Successful businesses often have a significant amount of cash sitting in a bank account earning two per cent or less – zero in some cases. Having cash for an extended period of time can impact long-term growth, and your retirement plan.
Let’s use as an example a medical corporation with $100,000 sitting in cash earning 1.5 per cent a year. In ten years time the compound growth amount would be $116,054.
Now compare the compound growth of $100,000 with the incremental impact of a one per cent change, if invested:
|Return||Value in Ten Years|
To make matters worse, the taxation of interest income in corporate bank accounts are fully taxable, with no deferral ability. The above numbers in the table are not after tax.
Creating a deferral strategy within a corporate “investment” account can have a positive tax impact if implemented correctly. Opening an investment account is straightforward.
It is not necessary to have your new investment account at the same place as your corporate bank account. When the company was created, there were legal documents drawn up such as Articles of Incorporation. Every year your company is required to pay an annual fee and you obtain a Certificate of Annual Filing, which should be filed in your corporate record book.
The record book is often kept with a lawyer who helps owners complete other documents like annual minutes. Some people have these documents at home enabling them to avoid paying for the above services. In these cases, it is important that you complete the required paperwork every year.
A copy of the above corporate documents is required to open an account, along with a void corporate cheque, size of company, and information about the authorized signing authorities.
Assuming you have just opened a new investment account, you can transfer funds into this account by simply writing a corporate cheque payable to the financial firm you are dealing with (include your corporate account number in the memo field and request a receipt).
If you ever require money to be moved back into your bank account, this can be done either electronically (details obtained from void cheque during account opening) or by cheque.
Prior to any investing within the corporate account it is important to establish an Investment Policy Statement. The IPS will outline time horizon, risk tolerance, and investment objectives.
For corporate accounts we like to approach it through a visual three bucket process:
- Bucket No. 1 is for cash and emergency purposes. Depending on the type of business, this bucket is adjusted accordingly. Some businesses are more cyclical than others. Obtaining an idea of your cash flows, and how variable they are should help establish a suitable cash reserve. The focus on this bucket should be liquidity and safety. Suitable investment options for this bucket may be cash equivalents such as high interest savings accounts, cashable GICs, and short term fixed income.
- Bucket No. 2 is for growth and this should be tied to your business plan. Every company should have at a minimum, a five year business plan. Sharing the cash flow component of this plan with your advisor may help determine the most suitable investments. As an example, if you have expansion plans in three years then fixed income options provide for capital preservation with a higher potential return than cash.
- Bucket No. 3 is for portion set up for a longer period of time, such as retirement. Depending on your IPS, this bucket may hold tax efficient type investments like preferred shares and investments set up for tax deferred growth like dividend paying common shares. Setting up a Dividend Reinvestment Plan (DRIP) helps with long-term growth. This bucket should be the largest of your buckets, provided you do not have growth plans and the business has stable positive cash flows.
An understanding of tax is very important in mapping out a strategy for corporate investment accounts. Corporate tax rates on qualifying active small business income are very low in British Columbia. The term “active” is important, and differs from how interest income, dividend income, and taxable capital gains are taxed. Three areas that we ensure our clients understand is Part IV tax, Refundable Dividend Tax on Hand (RDTOH), and the Capital Dividend Account.
Accounting for corporate accounts is easier if you communicate to your advisor a few key items. Let them know the fiscal year end of your company and the name of your accountant with contact information.
Similar to individuals, companies can do tax loss selling and carry net capitals losses back provided the trades settle in the fiscal year end. Most financial advisors have the ability the save transactions in an electronic format, along with electronic monthly statements and realized gain/loss report. This can be emailed to your accountant annually to save them time inputting each transaction.