As a business owner, you have put in a lot of effort to establish and grow your business into a profitable venture. Perhaps, in the initial years, you reinvested all the profits back into your business to promote its growth. Now that your business has stabilized, you may be considering taking some profits out of your business. It’s important to have a good understanding of the tax implications before withdrawing any money from your business, especially when you have engaged services like small business accounting. This article explores some of the commonly used tax-efficient methods that business owners can employ to withdraw funds, money from their business.
Withdraw Funds from Compensate yourself and your family
As a business owner, compensating yourself is akin to paying an employee. If your family members are part of your workforce, they can receive a fair wage or salary. This is particularly advantageous if your family members have limited or no other source of income. In this scenario, a “fair” wage would be similar to what an unrelated third party would receive for the same position.
Rewards through taxable dividends
One way to distribute corporate funds to you and your family members is by paying dividends (though this does not reduce corporate tax). To make this a tax-efficient approach, you, your spouse, and your children must have direct or indirect ownership of shares in the company (such as through a trust or holding company). However, before any distributions are made, it is important to consider the Tax on Split Income (TOSI) rules and the company attribution rules.
Converting “Hard ACB” to cash
When purchasing a business from someone else, the shares you acquire may have a “hard” adjusted cost base (ACB), which becomes important when considering withdrawing cash from the business. “Hard ACB” refers to the amount paid for the shares at the time of purchase, and it can potentially be converted to cash (or debt that can be repaid later) through a holding company. This allows you to access the invested capital without incurring taxes.
Repaying Shareholder Loans
If you have lent funds to your business to finance its startup or growth in the form of a shareholder loan, now that your business is profitable, it might be a good time to consider whether it will repay all or part of this loan. When you receive any amount upon the liquidation of your shareholder loan, it will be a tax-free distribution, much like a return of equity.
Consider paying a capital dividend.
You may also want to explore the option of paying a dividend from your company’s capital dividend account (CDA), which could be an untaxed distribution. The CDA is essentially a notional balance that typically represents a tax-free portion (currently 50%) of any capital gains (or similar income) earned by a private company from managing capital assets, both tangible and intangible.
What if my capital dividend account has a very low balance?
If your company has a small balance in its capital dividend account, you may consider making an internal sale of the company’s assets with unrealized capital gains. By doing so, you can create a capital dividend account that can be distributed as a non-taxable capital dividend. While taxes are still payable on the profits made by the company, distributing a combination of taxable dividends and equity can be a more advantageous option than simply paying a taxable dividend.
If you are unable to repay the shareholder loan, you may consider paying interest on the loan as a way to account for it in your small business and estimate future returns. However, it is important to keep in mind that any interest paid will be deductible to the company but taxable to you as investment income. Additionally, the taxation of interest income received by individuals from private companies may be subject to the TOSI rules in certain circumstances where the highest tax rate applies. Therefore, it is essential to evaluate whether the TOSI rules apply before paying any interest to avoid potential negative tax implications.
If you need to withdraw cash from your business, it is crucial to plan ahead and consider the most tax-efficient methods. While there is no guaranteed way to withdraw funds from your business without paying taxes, taking the time to plan and utilize the strategies discussed above can help you minimize the amount of tax you are required to pay.