Paying a salary to make RRSP contributions

Why the adage might be "age old"

Tax practitioners emphasize the importance of maximizing RRSP contributions but paying a salary for a small business owner may not be the most tax-efficient strategy.

Strategies such as paying out corporate dividends or leaving all funds to be taxed in the corporation’s hands are also worthy of consideration. Let’s have a look.

By Victor Lu and Justin Abrams

Advantages of leaving the money in the corporation

Integration & the tax rate advantage
In a perfect world, individuals should be indifferent to whether they receive income personally or through their corporation. Tax on salary should be equal to the combined tax on corporate earnings and personal dividends. Due to differences in provincial tax rates however, this is not the reality. 

Opportunities for absolute tax savings arise by allowing profits to be taxed in the corporation' hands and then taxing the dividends paid out to the individual shareholders.

In Ontario for example, this results in an absolute tax saving of 3.22%.

The tax deferral advantage
Another factor to consider is whether the shareholder requires the cash from the corporation to meet his/her personal consumption needs. If there are other sources of income to support personal living expenses, additional salary that maximizes the RRSP contribution may not be required. And since the small business tax rate is generally lower than the personal tax rate, a significant tax deferral can be obtained by retaining/reinvesting the funds in the corporation (or corporate group).

In Ontario for example, retaining the funds within the corporation at the 15.5% small business corporate tax rate instead of the 49.53% highest marginal personal tax rate, provides a tax deferral advantage of approximately 34%. This deferral does not represent actual tax savings, but is a timing benefit as these funds will eventually be taxed when they are extracted as dividends. The deferral advantage drops to approximately 23% if this income is taxed in the corporation’s hands at the general Ontario corporate tax rate.

Disadvantages of taking a salary

In addition to higher personal tax rates and loss of deferral, paying a salary generally results in additional payroll taxes to both the individual and the corporation.

Canadian Pension Plan (CPP) premiums
A business owner who receives a salary (and is therefore an employee of the corporation) must contribute a portion to the CPP. For 2013, both the employee and the employer must contribute 4.95% of any salary paid to the CPP to a maximum salary base of $51,100. This results in a cost of $2,356.20 to both the employee and the employer. To the employer the cost is tax deductible, while the employee can offset a portion of this cost via a personal tax credit upon filing his/her personal income tax return.

Employment Insurance (EI) premiums
If the employee is not exempt from payment of EI premiums on salary remuneration, he or she is subject to EI premiums on salary received to a maximum of $891.12 in 2013. The corporation must also make an EI contribution of 1.4 times the employee portion (i.e., maximum of $1,247.57), resulting in a total cost of $2,138.67. These costs are mitigated to both the corporation and the employee in the same way as CPP contributions described above. Employer Health Tax (EHT) Some provinces levy an additional payroll tax on salary remuneration. In Ontario for example, the 1.95% Ontario EHT is applicable to corporations exceeding $400,000¹ in total remuneration. 

Employer Health Tax (EHT)
Some provinces levy an additional payroll tax on salary remuneration. In Ontario for example, the 1.95% Ontario EHT is applicable to corporations exceeding $400,000¹ in total remuneration.

On the other hand…

RRSPs provide some protection from creditors
One advantage offered by an RRSP is that it can shelter savings from creditors. In bankruptcies, RRSPs are protected from creditors, whereas investments within the corporation are not.

Don’t lose your Lifetime Capital Gains Exemption (LCGE)
Investments made within a corporation can be tricky: they may disqualify the owner from claiming the LCGE upon disposition of otherwise qualified small business corporation (QSBC) shares.

The LCGE allows an individual to receive $750,000 (proposed to be $800,000 in 2014) in tax-free capital gains on the sale of QSBC shares. But to qualify as QSBC, 90% or more of the value of the corporation’s assets must be used in the active business on the date of sale. Investing retained funds that would otherwise have been paid out as salary to the owner(s) may be deemed to be generating passive investment income rather than active business income and may jeopardize the QSBC status of those shares.

Income splitting
Retaining funds within a corporation provides numerous income splitting opportunities not available under RRSPs. This includes paying dividends to shareholders over the age of 17 and/or reasonable salaries, which can effectively lower the overall family 'tax burden'.


If you need the cash, depending on your province of residence, you may end up paying more tax by receiving a salary as compared to leaving the funds to be taxed in the corporation and then withdrawing them as a dividend and forgo the RRSP contribution. If you do not need the cash immediately, you can potentially give up a significant tax deferral by taking a salary that will be taxed immediately, as opposed to leaving the funds in the corporation to be taxed at the preferential small business corporate tax rate.

While there are no longer generic rules of thumb, it continues to be important to understand the objectives and cash needs of the owner manager to determine what course of action makes sense.


¹ At the time of writing, the Ontario budget proposed that this exemption be increased to $450,000 beginning January 1 2014 and indexed for inflation. The budget has also proposed the elimination of this exemption for private sector employers with annual payrolls in excess of $5,000,000.

Victor Lu is a senior tax analyst who primarily works with Consumer Business clients, specializing in private corporate compliance and has exposure to and knowledge of personal income taxation.

Justin Abrams is a tax manager at Deloitte LLP specializing in private company/owner-managed taxation, including corporate restructuring, estate planning & Mergers and Acquisitions. 


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