Part of The manufacturing guide
Paying yourself and your family from a manufacturing company
In a family-run manufacturer, paying a spouse, son or daughter can make sense. But dividends to family members are caught by the tax on split income rules unless an exception applies. Here's how salary, dividends and TOSI work, with a family example.
Key takeaways
- Salary to a family member is fine if it's reasonable for the work they actually do
- Dividends to family members are taxed at the top rate under TOSI unless an exception applies
- The two main exceptions are working in the business about 20 hours a week, or owning at least 10% of the shares at age 25 or older
Many manufacturers are family businesses. A spouse runs the office, a son works on the floor, a daughter helps with the books during university. Paying them through the company is normal and legitimate. Doing it in a way the CRA accepts takes some care.
This article is part of our guide to the financial side of running a manufacturing business.
Two ways to pay: salary or dividends
| Salary (or wages) | Dividends | |
|---|---|---|
| Deductible to the company | Yes | No (paid from after-tax profit) |
| CPP contributions | Yes, both shares | No |
| Creates RRSP room | Yes | No |
| Payroll account and remittances | Required | Not needed |
| The main tax rule to watch | Must be reasonable for the work done | Tax on split income (TOSI) for family members |
Most owner-managers use a mix for themselves, and the right mix changes as the company's income and their own needs change. For family members, the question is usually simpler: what are they actually doing in the business?
Salary to family members: be reasonable
The company can deduct salary paid to a family member only if it's reasonable for the work they actually perform. In practice, think: what would you pay someone else to do the same job, for the same hours?
- Keep timesheets or a work schedule and a job description.
- Pay through regular payroll, with source deductions and a T4, just as you would for any employee.
- A teenager sweeping the shop on Saturdays can be paid a fair wage for those hours. Paying them $40,000 for it won't hold up.
Dividends to family members: the TOSI rules
When a family member receives dividends from a private company, the tax on split income (TOSI) rules apply. Under TOSI, the dividend is taxed at the top personal rate, unless one of the exceptions applies. The rules exist to stop business income being "sprinkled" to lower-income family members who don't contribute.
The exceptions that matter most in a family manufacturer:
1. They work in the business: the "excluded business" exception
If the family member is actively engaged in the business on a regular, continuous and substantial basis, dividends to them are excluded from TOSI. Working an average of at least 20 hours a week while the business operates meets the test. It counts in the current year or any five previous years (they don't have to be consecutive). It's available from age 18.
2. They own a real stake: the "excluded shares" exception
A family member 25 or older who owns shares with at least 10% of the votes and 10% of the value of the company is generally excluded. The company also has to earn less than 90% of its business income from services, and can't be a professional corporation. A manufacturer usually passes that test easily, because it sells goods.
3. Other exceptions
- A reasonable return for family members 25 and over, based on their work, the capital they've put in and the risks they've taken.
- Spouses of owners aged 65 or older: dividends can be excluded if they would have been excluded for the owner.
Example: one family, four answers
Greg owns a precision machining shop in Leduc. His family:
| Family member | Situation | Dividends taxed under TOSI? |
|---|---|---|
| Linda, 52, spouse | Runs the office about 30 hours a week | No: excluded business (20+ hours a week) |
| Tyler, 26 | Shop foreman, full time, owns 15% of the votes and value | No: excluded business, and excluded shares |
| Ava, 27 | At university in Ontario, doesn't work in the business, owns 5% | Yes: no exception applies, top rate |
| Noah, 19 | Works summers only, about 400 hours a year | Likely yes for dividends. Pay him a salary for his summer work instead |
For Ava, a dividend is taxed at the top rate, often more than if Greg had simply taken the money himself. For Noah, a reasonable summer wage, paid through payroll, is the clean answer.
Plan it before you pay it
TOSI is decided when dividends are paid, and mistakes are expensive: the dividend is taxed at the top rate, and penalties and interest can follow. Before paying dividends to family members:
- Confirm who qualifies for which exception, and keep evidence such as timesheets, payroll records and share registers.
- If you're considering changing who owns shares, get advice first. Share reorganizations have their own tax consequences.
- Review the plan every year: a family member who stops working in the business may still qualify (the five-year look-back), or may not.
Money leaving the company also affects your lender's view of the business. See reporting for owners and lenders.
The bottom line
Paying your family through the company can be good for everyone, as long as it reflects what they really contribute. We help owner-managers plan salary and dividends each year, set up family payroll properly, and keep the records that support it. Book a call before your next dividend.
Sources
This article is general information, not advice for your situation. Rules and rates change, so talk to us before acting on it.