What to do with cash
sitting in your corporation

Most business owners I meet have more cash in the company than they meant to leave there. It builds up quietly. You don't need the money personally. Taking it out means paying tax you'd rather put off. And you might want it for the business one day.

So it sits. Then one day you look and there's $400,000 in the business account, earning almost nothing, and it's been that way for three years.

The natural next question is "what should I invest it in?"

That's the wrong question to start with.

Why the money piles up

If your company qualifies for the small business rate, the first $500,000 of business profit is taxed at about 11% in BC and about 12% in Ontario and Quebec.

Pay that same money to yourself as salary and you could be taxed at up to about 53.5%.

So a dollar kept in the company leaves you roughly 88 cents to invest. A dollar paid out leaves you roughly 47 cents. You get to invest almost twice as much.

That's a real advantage. It's also just a delay. The tax still shows up later, when you take the money out. But in the meantime, a bigger pile is growing.

What happens once you invest it

Here's where owners get caught off guard. Business profits get the low rate. Investment income does not.

Interest and foreign income earned inside your company are taxed at roughly 50%. That's true in BC, Ontario and Quebec. The high rate is on purpose. It's meant to match what you'd pay personally, so nobody can use a company as a tax shelter.

You don't lose half of it for good, though. About 30 of those 50 points come back to the company later, once it pays a dividend to you. Think of it as the government holding a deposit until you actually take the money out.

That's the theory. In practice, personal and company tax rates don't line up perfectly, and they line up differently in each province. The result is that for most kinds of investment income, you end up with more money to reinvest by leaving it in the company than by taking it out and putting it in a personal non-registered account.

The catch that costs the most

So far the case has been one-sided: leave the money where it is. Here's what pushes back, and most owners hear about it from their accountant in the spring.

Earn more than $50,000 of investment income in a year and your company starts losing the small business rate. The rule uses a defined measure called adjusted aggregate investment income, or AAII, which covers interest, rents, portfolio dividends and the taxable half of any gains you've cashed in. For every dollar of AAII above $50,000, you lose $5 of the low-rate limit. By $150,000, the low rate is gone entirely.

One thing that catches people: if you own more than one corporation and they're associated, their AAII is added together for this test.

How the federal small business deduction disappears

What does that cost? If you lose the low rate entirely, $500,000 of business profit goes from being taxed at about 11% to about 27%. That's roughly $80,000 more tax in one year. Not because of anything your business did. Because of your investments.

How hard it hits depends where you are. Each province decided separately whether to copy this rule for its own small business rate, so the same portfolio can produce a different bill in BC than in Ontario. Quebec adds a test of its own based on hours worked in the business. Worth checking which rules apply to you before assuming $80,000 is your number.

Two things make it manageable. Gains you haven't cashed in don't count, so you have some say over timing. And it's based on last year, so you can see it coming.

Which makes this a December conversation with your accountant. Most owners have it in April instead, after the bill arrives.

Getting money out without tax

Not everything has to stay locked up. When your company sells an investment at a profit, half of that gain can be paid out to you completely tax-free.

Where a capital gain goes

The tax-free money from that capital dividend is worth having a plan for before it lands. One of the better uses is TFSA room. Money leaves the company with no tax, goes into an account that grows tax-free, and comes out tax-free later. You can also give your spouse the money for their own TFSA contribution without the usual rules that attribute the income back to you, so a couple can fill two accounts rather than one.

What about the fancier structures

You'll hear about holding companies, individual pension plans, and permanent insurance owned by the company. Each one solves a specific problem.

A holding company can keep your invested savings separate from the risks of running the business, which also helps when you eventually sell. An individual pension plan can let you put away more than an RRSP allows, and it tends to suit owners past 40 who've paid themselves a salary for years. Company-owned permanent insurance can be a more tax-efficient way to pass on money that's built up in the business.

They're also expensive, hard to undo, and less flexible than people expect. None of them is a default choice. They're worth a look once the company has enough in it that the setup cost is small next to the benefit. Before that, they're a distraction.

There's also a step that gets skipped more often than it should. Before any of these gets set up, the benefit should be modelled and measured, not assumed. I run each option through planning software, Conquest Planning, and compare the outcomes against whatever measure actually matters to you. That might be what's left in your estate. It might be how much you can spend each year while you're alive. It might be something else entirely. The point is to see the size of the benefit in your own numbers before you pay to build the structure, rather than taking it on faith that it helps.

Where to start

Before you optimize anything inside the company, check the personal accounts. A TFSA grows tax-free and comes out tax-free, and nothing inside a company can match that. RRSP room only builds if you pay yourself a salary, not dividends, which is one reason salary can win even in years when dividends look cheaper.

A sensible order:

1. Work out how much the business genuinely needs on hand, including a cushion.
2. Check your unused TFSA and RRSP room, and whether how you pay yourself lets you fill it.
3. Look at last year's investment income against that $50,000 line.
4. Sort out how you pay yourself and how you invest at the same time, not in separate meetings six months apart. This is the part I coordinate with your accountant, and it's where most of the value sits.