Unequal Dividends and Pay Between Co-Owners of a Corporation

Can two owners take different amounts out of one corporation?

Yes, but each kind of payment has its own rule. Salary can differ because it pays for work. Dividends are paid per share, so on one class each owner's dollars follow the shares held; the amount per share differs only if the owners hold different classes. A shareholder loan is not pay: it is money owed back, and it is added to income unless an exception, such as repayment in time, applies.

A case is not simple when the corporation has one class of shares, when a co-owner is a spouse or relative who does not work in the business, when the loan accounts already differ, or when unequal payments have already been made. Gather the articles, the share register, any shareholders' agreement, each owner's pay history and each owner's loan account before deciding.

This page cites federal corporate law. A corporation formed under a province's statute follows that statute, which this page does not describe.

Why must dividends on the same class of shares be equal per share?

When a corporation has only one class of shares, every holder has equal rights, including the right to receive any dividend declared (Canada Business Corporations Act, section 24). Each share therefore receives the same dividend. An owner who holds more shares of the class receives more dollars, in proportion; that changes ownership, so it is not a way to adjust pay.

The rights of each class are set out in the articles, and changing them takes an amendment to the articles, not an understanding between the owners (section 24; section 173).

The tax side matches. The CRA describes a dividend, in its usual meaning, as a distribution shared in proportion among the holders of a class or series of shares, where the corporate-law requirements to pay it are met. It adds that a payment's label does not decide its nature (CRA Folio S3-F2-C2, paragraph 2.17).

A payment that gives one holder of a class more than that holder's proportion is therefore not an ordinary dividend. The Act does not say in terms how such a payment is treated; the answer depends on the facts. The result depends on the share rights, the declaration and what each owner directed or agreed to. One possible result is a shareholder benefit. A benefit a corporation confers on a shareholder is included in that shareholder's income (Income Tax Act, subsection 15(1)). The corporation cannot deduct it, withholds no payroll deductions on it, and reports it on a T4A (CRA: shareholder benefits).

The owner who receives less can be affected too. If an owner directs, or agrees, that a payment goes to someone else as a benefit that owner wanted to confer, the payment is included in the owner's income to the extent it would be had it been paid to the owner, even though the owner received no cash (subsection 56(2)). That rule does not apply to an amount included in split income (subsection 56(5)).

For how to declare a dividend, see Declaring and paying a dividend; for the rate, see Tax on dividends from your corporation.

What if the amounts taken are already unequal?

Past unequal payments can sometimes be corrected, but how depends on what each payment was when it was made. A journal entry that relabels a past payment does not change what it was. The CRA says the substance of a transaction governs, and that tax follows what taxpayers actually did, not what they meant to do (CRA Folio S3-F1-C1, paragraphs 1.13 and 1.14).

Options a professional would test include repayment by the owner who took more, a further payment to the other holders, or treating the excess as a shareholder benefit. Each has its own corporate-law and tax result. Which is open depends on whether there was a duty to repay at the time, whether the corporation passes the solvency test now, and what was already filed. Gather bank statements, the loan ledger, any minutes and every slip issued for the years involved.

How can share classes let dividends differ, and what must be in place first?

The articles can create more than one class of shares and give each class its own rights. The directors can then declare a dividend on one class and not the other. The classes, their rights and the issued shares must exist before the dividend, because the rights at the time of declaration govern it.

1. Set the class rights in the articles. The articles must set out the rights, privileges, restrictions and conditions of each class (section 6; section 24). The right to vote, the right to dividends and the right to the remaining property on dissolution must each attach to at least one class.
2. Amend the articles if the classes do not exist yet. Creating a class and changing share rights are done by special resolution, which needs two-thirds of the votes cast or the signature of every shareholder entitled to vote (section 2; section 173). Holders of an existing class may also vote separately on changes that affect their class (section 176). Articles of amendment must then go to the Director, and the change takes effect on the date on the certificate of amendment, not the vote date (section 177; section 179).
3. Issue the shares. Subject to the articles, the by-laws and any unanimous shareholder agreement (a written agreement among all the shareholders that restricts the directors' powers, section 146), the directors decide when, to whom and for what consideration shares are issued, and a share cannot be issued until it is fully paid (section 25).
4. Pass the solvency test. A corporation cannot declare or pay a dividend if there are reasonable grounds to believe it cannot pay its liabilities as they come due, or that the realizable value of its assets would fall below its liabilities plus the stated capital of all classes (broadly, the amounts received for the shares issued, section 26; section 42). Directors who vote for or consent to a dividend paid contrary to section 42 are jointly and severally liable to restore the amount to the corporation, and an action must start within two years of the resolution (section 118).
5. Declare the dividend by class. The directors manage the corporation, subject to any unanimous shareholder agreement (section 102). A resolution that names the class and the amount per share shows what was declared.
6. Test the recipients for tax on split income. A dividend to a recipient whose relative works in or owns part of the corporation can be taxed at the top rate; see the tax on split income section further down.

