A Québec corporation pays roughly 12.2% tax on income eligible for the small business deduction. Remuneration is planned between salary and dividends, and surplus can be sheltered in a holding corporation.
Tax optimization has a bad name, which is a shame: there is a fundamental difference between evasion, which is illegal, and planning, which simply means arranging your affairs so as not to pay more tax than the law requires. For a Québec corporation the lawful levers are numerous and well marked out. You have to know them, and document them properly.
The small business rate
The corporation’s first advantage is structural: the first $500,000 of active business income benefits, subject to conditions, from the small business deduction. The combined federal and provincial tax on those profits then sits far below the upper brackets of personal income tax. Watch the conditions of eligibility, though: in Québec the reduced provincial rate is tied partly to the corporation’s number of paid hours, which can deprive very small structures of part of the advantage. A point to confirm with your accountant against your own situation.
Deferral, the quiet engine
The real lever is time rather than rate. Every dollar of profit left in the corporation instead of paid out as salary or dividend is taxed, for now, only at the corporate rate. The difference against your personal rate stays in the business and works: it funds equipment, pays down debt, builds a reserve. Personal tax will come one day, when you take the money out, but you choose that moment, ideally a year when your income, and therefore your rate, is lower.
Salary or dividends: a balance, not a doctrine
A corporation lets you choose how you are paid. Salary is deductible for the corporation, creates Québec Pension Plan entitlements and RRSP room, but bears payroll contributions. A dividend avoids those contributions, but creates no entitlement and is not deductible. There is no universal answer: the right balance depends on your age, your retirement plans, your need for cash and the programs you care about. It is a calculation to redo every year, not a decision carved into the articles.
Deductible expenses, but documented ones
A corporation deducts the expenses incurred to earn its income: rent, insurance, professional fees, training, a vehicle to the extent of business use, a home office under precise rules. The key word is “documented”. A real expense with no supporting record becomes indefensible on audit. Administrative rigour is not the enemy of optimization; it is its precondition.
The legal form of the decisions matters
It is easily forgotten: tax strategies rest on legal acts. A dividend requires a directors’ resolution; a year-end bonus, a documented decision; a poorly drafted shareholder agreement can compromise each person’s access to the capital gains deduction on a sale. Optimization is a team effort: the accountant calculates, the lawyer secures the form. When the two work together, the savings survive an audit.
The holding corporation, what it is really for
It gets talked about a great deal, often badly. A holding corporation is a corporation that holds the shares of your operating corporation, or that receives the surplus the latter generates. It saves no tax by its mere existence, which disappoints those who were sold it as a conjuring trick.
Its usefulness lies elsewhere, and in certain situations it is real. It allows surplus to be moved out of the operating corporation, which is exposed to commercial risk, into an entity that is not: the accumulated cash stops being within reach of a creditor of the active business. It also makes it easier for shareholders with different needs to coexist, each holding their interest through their own holding corporation and deciding the pace at which they pay themselves. Finally, it helps keep the operating corporation in a condition suited to thecapital gains deduction, by regularly clearing out assets that have no business being there.
It has its costs too: a second corporation to constitute, maintain, file for and have reviewed. Whether it makes sense therefore depends on the volume of surplus and the level of risk in the business. The question to put to your accountant is not “should I have a holding corporation?” but “what would it solve in my situation, and at what amount does it start to pay for itself?”
The shareholder account, to be kept with care
In almost every small business there is an account tracing the movements of money between the owner and the corporation: the initial investment, expenses paid personally, withdrawals, repayments. That account is a valuable tool and a frequent trap.
A balance in your favour, because you funded the corporation out of your own pocket, lets you recover those sums without their being income. A balance in the corporation’s favour, because you took out more than was attributed to you, is a debt owed to it, with the consequences described in our article on the tax advantages of incorporating. In both cases the account is only worth how it is kept: every movement dated, supported and consistent with the corporate records. Reconstructed three years later from memory, it proves nothing at all.
What draws attention on audit
Without giving away a recipe, certain signals come up constantly in the files that turn difficult. Expenses in round, repeating amounts with no matching record. A vehicle deducted in full with no travel log. Transactions with related persons, rent paid to a relative, a salary to a family member, with no proof that the work was done or that the price matches what a third party would have paid. Amounts paid to the shareholder whose character changes from year to year with no decision explaining it.
The common thread is always the same: it is not the transaction that causes the problem, it is the absence of a record. Paying a salary to your spouse is perfectly legitimate when they really work in the business and the pay is reasonable. It is being unable to demonstrate anything that turns a defensible decision into a reassessment. The minute book and watertight bookkeeping are, in that sense, tax tools as much as legal ones.
Sales taxes are not income tax
One last distinction, the source of a surprising number of cash-flow difficulties. Income tax bears on your profits and is paid once those are established. GST and QST are never yours at any point: you collect them on the State’s behalf and you remit them. Watching them pass through your bank account creates the illusion of working capital that does not exist, and that is how profitable businesses end up in default on their remittances. Our article on l'GST and QST registration explains the mechanism and the responsibilities attached to it.
Frequently asked questions
Is it better to pay yourself a salary or dividends?
There is no universal answer. Salary is deductible for the corporation, creates Québec Pension Plan entitlements and RRSP room, but bears payroll contributions. A dividend avoids those contributions without creating entitlements. The right balance is recalculated every year.
What is a holding corporation for?
It shelters surplus from the risks of the active business, lets shareholders with different needs each decide the pace at which they are paid, and helps keep the operating corporation eligible for the capital gains deduction.
What draws a tax audit?
The absence of a record, more than the transaction itself. Expenses in round amounts with no supporting document, a vehicle deducted in full with no log, or transactions with relatives with no proof of the work done or of a price comparable to the market.