The article “Business owners, you can – and likely should – be growing your corporate savings” was originally published in Canadian Family Offices on February 24, 2022. Photo by GETTY IMAGES.
Cash can be invested in stocks, funds or real estate and grow inside the corporation just like in other investment accounts
When I review my clients’ financial statements, it’s not uncommon to find hundreds of thousands of dollars sitting in “cash.” In fact, it often comes as a surprise to new – and not so new – business owners that corporate savings can indeed be invested, and that money can grow in their corporations just like in any other investment account.
Yes, that’s right. Not only can you invest your corporate savings in stocks, bonds, ETFs, mutual funds or basically anything you can put into your non-registered account, but you can also invest in real estate (actual brick and mortar buildings) such as rental property or commercial property, and also life insurance. In fact, corporate investing allows for greater investment opportunities.
Now that we have established corporate savings can be invested, let’s dig a little deeper into three aspects of corporate investing: What do I invest, how can I invest and how are corporate investments taxed?
What do I invest?
Generally speaking, it makes sense to leave as much money as possible in the corporation to benefit from tax-deferred growth. (Remember, any funds withdrawn are generally taxable to you personally either as a non-eligible or as an eligible dividend – but we’ll leave that discussion for another time.) Draw sufficient compensation to use the lower tax brackets or what is needed for living expenses, whichever is higher, and perhaps extra to maximize your TFSA, RESP and possibly RRSPs. But then leave the rest in the corporation. Please note, you should speak with your tax accountant and financial planner to determine your ideal tax-efficient savings approach.
Here are a few other factors to consider:
- You will want to know your operating costs and cash flow position so you can then determine how much is available to invest. For example, if the business needs money in the next one to two years, that money should probably not be invested. As with your personal finances, any money needed in the short term should remain safe and liquid.
- You may also need to maintain a cash balance to pay income tax or other expenses for the corporation. Often businesses are required to pay regular income tax instalments. These instalments most often will equal the amount of income tax paid in prior years, assuming the level of income is the same as the prior year. The importance of paying these instalments on time is huge because missing them can be costly.
- Harmonized Sales Tax (HST)/Goods and Services Tax (GST) is also paid on an instalment basis. You will pay interest on HST instalments missed, underpaid or paid late. If the interest is high enough, then there’s also a penalty. Instalments requested by CRA are based on the previous year, but it’s optional to adjust instalments to what is expected to be owed. HST/GST is calculated when the HST/GST return is prepared. This is done on a monthly, quarterly or annual basis.
- Your business might also face slow periods or months when revenue is low. As a business owner you need to anticipate these periods.
- Lastly, corporate debt may occur now and then. A business owner may need to consider paying down that debt.
In summary, set aside enough cash to cover income tax instalments, ongoing business expenses, HST/GST remittance and any corporate debt. The rest can be invested.
How can I invest?
First, determine your risk tolerance. Your investment advisor or financial planner can assist you here. They may ask you to fill out a risk tolerance questionnaire and also provide input based on your financial planning needs.
Then determine a suitable investment approach. Here are a few options:
- Large banking institutions: Whether it’s in mutual funds or a discretionary portfolio of stocks and bonds, small business corporate investing often happens through the business owner’s banking institution, for example at TD, RBC, CIBC, etc. Note that fees are often higher with these institutions.
- Online banks: Numerous smaller financial institutions (banks or credit unions) allow for corporate investment into savings accounts or GICs that offer higher interest rates than larger institutions. So, online banks are a great place to house your corporate savings (earmarked for short term use).
- Robo-advisors: They offer a digital online platform and provide automated investing with minimum advisor support. They have become more popular in recent years due to their simplicity, zero account minimums and low fee structures. Robo-advisors collect information about your financial situation and risk tolerance so they can place you in a suitable portfolio of exchange traded funds (ETFs) aligned with your investment goals and risk tolerance. Examples of Canadian robo-advisors include Wealthsimple and Questrade.
