One main objective of setting up a business is to earn profits. When cash flow is managed effectively, a common outcome for profitable companies is that funds will accumulate in the business bank account.
A common issue many business owners will face is what to do with these excess funds. Some options include:
- Keeping a portion of these accumulated funds in the business bank account. These funds can be kept on hand for various reasons, such as to support ongoing business operations, to purchase equipment, to engage in marketing initiatives, or many other reasons
- Repayment of loans
- Withdrawing these funds personally, such as through salary or a dividend
- Investing these funds, with the intention of earning investment income (ie – capital gains, dividends, interest, rental income)
Each business and owner has unique requirements, so it is important that planning is done to ensure smart decisions are made. This includes considering the tax risks.
One must be very cautious about having investment income in their corporation that carries on an active business.
If investing funds with the intention of earning investment income (passive income), it is vital to consider the potential consequences. If not carefully considered, there can be significant implications, which include the following:
1) Small Business Clawback – Under the proposed changes set to begin in 2019, the small business deduction limit will be reduced by $5 for every $1 of passive (investment) income above a $50,000 threshold. The small business deduction would be totally eliminated if the corporation earns investment income of $150,000 or more. The clawback will consider the aggregate passive income of associated corporations.
2) Jeopardizing the Lifetime Capital Gains Exemption – When investments are held in a corporation carrying on an active business, the passive investment income can jeopardize the eligibility of the corporation’s shares for the lifetime capital gains exemption.
If your corporation currently has investment income or is considering acquiring investments, you can contact us to learn about minimizing the impact on your business.