Who Can Receive Dividends?

As we get into the holiday season, many of us are in a giving mood. But one of the important seasonal questions for business owners is – “Who Can Receive Dividends from my company this year?

For some context, the reason that we care about this question is primarily that paying dividends to family members in lower tax brackets can lower the overall tax burden for a family. This is possible because we have marginal tax rates which means that the lower your income in a year, the lower the rate of tax.

A business owner may also want to pay dividends out of their operating company to a holding company to provide some creditor protection or to purify their company to qualify for the capital gains exemption, but this is a topic for another blog post.

Here are some tips for determining who can receive dividends:

1. Remember that dividends are a distribution of a share of PROFIT. If the company is not profitable in the year, there can be no dividends.
2. Dividends have to be paid to SHAREHOLDERS of a company. This requires that the family member receiving a dividend has been properly issued shares of the company AND the shares have a right to receive dividends. If shares are owned by a family trust, the family members receive dividends by being beneficiaries of the family trust.
3. If there is one class of shares, dividends have to be paid PROPORTIONALLY to each shareholder – i.e. if you own 50% and your spouse owns 50% of the same share class, you would each have to receive 50% of the dividend paid. If the shares are set up with DISCRETIONARY dividends, they can be paid in any proportions, at the discretion of the Directors, which is preferable.
4. The Income Tax Act (Canada) does put some restrictions on who can receive dividends and be taxed at their individual rate. In recent years and up to the end of 2017, the payment of dividends to children at a lower rate could begin in the year that they turned 18. Starting in 2018, the payment of dividends will be subject to a TEST OF REASONABLENESS (see link for more information). This will be very restrictive for many small businesses that have been paying dividends to family members.
5. The last but important point is that once you have figured out who can receive what amount of dividends by looking at #1 to #4, make sure that you document the amount(s) through a WRITTEN DIRECTOR’S RESOLUTION. This is the only way to make sure that any payments are legally considered a dividend.

Your call to action after reading this blog post is to talk to your CPA about how best to pay dividends in 2017 if you have not done so already.