Separate classes make unequal dividends possible, not automatically safe. Each dividend still needs the declaration, the solvency test and the tax check. A class created after a dividend was paid does not change that dividend.

The other owner matters too. A class structure that lets the directors favour one owner can be challenged even when the articles allow it: a shareholder whose interests are treated in an oppressive or unfairly prejudicial way, or unfairly disregarded, can apply to a court, which can make an order to rectify the matter (section 241).

How do salary and dividends work together when one owner works more?

An owner who works more can be paid a salary for the extra work, while dividends stay in proportion to shares. Salary pays for services. A dividend is a return on the owner's investment in the shares and is not payment for services (CRA: shareholder benefits). Salary does not depend on how many shares anyone holds, so it can reflect different work between equal owners.

Salary is also outside the split-income rules, which generally cover dividends and interest from a private corporation and not salary (CRA: guidance on the split income rules for adults). A salary is still deductible only to the extent it is reasonable for the work (next section).

A person who works in the business but holds no shares cannot be paid a dividend: dividends go to the holders of a class of shares. Pay for that person's work is usually salary through payroll, and it must be reasonable too. For a spouse or child, see Paying family members.

An owner who works for the corporation holds two roles. Each role is supported by its own records: written duties and a payroll record for the salary, and a share register and dividend resolution for the dividend. For running the payroll, see Running payroll. For one owner's choice between the two, see Salary or dividends; for the total each owner should take, see How much to pay yourself.

Is a reasonable salary limited, and what must each owner's pay reflect?

Yes. The Income Tax Act allows no deduction for an expense except to the extent it was reasonable in the circumstances (section 67). The Act gives no formula, so the question is a matter of fact.

Each owner's pay should reflect the duties, hours, skill and responsibility of the role. The CRA's published test for wages paid to a family member asks whether the work is necessary and whether the amount is what the business would pay someone else (CRA: line 9060). It is written for family wages, so it is a guide here, not a safe harbour.

A salary for little or no work is hard to support as a reasonable expense; a dividend, which is paid on shares, does not depend on work. Two owners who do similar work but are paid very differently should be able to say why, in writing, when the pay was set.

Can the shareholder loan account even things out?

First check who owes whom. If an owner genuinely lent money to the corporation, the corporation owes that owner the principal back; repaying it is a debt repayment, not salary or a dividend, so repayments to different owners can differ. The CRA's own example counts an owner's loan to the corporation when working out what the owner still owes it (CRA Folio S3-F1-C1, example 7). Reconcile each owner's advances and repayments first.

If the owner is the one borrowing, it works only as a short bridge, and a loan is not pay. Money an owner takes beyond their share is a loan only if there is a real obligation to repay. A loan from the corporation to a shareholder is added to the shareholder's income for the year it is received (Income Tax Act, subsection 15(2)). One exception is a loan repaid within one year after the end of the corporation's tax year in which the loan was made, where the repayment is not part of a series of loans and repayments (subsection 15(2.6)). A loan that avoids that inclusion can still create a taxable interest benefit if little or no interest is paid (subsection 80.4(2)); see Interest on a shareholder loan.

If there was no duty to repay, the money is not a loan at all. Subsection 15(2) does not apply, and subsection 15(1), the shareholder benefit rule, may (CRA Folio S3-F1-C1, paragraph 1.13).

The CRA says the series rule exists to stop a taxpayer from deferring tax indefinitely by using new loans to repay existing ones. A repayment made before the lender's year-end and followed by new borrowing is generally viewed as part of a series (paragraph 1.84), and so may a repayment funded by a new loan (paragraph 1.85).

A repayment made by applying a dividend, salary or bonus that the corporation owes the borrower is not treated as part of a series, even if the owner borrows again afterwards (paragraphs 1.82 and 1.86). With separate classes, a dividend on one owner's class can be applied against that owner's loan. Repayments apply to the oldest loan first unless the facts clearly show otherwise (paragraph 1.81).

A separate loan account for each owner shows which advance belongs to whom. For when a withdrawal becomes a taxable loan, including interest on it, see Shareholder loans; for the entries, see The shareholder loan account.

Does tax on split income apply to a spouse or relative who does not work?

