Frequently Asked Questions About Salary and Dividends by Owners of Corporations

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As an accountant and small business financial consultant,  one of the most common areas of confusion and questions I get asked by owners of Canadian small business corporations relates to owner compensation, i.e. how to pay yourself and if one way is preferable to another.  I have addressed some of them in my blog posts on the factors to consider when choosing salary vs dividends (in Canada) and the types of ways to structure your owner compensation .  There are however a number of specific questions that come up frequently.

Also check out my newsletter article where I try to “decode dividends” for small business owners.

What is the difference between a salary and dividend?

A salary is paid to an employee of a business while a dividend is paid to a shareholder of a business.  Since small business corporations often only have one or two owners they can either pay themselves a salary as a employee or a dividend as a shareholder, or both a salary and a dividend.

What are the reporting requirements for salary?

• When hiring employees, even if it is just yourself as the owner of the corporation, you must register for payroll numbers with Revenue Canada (CRA), and Revenue Quebec if you are located in Quebec.

• Once you have the payroll numbers, you can either calculate your salary manually or employ a service to take care of the calculations and reporting on your behalf.  Amounts are deducted from your salary that have to be remitted to CRA (and RQ when applicable) usually on a monthly or quarterly basis.

• At the end of the year T4s ( and RL1s in Quebec) have to be prepared and submitted to CRA (and RQ).  These amounts are then reported as employment income on your personal tax return.

What are the reporting requirements for dividends?

You can borrow money from the corporation as and when needed during the year.  Once a year, you determine the total amount that you have withdrawn from the corporation , prepare a T5 slip (RL3 slip in Quebec) and submit to CRA (RQ). The amount is then reported as dividend income on your tax return.

Are salaries tax deductible in the corporation?

Yes, salaries are considered to be an expense and deducted from your revenues in the corporation. 

Are dividends tax deductible in the corporation?

No, dividends are not tax deductible. Rather they are paid from after tax income. 

Do dividends result in double taxation?

No, dividends do not result in double taxation.  Even though dividends are not deductible as an expense, CRA compensates for this by allowing for a dividend tax credit.  This dividend tax credit is offset against the dividend income on your personal tax return (T1) and  results in lower income taxes payable, which are approximately the same as what you would pay on a salary when combined with the additional corporate taxes that you would pay (since a dividend is not tax deductible).  Note that income taxes paid on dividends does not include contributions to the Canada Pension Plan (CPP) and Employment Insurance – see below.

How does CPP and EI work with salary and dividends?

Deductions relating to the Canada Pension Plan (CPP) (QPP in Quebec) , Employment Insurance (EI) and Quebec Parental Insurance Plan (QPIP in Quebec) are only taken from salaries since this is considered to be active income rather than passive investment income.

These payroll taxes do not apply to, nor are they deducted, from passive income such as dividends.  Consequently, your total taxes payable are lower with dividends (in sense), however, you will not receive CPP (QPP) benefits when you retire if you only take dividends. 

EI contributions do not apply to shareholders who own more than 40% of their corporations.  They are not required to pay EI on their salaries nor are they entitled to claim benefits.

How do salaries vs dividends impact RRSP contribution room?

Salaries are considered to be “earned income” which essentially means that income is earned by active participation in a job or a business.  RRSP contribution room is calculated on the total income that is “earned” during the year at 18% of the gross earned income (total salary) up to a maximum of $175,333 for 2024. 

Dividends are considered to be passive income since they are earned as a shareholder of corporation.  This, according to CRA, means that they do not qualify for the RRSP calculation base.  In other words, dividends do not add to your RRSP contribution room.

This is a significant consideration when deciding whether to take salary vs dividends.  Since RRSPs contributions are one of the best way to reduce your taxes while saving for retirement, it often makes sense to take a combination of salary and dividend which allows you to accumulate some RRSP contribution room.

Do you have to pay yourself the full amount of profits from a corporation?

You do not have to pay yourself the full amount of profits from a corporation. In fact, you do not have to pay yourself at all.  The amount of salary or dividend that you take is your decision (although there might be other tax considerations such as spreading out your earnings over several years rather than taking a large amount in one year, which will result in higher taxes).

Do you have to take a fixed salary?

