Owner-Manager Compensation and the SBD Retention Constraint
Maple Ridge Consulting Inc. (MRC) is an Ontario CCPC wholly owned by Priya, a solo consultant. For 2024 MRC expects active business income of $210,000 before any salary to Priya. Priya needs about $110,000 after tax for living costs and wants to make an RRSP contribution. She has $28,000 of unused RRSP room and no other income. MRC must spend $40,000 on equipment in 2025 and wants to retain at least that much cash. The corporation has no GRIP, a modest RDTOH balance, and no other employees. Priya's marginal rate on ordinary income is roughly 43% and on non-eligible dividends roughly 47% in the relevant range. Her spouse has no income and owns no MRC shares. Priya is considering a $90,000 salary, a $90,000 non-eligible dividend, or a blend, and asks whether her spouse should receive shares to split income.
1. Recommend a 2024 salary/dividend mix for Priya. Identify the binding constraint and explain how the small business deduction, RRSP room, RDTOH, and cash retention affect the choice.
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Start by testing whether Priya's goals are jointly feasible. MRC's after-tax cash before any distribution is roughly $210,000 less combined small-business tax at about 12.2%, or about $184,000. Priya needs $110,000 after personal tax and MRC needs $40,000, leaving only about $34,000 for personal tax. At a 43% ordinary rate, $110,000 of after-tax cash requires roughly $193,000 of gross salary, which would leave far less than $40,000 inside MRC. The constraints therefore conflict; no mix fully satisfies both.
A practical starting point is salary of about $150,000 plus a non-eligible dividend of about $20,000. Salary is deductible and creates RRSP room, and Priya can use the $28,000 contribution to reduce personal tax, although that reduces current cash. The dividend uses after-tax corporate cash and triggers some RDTOH refund, but MRC has little GRIP, so the dividend is non-eligible. Because ABI is below the $500,000 business limit, salary does not preserve a SBD that is otherwise being ground down; the SBD is already available. The salary-versus-dividend decision is therefore mainly personal-tax, RRSP, CPP, and cash-retention driven, not an SBD-grind decision.
The client must reduce the $110,000 cash target, reduce the $40,000 retention, or accept a lower RRSP contribution. Salary should be used at least to the level that supports desired RRSP room and CPP benefits, with dividends for residual cash. The exact split should be modeled because the $20,000 dividend estimate is sensitive to Priya's marginal rate and MRC's RDTOH balance.
2. Priya asks whether transferring shares to her spouse would split dividend income. Advise her, considering the tax on split income rules.
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A share transfer to Priya's spouse would not achieve the intended income splitting. The spouse has no income and is not involved in MRC's business. Dividends paid on shares transferred to the spouse would generally be split income for tax-on-split-income purposes. MRC has no GRIP, so dividends would be non-eligible dividends, which are squarely within the TOSI rules.
The spouse does not appear to qualify for an excluded amount. He is not 65 or older, not engaged in the business on a regular and continuous basis, and not in a prescribed relationship exception. A discretionary dividend from a related business corporation would also be caught. Paying salary or management fees to the spouse would be deductible only if reasonable for services actually performed; a payment for no services would be unreasonable and could be recharacterized as a shareholder benefit to Priya.
The better recommendation is not to transfer shares. If income splitting is desired, the spouse could be employed in a genuine role with reasonable compensation, or the couple could use spousal RRSP contributions, subject to room and attribution rules. Any share transfer should be reviewed for section 85 rollover, deemed disposition, and TOSI before implementation.
3. Assume MRC pays $30,000 of Priya's personal expenses and records them as business promotion. What are the tax consequences, and does it matter whether the amount is treated as salary?
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If MRC pays $30,000 of Priya's personal expenses and records them as promotion, the amount is not deductible because it is not incurred to earn business income. The payment confers a benefit on Priya as a shareholder, so section 15(1) includes $30,000 in her income. The benefit is not grossed up like a dividend and does not create RRSP room. MRC cannot deduct the expense, and any HST paid on the expenses may not be fully creditable as input tax credits because the purchases were not for commercial activity.
If the amount is instead bona fide salary, MRC can deduct it and must withhold CPP, EI where applicable, and income tax. Salary is included in Priya's income and creates RRSP room. The characterization matters: a section 15(1) benefit is generally less attractive than salary because it is non-deductible to MRC and may attract penalties, while salary is deductible but creates payroll obligations.
If the expenses were recorded as promotion and CRA reassesses, Priya could potentially repay the benefit to reduce the section 15(1) inclusion, but repayment does not cure the corporation's improper deduction. Because the amounts were knowingly mislabeled, CRA may also consider a gross-negligence penalty under section 163(2). The recommendation is to correct the records, include the benefit, and consider whether a voluntary disclosure is available before CRA raises the issue.