In Canada, small business owners have unique opportunities to structure their corporations in ways that can optimize tax efficiency and provide income streams for family members. One popular method involves using different classes of shares to allocate dividends to family members. When done correctly, this strategy can minimize the family's overall tax burden and serve as a valuable income-planning tool. Here's how it works.

Understanding Share Classes

Corporations can issue different classes of shares, each with distinct rights and privileges. For tax planning, these shares are often structured to allow flexibility in paying dividends. For example:

• Class A Shares might belong to the primary owner.
• Class B Shares could be allocated to a spouse.
• Class C Shares might be issued to adult children.

This structure allows the corporation to declare dividends to specific shareholders, tailoring payouts to align with their individual tax circumstances.

Tax Advantages of Dividends

Dividends are generally taxed more favourably than salary income due to the dividend tax credit in Canada. When dividends are paid to family members in lower tax brackets, they benefit from reduced tax liabilities compared to the primary shareholder receiving all the income. For example. if the family member is a student with little or no other income, they will benefit from the dividend tax credit, resulting in minimal or no tax liability. The dividends received can be used by the shareholder (your child) to cover post-secondary costs, such as tuition, housing, books, and other education-related expenses.it can be a very powerful financial planning tool.

Income Splitting Opportunities

The primary benefit of using different classes of shares is income splitting, which involves spreading income among family members to reduce the overall tax burden. By paying dividends to family members who fall into lower tax brackets, the corporation can achieve significant tax savings.

For example:

• A spouse who is not working or earns minimal income can receive dividends taxed at a lower rate.
• Adult children attending university might use the dividend income to fund their education, benefiting from their low-income tax bracket.

Key Considerations and Tax on Split Income (TOSI) Rules

While this strategy offers many benefits, it must be implemented with care to comply with Canada Revenue Agency (CRA) regulations, particularly the TOSI rules. These rules limit income-splitting benefits in specific scenarios:

• Dividends paid to family members not actively involved in the business may be subject to higher taxation unless they meet certain exemptions.
• Exemptions apply if the family member is over 18 and makes meaningful contributions to the business, such as working a minimum number of hours per year or owning a substantial equity stake.

Steps We Use to Implement the Strategy

1. Incorporate or Amend Corporate Structure: Ensure your corporation allows for multiple share classes.
2. Issue Shares to Family Members: Allocate shares based on your tax-planning goals.
3. Meeting to Discuss Compliance: Work with a tax advisor or accountant to ensure compliance with CRA rules.
4. Monitor and Adjust: Review the strategy annually to adapt to changes in family circumstances, tax laws, or business performance.

At Allan Bush Investment Team, we help many of our clients create tax-efficient income through the use of different share classes. It can be a powerful tool for Canadian small business owners to achieve tax efficiency and provide family members with income streams. However, it's crucial to navigate the complexities of TOSI and other CRA regulations carefully. With proper planning our Team will help execute this strategy which can contribute significantly to your family’s financial well-being.