It can, when the person receiving the dividend is a Canadian resident with a relative who works in the corporation or owns enough of it (test below). Tax on split income (TOSI) charges the highest individual rate on certain private-corporation dividends received by a Canadian resident, unless an exception applies (section 120.4). An amount included in income under section 15 because of share ownership, such as a shareholder benefit, is within the same definition.

The test looks at each recipient's own relatives. A dividend is tested when it comes from a business that a Canadian-resident relative of the recipient is actively engaged in, or in which that relative owns shares worth at least 10% of the value of all its shares (CRA: line 40424). Relatives are people connected by blood relationship (a parent, child or other descendant, or a brother or sister), marriage, common-law partnership or adoption, so a cousin, aunt or uncle is not one (section 251, subsections (2) and (6)). Two co-owners who are not related to each other are therefore generally not tested against each other, while a co-owner whose spouse or other relative works in the corporation or holds shares in it can be.

Exceptions exist for a recipient who works in the business, holds qualifying shares or receives a reasonable return. Which one applies turns on the recipient's age and own facts; see Paying family members.

What do the books and paperwork show for each owner?

Each owner's salary, dividends and loan account are tracked separately, and each is backed by its own document. The corporation must keep its articles with all amendments, any unanimous shareholder agreement, shareholder minutes and resolutions, and a securities register, along with adequate accounting records and its directors' resolutions (Canada Business Corporations Act, section 20).

For the entries, see Recording dividends in the books and The shareholder loan account.

When do we need a lawyer or accountant before changing the share structure?

Before you create a class, swap existing shares for new ones, or sign or change a shareholders' agreement. Each changes what an owner holds, and some trigger tax.

• Creating a class or changing class rights. This is an amendment of the articles by special resolution, and a class vote can apply. Drafting the class rights is legal work.
• Exchanging an owner's existing shares for new ones. A reorganization of capital of this kind, sometimes called a freeze, is a disposition of the old shares. Section 86 of the Income Tax Act sets the cost and proceeds rules when its conditions are met, and a separate rule applies if value is shifted to a related person (section 86).
• A shareholders' agreement. A unanimous shareholder agreement can limit the directors' powers, and a higher voting requirement in it prevails over the Act's default (section 102; section 6).

Example

These examples are illustrative. All amounts are Canadian dollars, with no tax calculation.

Equal shares, unequal work

Two owners each hold half of the common shares. Owner A works full time; Owner B works occasionally. The corporation pays A a salary of $100,000 through payroll for the full-time role, then pays equal dividends of $50,000 on each owner's shares. A receives $150,000 in total and B receives $50,000. The salary accounts for the difference in pay, and the dividends stay equal per share. The salary has to be reasonable for A's duties, supported by written duties and payroll records.

Unequal dividends on the same shares

Owners A and B each hold half of the common shares. A receives $60,000 and B receives $20,000, both described as dividends. The cash difference is $40,000. An equal split of the $80,000 would be $40,000 each, but that comparison does not set either owner's taxable dividend or the value of any shareholder benefit. The classification depends on the declaration, each owner's entitlement and any loan obligation, none of which is given here. How it can be corrected depends on what the payments were when made.

Separate classes

Owner A holds Class A shares. A's spouse, Owner B, holds Class B shares and does not work in the business. The articles, amended before the dividend, let the directors declare dividends on either class. After the solvency test, the directors declare $40,000 on Class A only. The articles allow it; whether it treats B fairly is a separate question (see the steps above). A dividend declared on Class B would first have to be tested for tax on split income.

Different for you?

• Your corporation has one class of shares and you want unequal dividends, or the amounts taken are already unequal: whether to add a class, how to split salary and dividends, and how to correct past payments are share-structure and tax decisions. Gather the articles, share register, pay history and loan accounts first; the next step is corporate tax help.
• A co-owner is a spouse or relative who does not work in the business: tax on split income can apply to their dividends. The exceptions turn on the relative's own work, shares and contributions; see Paying family members and corporate tax help.
• Loan accounts already differ, or the books are behind: rebuild each advance and repayment before choosing the tax treatment. See Shareholder loans, Catching up on overdue books and bookkeeping help.
• A co-owner lives outside Canada: tax on split income reaches only Canadian residents, and payments to a non-resident owner follow different rules. See Non-resident owners of a Canadian corporation and corporate tax help.
• The CRA has said a payment was personal or a benefit: see Shareholder benefit found in an audit.
• You are adding, buying out or giving shares to an owner: see Adding or removing an owner.
• Your corporation is a professional corporation: who may hold shares is restricted. See Professional corporations.
• You gave or sold shares or property to a spouse or child: separate attribution and transfer rules can apply. See Transferring property to family.
• Your corporation is formed under a provincial statute: confirm its dividend and share-class rules in that statute and its articles with corporate tax help.