Capital Gains Versus Dividends – What is the Issue?

June 2017

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Bill Morneau, the Minister of Finance, vowed to take action to create tax fairness for the middle class when he tabled the 2017 Federal Budget in March of this year. As a result, he targeted private corporations as a key way that certain taxpayers can achieve tax savings, which are not available to employees or owners of an unincorporated business. The government intends to table a report setting out tax-saving strategies employed by the owners of private corporations and the corresponding policy responses to make appropriate changes to the current law. One of three key areas to be addressed in this report is the manner in which shareholders of private corporations extract funds from their corporations.

“Traditionally, a shareholder would receive after-tax profits in the form of a dividend and would only realize a capital gain when the shares were disposed of”, says Dan Kostenchuk, a Tax partner in the BDO Canada Winnipeg office. An individual taxpayer in Canada who pays tax at the highest personal tax rate in 2017 would pay tax on a capital gain at rates varying from about 22% to 27%, depending on the province of residence.

There are two types of dividends that a Canadian private company can pay: eligible and non-eligible. The tax rate on eligible dividends varies across the country from about 25% to about 43%. The tax rate on non-eligible dividends varies from about 36% to about 47%, depending on province of residence. If a taxpayer had a choice of paying tax on a capital gain or paying tax on non-eligible dividend, they would choose the capital gain in order to minimize personal tax.

An owner-manager can also withdraw funds from their company by paying themselves a salary for the work performed. The salary is deducted from corporate income for tax purposes but is taxable to the owner-manager as employment income. The individual would then pay personal tax on the salary, at the highest rates that vary from about 44% to 54% across Canada.

A shareholder may be able to extract funds from the company and pay a capital gains tax rate on the funds received in certain circumstances while keeping the shares of the company. “In some cases, the Canada Revenue Agency has challenged these arrangements”, says Kostenchuk, but the Canadian Tax Courts have generally found that such planning is allowed under the Canadian tax rules. This planning does not result in a taxpayer avoiding paying tax, but the tax is paid at capital gains tax rates rather than dividend tax rates. In the past several years, Canada has seen the tax rate on corporate profits decline, while personal tax rates have increased. It is this tax rate differential that has created a situation where capital gains income is taxed at a much more preferable rate than dividends.

As announced by Minister Morneau at a recent Board of Trade speech in Toronto, we expect the government to release a consultation paper in the coming days or weeks proposing changes to the way private corporations are taxed as a way of dealing with these three tax savings strategies. Following the release of this paper, we will be hosting a webinar with Dave Walsh, Tax Service Line Leader for Canada along with a number of our Partners in order to review and discuss the impact on private corporation owners. Our BDO Canada Tax advisors will remain dedicated to providing you with updates and information as it is released.

Update - July 18, 2017

Finance Minister Bill Morneau released the much anticipated consultation paper on July 18 proposing changes to how private corporations are used to gain tax advantages. The Canadian Department of Finance promised a consultation paper, however, Canadian taxpayers received proposals with effective dates and draft legislation on income splitting and conversion of capital gains. The federal government is asking for further consultation around holding passive investments inside a private corporation.  See our detailed review and watch our on demand webinar to learn more about the proposed reforms and how they might impact you.

For more information or assistance, please feel free to contact us.


The information in this publication is current as of June 26, 2017.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.