How to Invest Retained Earnings in Your Corporation

Retained earnings are the profits your corporation has kept after tax. When the business does not need all of that money, the corporation can invest it. A corporation can hold an investment account in its own name. You do not need a holding company to do it.

The question is how. A corporation is taxed differently from you, so a portfolio that suits a personal account may not suit a corporate one. This article is educational. Your accountant confirms your corporation's figures.

Decide what the money is for

Before choosing investments, sort the money by its job.

• Operating cash. What the business needs to run and to pay its tax.
• A reserve. Money set aside for a slow stretch, equipment or an opportunity.
• Long-term surplus. Money the business is unlikely to need for years.

Only the third group belongs in a long-term portfolio. The first two need to stay stable and easy to reach.

How each kind of return is taxed

Inside a corporation, the kind of return matters as much as the amount.

Dividends from Canadian companies follow their own rules, which your accountant can explain.

Two tax accounts sit behind the portfolio.

• The capital dividend account. The non-taxable half of a capital gain is added to it. A capital dividend paid from that balance is received tax-free by Canadian-resident shareholders. See The Capital Dividend Account, Explained.
• Refundable tax. Part of the tax a corporation pays on investment income is refundable when it pays taxable dividends. It is tracked as refundable dividend tax on hand, or RDTOH.

The $50,000 line

Investment income can also change the tax on the business. A Canadian-controlled private corporation gets the federal small business rate on up to $500,000 of active business income. When the corporation and its associated corporations together earn more than $50,000 of passive investment income in a year, that limit is reduced by $5 for every $1 over $50,000. At $150,000 it is gone.

The full rule is in The Passive Income Rule for Canadian Corporations.

A worked example, in dollars

Two corporations each have $500,000 or more of active business income. Each earns $80,000 from its investments in a year, in different ways.

For Corporation A, the federal rate on the $150,000 of business income that loses the limit is 15%, not 9%. That difference is the $9,000.

Both corporations still pay tax on the investment income itself. The table shows only what happens to the business limit and the capital dividend account. The two portfolios are not the same investments and do not carry the same risk. The point is narrower: the kind of return changes the tax result. This is an illustration, not your corporation's figures.

What a low-distribution portfolio does

A low-distribution portfolio is built to pay out less along the way, so less investment income lands on the corporation's return each year. Growth that stays in the portfolio is not on the return until a gain is realized. When it is realized, half is taxable and the other half is added to the capital dividend account.

It does not remove tax. The taxable half of a realized gain still counts as investment income in the year it is realized, so the timing of gains is part of the plan.

Tax is one input, not the only one. How long the money can stay invested, the risk the business already carries and your need for cash all matter.

If you may sell the company one day, raise it with your accountant early. A corporation that holds too much in passive assets can put the lifetime capital gains exemption at risk on a share sale.

What your accountant does, and what we do

Your accountant is in charge of the corporation's tax. They know what the corporation earned, how you are paid and what its tax accounts hold. They prepare the year-end, file the return and decide with you when dividends are paid.

Our part is the investment account: what the corporation owns, what it pays out and when gains are realized. We build corporate portfolios to be low-distribution, so passive income is planned for, not discovered at filing. With your permission, we coordinate directly with your accountant. Nothing is ever paid between us and your accountant, in either direction.