funds inside the corporation for investment. Given sufficient time, RRSP and TFSA investing would outperform corporate investing when earnings come from interest, eligible dividends, annual capital gains, or a balanced portfolio. Only corporate investments exclusively earning deferred capital gains would outperform RRSPs and TFSAs; however, few investors would be likely to defer 100% of capital gains over a lengthy period. These results are further outlined in our reports RRSPs: A smart choice for business owners 12and TFSAs for business owners… a smart choice.13 Removing funds that would otherwise be invested within the corporation could reduce future passive income. This is another reason to consider withdrawing sufficient salary or dividends from a private corporation to maximize contributions to RRSPs and TFSAs. Receiving salary of at least $162,278 by December 31, 2021 will allow the maximum RRSP contribution of $29,210 in 2022. (TFSA contribution room is not dependent on income level.) Reasonable salaries may also be paid to family members who work in the business to generate RRSP contribution room and funds for contributions to RRSPs and TFSAs. It should be noted, however, that where salary is paid there may also be various associated payroll taxes, such as Canada or Quebec Pension Plan premiums, Employment Insurance premiums and provincial health taxes to consider.

Tax-free withdrawals

Consider whether any amounts can be withdrawn from the corporation on a tax-free basis that would otherwise be invested in the corporation. For instance, if a shareholder previously made a loan to the corporation, and those funds are no longer required by the corporation, consider if the shareholder loan can be repaid. Capital dividends can be paid without being included in the shareholder’s income. A capital dividend may be paid at any point in time when there is a positive balance in the Capital Dividend Account (CDA) of a corporation. Certain transactions, such as the realization of capital gains and the tax-free death benefit from a corporately owned life insurance policy, result in additions to the CDA, while other transactions, such as capital losses, cause a reduction to the CDA.

Investment strategies

Any reduction to the SBD Limit is based on passive income in the previous year. Depending on the level of passive income otherwise earned in a particular year, you may wish to consider investments that lean towards growth rather than annual interest or dividend income, as you may better be able to time the recognition of a capital gain. In addition, since capital gains are only 50% taxable, it would take $100,000 of realized capital gains to generate $50,000 of passive income that is counted towards the passive income test. Consider a “buy and hold” strategy to defer capital gains if a corporation is approaching the $50,000 passive income threshold in 2021. By deferring some capital gains, the SBD Limit may be maintained in 2022. It may also be possible to stagger dispositions of investments between calendar years. For example, if there will already be more than $150,000 of passive income in one year, consider triggering additional capital gains in that year, rather than the next, if that might reduce passive income below the threshold in the next year. Conversely, you may wish to trigger capital gains or losses in a specific year because capital losses cannot be carried forward to a future year for purposes of reducing passive income. As a result, you may wish to realize capital losses and gains in the same taxation year. Some investments, such as certain notes, T-class units of mutual funds and REITs, pay a mixture of income and a return of capital. A return of capital is not included in income in the year received; rather, it reduces the adjusted cost base of the investment and increases the capital gain (or decreases the capital loss) on the future disposition of the investment. When considering these investment strategies, you should consider your overall investment plan, as well as passive income expectations for future years.

Individual Pension Plans

An Individual Pension Plan (IPP) is a pension plan created for one person, rather than a large group of employees. An IPP could be a strategy to consider once passive income nears or exceeds the $50,000 threshold. An IPP is a defined benefit pension plan, meaning that the pension paid on retirement is set out by a formula, so the amount of the pension benefits is predictable. Since the corporation contributes to the IPP and the income earned in the IPP does not belong to the corporation, that income is not passive income. Another advantage of an IPP is that the corporation may be able to make higher contributions to the IPP than you could have made into an RRSP. This, in turn, may lead to higher tax-deferred accumulation inside the IPP than you could have built up inside an RRSP. CCPC tax planning for passive income I 10 An IPP also allows you to split any pension payments with your spouse or common-law partner any time after age 55,14 rather than having to wait until age 65 as would be the case for RRIF income. The tax benefits of an IPP need to be offset against the administrative costs, including actuarial costs, to set up and maintain the plan.
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Life insurance

You may choose to invest after-tax income of the corporation into a corporately owned life insurance policy that insures the life of the business owner, or some other individual. There are numerous reasons to hold life insurance in a corporation, including certain tax benefits. For instance, there is a lower after-tax cost of the insurance premiums, which can be paid with funds that are taxed at a lower tax rate inside the corporation than funds that are earned personally. Depending on how long the life insurance is held, the death benefit may flow out to the corporate shareholders on an entirely tax-free, or partially tax-free, basis via the CDA. Now that passive income could impact the SBD Limit, life insurance may offer an additional advantage. If the income from the investments underlying the life insurance policy is not included in the corporation’s income on an annual basis, it should not be included in passive income. This will be the case for permanent life insurance policies qualifying as “exempt policies.”16 That means, permanent, exempt life insurance may be an alternative investment solution for business owners to consider where there is a life insurance need as well as a concern that the corporation’s passive income could limit access to the SBD.

Donations

If you are considering making a charitable donation, consider whether that donation should be made from your private corporation, rather than by you personally. Not only will your corporation receive a deduction for the donation, donating will reduce the funds that may be invested in your corporation to produce passive income. There could be additional tax benefits if your corporation makes an in-kind donation of publicly listed securities or mutual funds with unrealized capital gains. First, no tax will apply to the capital gains on the donated securities. Second, the entire capital gain is added to the CDA, and capital dividends can be paid to the extent that there is a positive balance in the account, as discussed in the section called “Tax-free withdrawals.” You can then receive capital dividends, which are tax-free, instead of taxable dividends. Third, capital gains on donated securities are excluded from passive income, so they will not impact the SBD Limit in the following year.

Conclusion

Since 2021 investment income in your private corporation may reduce the SBD Limit in 2022, you may wish to take steps in 2021 to potentially minimize the reduction of the 2022 SBD Limit. This decision should consider whether a reduction in the SBD Limit will result in a decline in any tax deferral, with a resultant reduction of future after-tax funds to withdraw from your corporation.

As with all tax planning, be sure to discuss the above strategies with your tax advisor to make sure they are appropriate for you.