- Independent investment firms: Independent (boutique) investment firms offer customized investment advice in harmony with the construction of a well diversified investment portfolio at a lower fee than many of the larger investment firms. Investment options may include ETFs as well as fully discretionary portfolios of individual stocks and bonds. Typically, portfolio minimums are at least $500,000 and most commonly $1 million or higher.
- Real estate: Rather than invest in savings and investment funds, a corporation can also invest in real estate. It might make sense to purchase your office space instead of renting, for example, or invest in a property that provides rental income.
It is often far less costly to purchase rental property in your corporation since the down payment comes from after-tax corporate dollars (small business rate taxed between 9 percent to about 12 percent depending on your province, and between 25 percent and 31 percent at the general business tax rate) versus after-tax personal dollars (often taxed at 43 percent or more based on income over $100,000 in Ontario).
Most expenses are deductible if incurred for the purpose of earning income and are reasonable, the same as with rental properties held personally if 100 percent is used for rental purposes and not personal use.
You will want to speak with your corporate or commercial lawyer about the pros and cons and tax implications of either buying the property directly in your existing corporation or setting up a second corporation, a holding company (to provide greater liability protection). Real estate is a less liquid investment and as such should be undertaken only if funds are not required in the near term.
How do you know which option(s) is best for you? A qualified and experienced fee-only, advice-only financial planner will be able to help navigate the options. However, to ensure unbiased advice, be sure that the professional advising you is not receiving referral fees. This is key. Remember, if the person advising stands to benefit if you follow their advice, be wary. You will want to take their advice with a grain, or perhaps two, of salt.
In addition, please note that you will want to make sure any institution you work with is insured, and a member of the CDIC for savings accounts or CIPF for your investment accounts.
How is corporately passive investment income initially taxed?
Investment income earned within a corporation is subject to tax each year. The tax rates are different than if the investment income were earned personally.
For example, let’s assume a business owner earned $10,000 of capital gains, $10,000 of interest income and $10,000 of dividends within their CCPC (Canadian Controlled Private Corporation), and let’s assume the CCPC is resident in Ontario and this occurs in the 2021 tax year. The taxes payable will be as follows:
$10,000 of capital gains
- 50% of the gain is taxable and 50% is tax-free.
- The 50 percent taxable portion is included in taxable income and the tax rate on this income is 50.17 percent.
- Therefore, the tax will be $5,000 * 50.17% = $2,508.50.
$10,000 of interest income
- Interest income is fully taxable and the tax rate on this income is 50.17 percent.
- Therefore, the tax will be $10,000 * 50.17% = $5,017.
$10,000 of dividends
- Let’s assume “eligible” dividends earned from publicly traded Canadian companies and let’s assume the business owner does not pay out a dividend to him or herself for simplicity.
- The tax rate on the dividends will be 38.33 percent.
- Therefore, the tax will be $10,000 * 38.33% = $3,833.
Of course, to understand the total tax impact of passive investing through the corporation, it is also advisable to consider the personal tax consequences as well, since the corporate tax isn’t the end of the story.
Lessons learned
To summarize, you can – and likely should – grow your corporate investments. Really, one of the main objectives of having a corporation is to benefit from the initial tax deferral during your working years, growing your investments so you can draw them down when you are in a lower tax bracket during retirement.
How you invest is a function of your risk tolerance, liquidity needs and suitable investment approach. But there’s more. You will want to ensure you invest in a tax efficient manner. I see a lot of missed opportunity in this area. How can you do that? Stay tuned for an upcoming article that will explore further the world of tax efficient corporate investing.
And if you feel overwhelmed, you’re not alone. Work with a certified fee-only, advice-only financial planner to help you oversee your financial plan and integrate the many moving parts of your financial life with your investment planning and tax planning needs.
Nancy Grouni, a Certified Financial Planner with Objective Financial Partners Inc., specializes in financial, tax and estate planning for business owners and professionals. She is based in Markham, Ont.