No, you can take any amount of salary that you want and in any frequency i.e weekly, monthly, biweekly, quarterly or even annually.  The salary that you earn in a year and that is reflected on your T4 is based on the date on which it is paid (i.e. taken from your bank account) .

Do you have to pay dividends to all shareholders?

All shareholders in the same class must receive dividends in proportion to their ownership in that class.  For example, if you are paying $1,000 of dividends to the shareholders of Class A or Common Shares and you own 80% and your partner owns 20%, you would pay out $800 and $200 respectively.

If you want to pay different shareholders, different amounts that are not in proportion to their shareholdings, you would structure your corporation shares so that there is more than one class.  You would then have flexibility in how you pay the dividends.

Do you have to prepare minutes when you pay a salary or dividends?

You do not have to prepare minutes when you pay salaries as this is part of the internal operations of the corporation.  You should however prepare minutes whenever dividends are paid as shareholders are external to the corporation.  Minutes can be prepared by the business owner or an employee of the corporation for which templates can be found on the internet - a lawyer is not necessary.  You can, of course, also hire a lawyer to prepare your minutes, but this can be costly and is more appropriate when you have a more complex corporate structure.

What is the difference between eligible and non eligible dividends?

Eligible dividends are those that are paid from corporations that are not entitled to the small business deduction.  They receive a higher tax credit since the corporation paid a higher tax rate.  Non eligible dividends (sometimes incorrectly referred to as ineligible dividends) are paid from businesses that are eligible for the small business tax deduction.  There are, however, situations where a corporation considered to be a small business can pay eligible dividends, which are tracked via a tax account called the General Rate Income Pool (GRIP). The most common reason that a small business corporation would have eligible dividends is if they received them from another corporation. This is a more complex area of tax and likely requires the assistance of an accountant.

Can I prepare my own salary reporting and year end slips?

You can calculate, submit your monthly deductions at source (salary deductions) to CRA and prepare your T4s at the end of the year.   Alternatively, if you don’t want to do the extra administration yourself you can use a payroll service.  It is important to ensure that submissions to CRA are done on time, otherwise penalties can be steep.

Can I prepare my own dividends slips?

Dividends declarations i.e. the T5 and RL3 are only required once a year and are relatively easy to do on your own. For more details, you can take a look at my small business dividend guide. Alternatively, if you already have an accountant they can take care of the dividend declarations as part of their year end services.

How do you withdraw And account for dividends from the corporation ?

When you borrow or withdraw money from the corporation for any reason, it should be allocated to a shareholder loan account which is a “current liability” on your balance sheet. This can be done at any time (or multiple times) during the year. If you decide to take dividends (rather than repay the loan), then you would reallocate the amount from the shareholder loan account, via a journal entry, to a “dividends paid” account which is part of your equity. The journal entry to reallocate the dividends declared is:

Debit: Dividends Paid (reduction of equity)

Credit: Shareholder Loan (clearing out the loan receivable amount)

My video below explains the different types of transactions that affect the shareholder loan account:

Note that dividends are not expenses but a reduction of equity.

What is a Capital Dividend?

When a corporation has a realized capital gain, most commonly due to sale of investments, 50% of the capital is non taxable (in the same way as it is for an individual). The capital dividend remains in a notional tax account called the capital dividend account (CDA) in the corporation until it is disbursed to the shareholders. To pay it out to the shareholders, you must file a special form - the T2054 - indicating the amount in the CDA and the amount being paid. For more details, please see my blog post on capital dividends.

Note that as part of the 2024 federal budget, the amount of non taxable capital gains (the amount leftover in the capital dividend account) is scheduled to decrease to 33.33% for all corporations.

Is it better to take salary or dividends?

The decision to take salary vs dividends or both depends on your circumstances.  While dividends are certainly easier and require less administration, you lose out on contributions to the Canada Pension Plan (CPP) and do not accumulate RRSP room.   As with all things, it is a good to review your situation, calculate different scenarios and make the best decision possible, recognizing that there is probably no perfect answer.

Looking for guidance on small business dividends and how to prepare your year end T5 dividend declarations? Download my free small business dividend checklist and check out my book on dividends for small business and how to prepare the T5s .

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