Updated November 2024
The quick answer is no; if you want to know why read on.
Profit is good
Many corporate business owners get to this point in the year and are looking at a profit. Good. That’s what a business is supposed to do, generate profit for its investors.
“But I don’t want to pay any tax.”
It’s silly. Taxes pay for our roads, schools, healthcare, and COVID subsidies. Paying taxes means you made money.
Besides, paying taxes in your corporation is much cheaper than paying them personally.
Spending More Than You’re Saving
When you spend your profit, you’re spending $1 to save pennies. Even if you’re self-employed and in the highest tax bracket, you’re spending $1 to save 54 cents. If you’re incorporated, it’s even less savings – somewhere between 11 and 26.5 cents.
Some scenarios
Let’s look at some scenarios about what some business owners may consider doing ahead of their fiscal year-end.
Buying something you need
Buying something you need with your profits isn’t a bad idea. However, you need to ask two critical questions.
The first question is, Is it an asset or an expense?
The second question is, what period does the benefit apply to? For example, lifetime access to a software product. In this case, capitalize it and amortize it like a fixed asset.
Buying an asset
An asset is a larger item that provides value over time. Computers, machinery, furniture and vehicles are some examples of assets.
When you buy an asset, in many cases, you get to deduct a portion of it over time. The recognition of this expense is called depreciation or amortization.
Generally, you don’t get the entire amount when you buy an asset. In addition, there can be special rules and limits. For instance, passenger vehicles are only deductible up to a certain amount. Another example, there is no depreciation on land.
Some special tax rules for certain assets allow them to be deducted completely in the year of the purchase or at an accelerated rate. Discussing this idea with a tax professional BEFORE spending the money is essential. You wouldn’t want to spend all the money in your account and then find out you still need to pay tax or that the asset isn’t tax deductible.
Buying an expense
Smaller items are usually recorded as expenses; that is, they generally have a direct and immediate impact on your profit.
In this case, the vital question is, in which period is the benefit from the expense derived?
For instance, if you buy a piece of software with an annual license, most of the benefit occurs the following year. If your bookkeeper knows what they’re doing, they will list this as a prepaid expense and take in one month’s worth of the expense every month. The total amount you spend won’t be taken out of your profit in the current year.
If you do your own bookkeeping and take the entire expense immediately, recognize that you’re taking a risk and are not in line with accrual accounting. In Canada, all corporations are required to keep their books and records on an accrual basis.
Issuing staff bonuses
Taking care of your people is generally a good idea. Without your team, you wouldn’t have a business. There are a couple of things to consider when issuing bonuses.
First of all, is the bonus merited and reasonable considering the position and pay of the employees? Some employees may get upset that others are getting bonuses if they aren’t. If the amounts get out, it can create friction among your team. And don’t kid yourself; the team talks to each other, so it’s likely to get out.
More importantly, would you be setting a precedent with a big bonus? Will your team expect this kind of bonus every year? As your team grows, providing large bonuses regularly will become more difficult.
Is the bonus arms-length? If you own the corporation and your spouse works for it, issuing them a large bonus to get the money into family coffers is tempting. However, special rules about non-arm’s-length transactions need to be considered. Make sure you consult a tax professional if you’re considering this route.
Keeping it for yourself
Issuing a management bonus
A management bonus is an interesting tool. It is a tax deduction for the corporation, reducing your profit. It can also be paid up to 6 months after year-end but can be declared in the corporation immediately. This means that you can make the decision after the year is over. It also means that the personal taxes owing on it may be split between two years.
It’s important to remember that the source deductions on the management bonus will need to be paid. Make sure you budget for that, not just the bonus itself.
Issuing a dividend
A dividend is not a tax deduction for the company; it comes from after-tax profits. This confuses a lot of people. Essentially, it means that issuing a dividend won’t impact the bottom line of the company.
Since the company has already paid tax on the profit, the dividend comes with a tax credit for the individual. In Canada, our tax system is based on the principle of equalization. That is, essentially, the same amount of overall taxes should be paid. The dividend tax credit helps to satisfy this concept.
Splurging
This can be dangerous. Remember the most important question about whether or not an expense is required to earn revenue. We have a good blog post about business vs personal expenses you can check out If the expense was not required, CRA might disallow it if you are selected for a review or audit.
If you splurge, be sure you’re getting value for your money. Canadian Controlled Small Businesses pay less tax than individuals. In Ontario, it’s 12.5%. This means you only save 12.5 cents for every dollar you spend.
Build a war chest
This is what you should do.
The businesses that built a war chest before COVID fared far better than their competitors who didn’t. A war chest allows you to invest when needed, attract and keep talent, and weather economic downturns.
Based on the performance of our customers, those who did best through the pandemic had a war chest. This allowed them to pivot quickly and take advantage of opportunities that presented themselves.
If you don’t have any war chest built up, this is the most important first thing to do.
Pay less tax
Having a corporation provides an opportunity to defer paying taxes personally.
Your corporation will pay tax at a lower rate than you will as an individual. Then, you’ll have money available in your corporation to grow your business or react to economic downturns. Corporations also can carry back losses to offset years in which they made profits, recovering some of the taxes they already paid. We don’t have that option as individuals.
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