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Understanding the art of Capital Gains Stripping

What is Capital Gains Stripping?

The Capital Gains Stripping method is used efficiently to distribute retained earnings from a corporation through Capital Gains, a tax-efficient approach from the traditional method of issuing dividends. Business owners use this technique to withdraw money from their corporation at a lower tax rate compared to the regular dividends rate.

An example of how Capital Gains Stripping can be done, and how it can benefit you:

MDM.ca (MD Financial Management) provided this example that simplifies how Capital Gains Stripping can be done:

 “You start by creating a new corporation (which we’ll call “Newco”). Your medical professional corporation (“MPC”) then goes through a special transaction where you get different shares of your MPC. You then sell these different MPC shares to Newco at their fair market value in exchange for a note payable. This series triggers a capital gain that you must report on your personal income tax return.”

To further describe this example, the reason why you would rather have a capital gain than a dividend would be because you only need to pay tax at 50% of the total capital gain.

The table below outlines how much you could save in personal taxes through the Capital Gains Stripping method;

 Capital Gain (27%)(Fed+Ont)Non-Eligible Dividend (47.74%) (Fed+Ont)
Gross Income$684,931.51$956,754.69
Taxes Payable$184,931.51$456,754.69
Net Income$500,000.00$500,000.00

As per the scenario, an individual could save around $271,000 in personal taxes by using the Capital Gains Stripping method for a net withdrawal of $500,000.

IMPORTANT DISCLAIMER

While the Capital Gains Stripping method may seem as easy as it sounds, it’s rather a method that must be carefully performed as the Income Tax Act contains provisions, such as the general anti-avoidance rule (GAAR) in section 245, and the specific anti-surplus-stripping provisions in section 84.1 which might be applicable and must be looked in to by a tax professional who has the appropriate legal resources.

Our associates at Senathi & Associates will prepare all the supporting documents you need to get started, while also providing consulting services to ensure you’re making the best decision for yourself and your business.

For all inquiries/questions regarding Capital Gains Stripping, please call Senathi & Associates at (416) 479-0600 or email us at info@gtacpa.ca, and we’d be more than happy to be of assistance!

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