Extracting cash from a corporation

May 31st, 2016

Our tax lawyers explain which strategy to use.

PIERRE D. SAINT-AUBIN, Partner, Lawyer, JULIE LAVIGNE, Partner, Lawyer & FRANÇOIS GIROUX, Partner, Lawyer | Montréal

An analysis of the tax implications of extracting cash from a corporation is often based on the salary-dividend axis.

The following table illustrates that, from a tax standpoint, extracting cash from a corporation could be much more beneficial for a shareholder if that cash were extracted through the disposition of goodwill, such as in the context of a sale, business restructuring, estate freeze or employee incentive plan.

For example, the extraction of cash from a corporation which was generated by $1,000 of business income through the sale of goodwill in 2016 yields for the shareholder, after corporate and personal income tax, net cash of $529, compared to $440 in the case of an eligible dividend. Thus, the extraction of such cash through the sale of goodwill in 2016 yields for the shareholder, after corporate and personal income tax, $89 more net cash compared to the eligible dividend, i.e. a difference of 20.23%. Meanwhile, in the case of the sale of goodwill in 2017, the extraction of such cash would yield $544 for the shareholder, after corporate and personal income tax, compared to $440 in the case of an eligible dividend, i.e. a difference of 23.64%.

NEW RULES

The federal budget of March 22, 2016 proposes amendments to the Income Tax Act (the “New Rules”) pursuant to which, as of January 1, 2017, the taxable portion of the proceeds of the sale of goodwill (50%) will no longer be taxed as business income (26.9%), but will rather be taxed as investment income (50.6%), subject to a 30.6% refundable tax payable to the corporation upon the payment of taxable dividends to the shareholder at a rate of $1 for each $2.61 of taxable dividends paid.

Under the current rules, the taxable portion of the proceeds of the sale of goodwill (50%) will trigger an immediate corporate income tax of $98 ($731 x 50% x 26.9%). With the New Rules, the tax that will be payable by the corporation immediately upon the sale of goodwill will be $185 ($731 x 50% x 50.6%), subject to a refundable tax of $112 when taxable dividends of approximately $292 are declared in favour of the shareholder. Therefore, to the extent all or part of the taxable portion of the proceeds from the sale of goodwill (50%) is retained in the corporation, a sale of goodwill will be more advantageous if it occurs before January 1, 2017.

The “New Rules” will come into effect on January 1, 2017. Accordingly, any transactions connected with the disposition of goodwill finalized before January 1, 2017 will benefit from the current tax treatment.