As an owner of a small business in Canada, you have an option to choose between dividends or salary as your main form of income or have a mix of both. While there’s no right or wrong answer, the option you choose will play an important part when the time comes to file your income taxes, and ultimately, is dependent on what kind of Canada Pension Plan or retirement savings plan you have in mind for yourself. Also, the type of remuneration you choose has significant tax consequences and can affect your ability to plan for the future. Each approach has advantages and disadvantages, and your situation will play an essential role in which one is best for you. Let’s take a closer look at the difference between a dividend income and a business salary to help choose the right one for your needs.

Dividend vs. Salary: key differences

Let’s understand the key difference between dividends and salary first.

Salary is paid out by the corporation to you as an employee and thus, are considered an expense by the business. The corporation issues a T4 slip showing the amount of salary paid. Individuals paid a salary are responsible for claiming all taxable income on their personal tax return at the end of the year.

On the other hand, a dividend is the distribution of a set amount of the company’s earnings to its shareholders. Unlike a salary, which counts as personal income, dividends are considered investment income, and as such, they are not subject to the standard tax deductions that many employees on salary see on their pay stubs.

Paying yourself in salary

Let’s explore the benefits of paying yourself a salary or wages as a small business owner who has set up their business as a corporation in Canada.

If you decide to pay yourself a salary, it has several advantages, including:

• RRSP Benefits: Salaries and wages are eligible income for RRSP – Deductible Registered Retirement Savings Plan. Paying yourself via dividends does not allow for this.
• CPP Contributions: Paying yourself a business salary means that you will be eligible for the Canada Pension Plan (CPP). With CPP contributions, you can receive pension or retirement benefits as early as age 60. You cannot contribute to a Canada Pension Plan if only dividends are paid.
• Mortgage Qualification: Paying yourself a business salary may favour you when you are attempting to qualify for a mortgage. Banks like to see a steady source of employment income, and a salary guarantees this, so you’re more likely to qualify for a loan.
• Less surprise tax bills: When the time comes to file your personal taxes, you’ve already paid your income tax, so you’re less likely to see tax charges or tax consequences that don’t add up.

Paying yourself in dividends

In short, dividends allow the corporation to withdraw funds with ease and provide the following key advantages:

• Lower Tax Rate: Dividends are taxed at a lower rate than salary, which can result in you paying less personal tax. But keep in mind, that Dividends are not a tax deduction. They are a distribution of profits (usually), which means the corporation likely has taxable income.
• Lower Cost:By paying yourself dividends, you do not need to contribute to CPP, which means that there will be a reduction in corporate and personal cost and less administrative cost.
• Simple & Easy to Navigate: Dividends come with a dividend tax credit, making it carry less personal tax liability than business salaries or wages. They don’t reduce the corporate tax paid as they are not a corporate expense, but are a more straightforward and easy to implement payment option for small business owners in Canada.
• No mandatory payroll: if you own the corporation, you can withdraw or invest as much or as little money as you’d like without worrying about registering your business for payroll, or dealing with source deductions.
• Less chances of payroll penalties: when you own the business, you’re likely responsible for everything, and it’s easy to make a payroll mistake. Because dividends don’t require payroll, this is avoided. When paying yourself dividends, the only thing you need to worry about is completing and filing your T5s on time once every year.

Salary vs. Dividend: Which is better?

There’s no right or wrong answer to this question. Now that you know the pros and cons of dividends and salary you should consult with your accountant in Surrey, BC to determine which one fits your circumstances. 

DM Tax helps small business owners in Canada with bookkeeping, accounting and tax services. Schedule your tax preparation appointment with us and take the first step towards proper management of your finances.