When it comes to your investments, business owners have the option to hold assets personally, as a business or to reinvest them into their business. How you choose to invest should factor in your financial goals, costs, and return on investment.
Below we explore some key things to consider when investing as a business owner.
Capital Retention
Capital held within the business can provide you with a larger sum of money to use for investment purposes. This difference in the capital is attributed to the small business deduction, a benefit that offers a lower tax rate to small businesses for active business income.
Business income paid out to shareholders to invest personally may be subject to a higher personal tax rate, providing less capital for investment purposes.
As an example, $10,000 in business income taxed at 11% leaves $8,900 for investing. The same $10,000 in business income paid out in salary or as a dividend to a shareholder may be taxed at a personal rate of up to 48%, providing as little as $5,200 for investing.
However, if the capital withdrawn personally is invested into a Registered Retirement Saving Plan, the tax deferment can provide the individual with the full amount of capital for investment (providing the tax deduction is reinvested into the RRSP). To take advantage of the RRSP benefit, the individual must have enough RRSP contribution room, which is calculated based on reported earned income each year. Similar to a TFSA, RRSPs also have a lifetime accrual amount that can allow an individual to invest unused amounts from previous years.
Income Tax
Although the active business income tax rate can be an advantage to investing within a business, the tax rate for investment income earned by a business must also be considered. In Alberta, this rate is 47% for interest and rental income and 38% for dividend income but some of these costs can be claimed as a deduction when the income is paid out as dividends to the shareholders.
It’s important to note that the small business deduction is reduced if investment income earned by the business passes a $50,000 threshold. This results in a higher corporate tax rate, reducing the tax benefits of investing as a business.
On the personal investment side, individuals have the option of using their Tax-Free Savings Account to shelter capital gains from taxation.
Use & Timeline
How and when your investments will be used can help determine where to invest. If you’re looking for personal, long-term retirement savings, the tax advantages of taking a reasonable income to build contribution room in an RRSP may be an easy choice.
Long and short-term reinvestment into the business is another investment option to consider. This can lead to increased profits and income for shareholders while also increasing the value of the business if it will be sold later.
If the liquidity of the investment is a priority, for future expansion or a business-related purchase, holding the investment within the business can be a simpler way to earn a return on excess cash while providing access to funds quickly.
If you’re considering changing your investment approach and want personalized recommendations or comparative calculations of the options available, give us a call at McNabb Lucuk LLP. Our chartered, professional accountants can walk you through the options to guide your investment decision-making.