Payroll (T4) Advantages for Owner-Managers
Clients of our firm who are owners of their own incorporated businesses will be familiar with our oft-stated recommendation to treat themselves as “employees” of their own corporation, and in so doing, subject themselves to regular, monthly remittances of personal income tax and Canada Pension Plan contributions. This also leads to the annual obligation to account for these remittances in a T-4 information return, by the end of February, covering the prior calendar year.
There are a number of reasons why operating a payroll account for yourself is a good idea, even if you are the only “employee” of the business:
- It is undesirable to fall behind on personal taxes. Firstly, it draws undue attention to oneself, and the business, from officials of the Canada Revenue Agency (CRA). Certainly, more than a few audits have been triggered because of repeated tax delinquency. Having a convenient means of paying taxes monthly makes taxes more manageable and easier to budget.
- Regardless of the facts of the situation, technically a state of “employment” exists between the individual owner-manager and his corporation - this is prescribed by statute. For instance, the holding of the office of a corporate director is deemed under the Income Tax Act to be a state of “employment”. And certainly, any holder of the majority of the voting shares of a corporation would be a director under B.C. company law.
- If a state of “employment” exists, the Income Tax Act requires “employers” (the corporation) to make cash withholdings from the remuneration of the employee, and to remit these withholdings within prescribed time limits (in most cases, by no later than the 15th of the month following the calendar month in which the remuneration was paid).
- The only alternative tax position that an owner-manager could take with respect to his income from the corporation (other than treating the draws as dividends - another topic completely) is to consider the fees paid to be in the nature of compensation to an independent contractor. The quid pro quo of such a position is that the independent contractor should be charging GST on the fee (assuming it exceeds $30,000 per year). This is an administrative and cash flow burden that few owner-managers are willing to deal with.
- The filing of T4 slips every year qualifies the owner-manager for the privilege of setting up an “individual pension plan (IPP)” - see the Topical Library for a separate article on these structures. IPPs are denied to those who have never reported their remuneration on a T4 slip.
- Tax instalments are required on a quarterly basis for all taxpayers, at a minimum. Payroll accounts can override that requirement, and can completely eliminate the need to make quarterly instalments.
- Certain banking and other practical situations are often made easier, or facilitated, when T4s exist.
The biggest and most obvious problem for owner-managers who have payroll remittance accounts is to determine what their “remuneration” actually is. To some degree, this will be determined by cash draws, but of course the overall level of profits in the business will be a significant determining factor. Some businesses, such as those in health care, have characteristically consistent profits, so a prediction of remuneration can be made quite accurately. For most other businesses, the best that can be done is to make an estimate, based on likely household consumption needs, and work backwards to the necessary tax remittances.
Usually, in situations such as this, mid-year adjustments are necessary. However, with taxes already paid to date, the adjustment is usually much easier to deal with, and the owner-manager is seldom faced with a huge and difficult to finance tax obligation, payable immediately. Sometimes, the news is good - the remittances to date are greater than they needed to be, and the payments for the rest of the calendar year can be greatly reduced, or even eliminated.
Payroll accounts also facilitate the declaration of income tax on a “fiscal” basis - that is, the draws for a fiscal period (say, the business year ending on July 31st), will form the basis for “management remuneration” for the calendar year in which the fiscal year ends. Thus, with a July fiscal period it becomes possible to defer taxation of cash drawn from the business for the period August 1st to December 31st of each year. It also allows us to calculate the taxes that flow from the remuneration for the fiscal period, and recommend adjustments, if necessary - because the “income” is determined on a fiscal basis, but the tax remittances are made, of course, on a calendar basis.
Therefore, this system allows for both deferral, and “catch-up”. The most common final deadline for the remittance of taxes for a particular year is January 15th of the following calendar year. Any remittance received by CRA after that date will be automatically assumed to be either in respect of remuneration for the new calendar year, or else late, and subject to penalties. We urge our clients to take great care when making remittances on or close to the deadline, to avoid the incurrence of undue penalties.
The important distinction between “income” (which is a legal concept, subject to income tax), and cash draws, is a constant source of discussion with clients, particularly those with fiscal years that do not end on December 31st. We maintain careful and extensive monitoring systems to keep track of this for our clients.
The arm’s length employees of the business will of course be required to be part of the same payroll system - and their withholdings are determined precisely, pursuant to prescribed withholding guides. These withholding requirements must be adhered to strictly. What happens in practice is that the owner-manager’s personal taxes are simply “added” to the precise remittance for the employees.
For example, an owner-manager and spouse might require monthly tax and CPP remittances, based on the budgeted target, of $4,000.00 per month. If the remittance requirement for all of the employees of the business is calculated to be, say, $105,681.25, then the amount to be actually remitted to the CRA payroll remittance account would be $109,681.25 (i.e., the $4,000.00 is simply added on).
Thus, a pool of cash remittances accumulates (along with the employee withholdings) at CRA within the payroll remittance account. The T4s that are issued in February “instruct” CRA how to allocate that pool of cash - and our objective is always to have enough “surplus” to cover the taxes on the income that the owner manager must put on his T4 slip for the year.