Tax Planning: Capital Gains Surplus Stripping
2020 was a challenging year for everyone. Due to the economic impact of the pandemic, the Canadian government has helped alleviate some of the financial pressures experienced by businesses with an unprecedented level of spending. While the spending was necessary to keep businesses afloat, it brought about significant government debt. This has initiated conversations about the eventual increase in taxes to service the increased debt load. Although this remains an open question, most tax practitioners are in agreement that there is a high probability of an increase.
The Federal government has, in the past, and will continue to focus on high-net-worth individuals and certain corporations to fill their tax revenue base. The next Federal budget is likely to be released in March of 2021 and there are concerns, amongst the tax community and academics, that the capital gains inclusion rates will be increased and/or certain existing tax planning strategies may no longer be available.
One of the strategies that may no longer be available is the Capital Gains Surplus Strip (CGSS). The CGSS has been utilized increasingly by business owners over the past few years as it provides for a highly tax efficient way of extracting funds out of a successful business. This strategy can also be used by an owner of a business who has a large shareholder loan balance owing to their company.
Outside of the CGSS, there have been two main approaches in the extraction of business funds by shareholders. They consist of either paying a salary (highest marginal tax rate of 53.53%), or paying a dividend (highest marginal tax rate of 47.74% on non-eligible dividends). As an alternative, the CGSS taxes funds withdrawn by an individual in the highest marginal bracket at only 26.76%. Below are the taxes owing by an individual trying to extract $2 million out of their business using the three alternatives discussed above.
|Capital Gain Surplus Strip||Non-Eligible Dividend||Salary|
|Amount before tax||$ 2,000,000||$ 2,000,000||$ 2,000,000|
|Tax||$ 535,200||$ 948,000||$ 1,070,600|
|After tax payout||$ 1,464,800||$ 1,052,000||$ 929,400|
As you can see, the CGSS results in significant tax savings as this strategy can save between $412,800 and $535,400 in personal tax, when compared to a salary or non-eligible dividend on a $2 million payout. The CGSS is a very complex transaction which requires intricate tax planning and must be done by an experienced tax professional. If executed correctly it is a legitimate tax planning tool and is permissible by the CRA. As mentioned previously, there is considerable concern amongst the tax community and academics that this type of planning will no longer be available, or may become less advantageous, after the reading of the next Federal Budget in March 2021.
The information provided in this publication is a brief overview of the CGSS. If you would like additional details, including applicability to your personal situation, please feel free to contact us at 647-969-7382 or at firstname.lastname@example.org.