Optimal Compensation for Canadian Business Owners
As a Canadian business owner, one of the most strategic decisions you face isn’t just how to grow your company – it’s how to pay yourself. The mix of salary, dividends, and retained earnings can dramatically impact your taxes, CPP contributions, future retirement income, and even access to certain credits or benefits. And the “right” answer isn’t static – it changes based on your income level, your goals, and how your corporation is structured. This article outlines the key considerations when designing a compensation strategy and highlights a few common myths that often lead to suboptimal decisions.
The foundational question for many incorporated professionals is whether to draw a salary, take dividends, or use a combination of both. Here’s how they differ:
- Salary is a tax-deductible expense for the corporation and generates RRSP contribution room. It also contributes to CPP and qualifies you for employment income-related benefits.
- Dividends are not tax-deductible for the corporation but are paid out of after-tax profits. They don’t generate RRSP room or CPP contributions.
While many advisors default to dividends to avoid paying into CPP, it’s worth revisiting whether that trade-off is actually worthwhile.
Is CPP Worth It?
There’s a perception among some business owners that CPP is a “bad deal.” But when you crunch the numbers, it often isn’t. CPP contributions function like a forced savings plan with inflation-protected, indexed lifetime income.
Importantly, CPP is risk-free. That’s not a phrase we use lightly in investing. While GICs or government bonds may currently yield 4–5%, those rates aren’t guaranteed over decades. In fact, they were closer to 2% for much of the last decade, making it even harder to match the long-term value of CPP without taking on market risk. CPP is. The payout is backed by legislation, indexed to inflation, and runs for life – and you don’t need to manage it.
Compare that to equities, which have historically returned around 6% annually over the long run, but with substantial volatility along the way. CPP is essentially a guaranteed annuity with a competitive return and none of the behavioural risks.
In addition, the CPP death benefit recently increased to $5,000. And there are also survivor benefits, the child-rearing provision, and disability protections that can increase the overall value.
If you’re already maximizing CPP through other income sources, this may not apply. But if you’re considering whether salary makes sense, CPP should be factored in as a long-term asset – not just a payroll cost.
RRSPs: An Overlooked Benefit of Salary
One of the most powerful advantages of salary is that it builds RRSP contribution room. RRSPs are still one of the most effective tax-deferral and income-smoothing tools available, especially for professionals in higher tax brackets.
RRSP room is calculated as 18% of earned income (up to an annual maximum). Since dividends don’t count as earned income, they don’t create any room. If you draw only dividends for years, you may find yourself with a smaller RRSP than you otherwise could have had.
And remember, RRSP contributions can also reduce your net income for purposes of calculating benefits like the Canada Child Benefit (CCB), creating further household-level tax efficiency.
The “GRIP” Advantage
The General Rate Income Pool (GRIP) is a notional corporate account that tracks after-tax profits taxed at the higher general rate (i.e. above the small business limit). When your corporation earns active income taxed at the higher rate, those profits go into GRIP, and dividends paid from GRIP can be marked as “eligible dividends.”
Eligible dividends are taxed at a lower personal rate compared to non-eligible dividends, which are paid from small business income. If your corporation consistently earns income above the $500,000 small business threshold, you may want to ensure that you are utilizing GRIP to pay yourself more tax-efficient eligible dividends
Understanding RDTOH: Eligible and Non-Eligible Refund Pools
Another layer to dividend planning is how corporate investment income is taxed and refunded. The Refundable Dividend Tax on Hand (RDTOH) system is split into two buckets:
- Eligible RDTOH (ERDTOH) applies when your corporation earns eligible portfolio dividends from public Canadian companies.
- Non-Eligible RDTOH (NERDTOH) applies when the corporation earns other passive investment income like interest, foreign dividends, or capital gains not eligible for the capital dividend account.
When your corporation pays out taxable dividends, it recovers a portion of previously paid tax from these pools:
- For NERDTOH, the refund is $0.3833 per $1 of non-eligible dividend paid in 2025. So, to recover $10,000 of refundable tax, you’d need to pay approximately $26,100 in dividends.
- For ERDTOH, the refund is the same
These pools are important when planning how and when to draw funds from your corporation.
Consider letting me coordinate directly with your accountant to ensure the timing and structure of withdrawals are optimized for both personal and corporate tax efficiency.
You don’t want refundable taxes trapped indefinitely.
Additionally, it’s important to understand that not all passive income is created equal. Interest income and foreign dividends are fully taxable inside the corporation, and when that income is eventually paid out as a non-eligible dividend, the combined corporate and personal tax rate can approach 65%, depending on your province and personal marginal rate. That means less than 35 cents on the dollar may be left in your pocket. This is one of the most inefficient forms of income when passed through a corporation, and extra caution should be used when allocating large amounts to these asset classes inside the corp.. You don’t want refundable taxes trapped indefinitely. Coordinating salary and dividends can help trigger refunds in a way that fits your broader financial goals.
Planning Around the $500,000 Active Business Income Limit
If your corporation earns more than $50,000 in passive investment income, it can start to lose access to the small business deduction (SBD) – a phenomenon called the “SBD grind.”
In this case, part of your active income may be taxed at the higher general rate anyway. When that happens, those earnings generate GRIP, and it may make sense to use eligible dividends more strategically.
At the same time, be mindful of how your salary or dividends impact your passive income exposure. A proper withdrawal strategy helps reduce unintended tax consequences
What About Leaving Money in the Corporation?
Some business owners opt to leave money in the corporation for tax deferral purposes. If you don’t need the money right away, this can be effective – you pay a lower corporate tax rate initially and invest with more capital upfront. But eventually, that money has to come out – and when it does, the tax bill arrives.
That’s why compensation decisions should be aligned with long-term withdrawal plans. Taking some income now (even if it means paying some tax) can lead to more flexibility and fewer surprises down the road.
Putting It All Together: The Compensation Framework
There is no one-size-fits-all strategy, but here are a few rules of thumb:
- If you want RRSP room and CPP benefits, include some salary in your plan
- If you prioritize tax simplicity and short-term deferral, dividends may be more attractive
- If your corporation is earning above the small business limit, explore eligible dividend strategies
- Be aware of your GRIP, ERDTOH, and NERDTOH balances when planning distributions
- If you plan to leave money in the corporation, be proactive about how and when it will be withdrawn
Your personal goals, family needs, and expected retirement income sources all factor into the decision. A good compensation plan isn’t static – it should evolve as your business and life circumstances change.
If you’re unsure which approach best fits your situation, a personalized plan can help clarify the trade-offs and optimize your after-tax outcomes over time.
Disclosures:
Important information about mutual funds is found in the Fund Facts document. Please read this carefully before investing. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Unit values and investment returns will fluctuate.
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.
Stick to evidence. Ignore the hype. Build wealth systematically.
And remember: discipline beats timing.
