TAX DEFERRAL - Corporate Tax Planning Strategies

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

Tax deferral is a financial strategy that allows a taxpayer to delay paying taxes on income, investment gains, or other sources of wealth until a future date. The core concept is that the taxpayer doesn't pay the tax liability now, which allows the principal amount and any earnings that would have been used to pay taxes to remain invested and potentially grow.

From a corporate business perspective, the value of tax deferral in a Canadian business setting primarily lies in the ability to retain and reinvest a larger amount of money sooner, which can significantly accelerate business growth and long-term wealth accumulation.

A. Enhanced Cash Flow and Reinvestment

  • Immediate Availability of Funds: By delaying the payment of personal tax on business profits, the corporation retains more cash. This increased cash flow can be immediately reinvested in the business for things like:

    • Operational expenses

    • Research and development

    • Marketing campaigns

    • Acquisition of new assets (where the Capital Cost Allowance can further reduce taxable income)

  • Compounding Growth: Reinvesting the pre-tax funds allows the larger amount to generate returns, a process called compounding. Since the principal is larger than what the owner would have if they took the income personally and paid tax on it immediately, the growth can be significantly higher over time.

B. Lower Initial Corporate Tax Rates

  • Small Business Deduction (SBD): Canadian-Controlled Private Corporations (CCPCs) benefit from the SBD, which taxes active business income up to a certain limit (federally, $500,000) at a much lower corporate tax rate compared to the highest personal marginal tax rate [more on small business deduction].

  • The Deferral: The difference between the low corporate tax rate (often in the 9% to 12.2% range, depending on the province) and the higher personal tax rate (which can exceed 50%) represents the amount of tax that is effectively deferred. This deferred amount is what remains in the company for reinvestment.

C. Timing and Control Over Personal Taxation

  • Flexibility in Withdrawal: The business owner controls when to withdraw the retained profits from the corporation (usually as salary or dividends). This allows them to manage their personal tax liability by withdrawing funds in a year when their personal income (and therefore, their marginal tax rate) is lower. This is particularly valuable when planning for retirement.

D. Mechanisms and Strategies

Tax deferral is often achieved through strategies such as:

  • Retaining Earnings in the Corporation: Instead of immediately paying out all profits to shareholders as salary or dividends, the corporation retains profits. With Canadian-Controlled Private Corporations (CCPCs) benefiting from a lower corporate tax rate on their first $500,000 (or other small business limit) of active business income than the highest personal income tax rates; keeping the income inside the corporation, the personal tax on that income is deferred until the owner eventually withdraws the funds as dividends or salary [more on retained earnings].

  • Using a Holding Company Structure: Transferring retained profits from an operating company to a separate holding company through tax-free intercorporate dividends. This can shield the retained earnings from the operating business's risks and creditors. The funds can then be invested by the holding company, and the personal tax on those investment earnings is deferred until the shareholder withdraws the money from the holding company [more on holding companies].

  • Deferring Salary and Bonuses: Business owners can strategically time the declaration and payment of salaries and bonuses.  A bonus declared in the current fiscal year but paid within a certain number of days (e.g., 179 or 180 days) after the fiscal year-end can be deducted by the corporation in the current year, but the owner recognizes the income for personal tax purposes only in the next calendar year, achieving a short-term tax deferral.

  • Capital Cost Allowance (CCA) and Accelerated Deductions: Claiming deductions for the depreciation of capital assets (CCA) and utilizing temporary accelerated investment incentives. CCA is a tax deduction that reduces taxable income, even if the cash was spent in a prior year. The recent temporary enhanced First-Year CCA deductions (like the immediate expensing for certain property) allow businesses to deduct a much larger portion of the cost of eligible property in the year it becomes available for use, significantly reducing current-year taxable income.

  • Scientific Research and Experimental Development (SR&ED) Tax Incentives: Deducting eligible SR&ED expenditures and claiming Investment Tax Credits (ITCs) for R&D conducted in Canada. While not strictly a deferral, the program provides a significant benefit by reducing the amount of income tax payable or providing a cash refund. The deduction against income effectively reduces current taxable income, while the credit offsets tax liability or is refunded [more on SRED tax incentives].

  • Tax-Deferred Rollovers (e.g., section 85 Rollover): Using provisions in the Income Tax Act (like section 85) to transfer eligible property (such as inventory, capital property, and accounts receivable) to a corporation on a tax-deferred basis in exchange for shares. This allows a sole proprietor, for example, to incorporate a profitable business without immediately triggering tax on the accrued gains of the transferred assets. The tax is deferred until the corporation eventually disposes of those assets [more on section 85 rollovers].

It should be noted that tax deferral in Canada operates under the principle of tax integration. The system is designed so that the total tax paid on business income (corporate tax + personal tax on withdrawal) is eventually supposed to be similar to if the individual had earned the income directly. The true value, therefore, is not a permanent tax saving on all the income, but the significant financial advantage gained from having the cash in the corporation to grow sooner and longer.

For knowledgeable and experienced tax law representation for corporate tax planning strategies, as your business enterprise strives to optimize the financial advantages of legal tax structuring, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

What is a Section 85 Rollover

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