Few questions arise as frequently in the life of an entrepreneur as that of compensation: should one favour a salary or opt for dividends? At the end of each fiscal year, this dilemma resurfaces at the heart of financial and strategic planning, with implications that span taxation, social benefits and personal finances. However, beneath this apparent dichotomy lies a far more nuanced reality. The decision between salary and dividend depends on a complex interplay of interrelated factors that must be examined through the lens of your specific circumstances. This article explores these variables using a practical analytical framework that encapsulates the key considerations at stake.
Understanding the concepts: Salary vs. Dividend
The distinction between salary and dividend extends beyond mere tax terminology. It fundamentally affects how a company executive is remunerated, their social security contributions, personal taxation and overall financial strategy. Each option comes with its own set of benefits and hidden pitfalls.
What does “salary” mean?
Legally, a salary refers to compensation paid in exchange for work performed. It implies an employment relationship, even for shareholder-directors of their own corporations. It is disbursed by the business, recorded in accounting books and subject to source deductions such as Employment Insurance (EI), the Quebec Pension Plan (QPP) and the Health Services Fund (HSF). In Quebec, executives choosing to pay themselves a salary must fulfill the same obligations as any employer: issuing T4/Relevé 1 slips, remitting payroll taxes and withholding income taxes.
What is meant by dividend?
A dividend refers to a portion of a company’s profits that it elects to distribute to its shareholders. It constitutes investment income rather than earned income in the fiscal sense, meaning it is not tied to an employment relationship or any contractual obligation to pay. The issuance of a dividend is contingent upon the generation of net profits after taxes and must be approved by the board of directors.
In Quebec, two types of dividends are distinguished: eligible dividends, which benefit from a reduced tax rate and are generally issued by corporations taxed at the general rate and non-eligible dividends, which are distributed by small and medium-sized enterprises (SMEs) subject to a lower tax rate. However, this form of income does not entitle the recipient to benefits under the Quebec Pension Plan (QPP) or other social protection mechanisms.
What factors truly influence the choice between salary and dividend?
Opting to receive either a salary or dividends is not merely a matter of personal preference; it hinges on a combination of tax, legal and strategic considerations specific to each business situation. The ownership structure, targeted income level, social contribution requirements and financial planning goals all play a decisive role in this choice.
Personal and family situation
Having dependent children or planning for parental leave significantly alters the equation. For instance, an individual intending to claim benefits under the Quebec Parental Insurance Plan (QPIP) should favor a salary, as this program is based on income subject to social contributions. The same applies to childcare expenses, as the corresponding tax credits are calculated based on earned income.
Age and family circumstances also influence the decision. Someone in their thirties aiming to build a history of income eligible for public retirement benefits (QPP) would be well-advised to opt for a regular salary, especially if they have a conservative investor profile.
Conversely, an older individual or one whose children are financially independent might lean toward dividends, provided they already have adequate social coverage.
Retirement rights and contributions to the QPP: only salaried income is contributory
The Quebec pension system is based on a contributory model. Income earned from salaried employment is subject to contributions to the Quebec Pension Plan (QPP), which in turn generates retirement entitlements. An entrepreneur planning for early retirement (around age 60), or anticipating a shorter life expectancy due to family history, would benefit from contributing more in order to receive the maximum QPP benefits.
Conversely, an individual with a longer projected lifespan or who plans to retire later (after age 65) may offset the lack of contributions by relying on alternative forms of savings. In such cases, dividends become a viable option—especially when the income is invested in an RRSP or TFSA.
Moreover, inconsistent or incomplete contribution periods often call for reinforcing eligible income. In this context, salary becomes more attractive, as it prevents gaps in the contributory history.
Shareholding structure: dividend as a strategic advantage
The structure of a company’s shareholding significantly impacts the flexibility of income distribution. In companies with multiple shareholders who have differing financial needs, dividends provide a way to tailor remuneration to individual circumstances—provided the distributions comply with proportionality rules. The same applies to corporations with passive shareholders who have no employment contracts with the company: in these cases, dividends are the only viable form of remuneration. On the other hand, in a sole proprietorship or a small business managed by a single founder, salaries can be managed more freely—particularly to optimize access to certain social benefits.
Social coverage and Disability protection: a privilege reserved for salaried workers
Drawing a salary provides access to public social protection programs such as health insurance, employment insurance, the QPP and parental benefits. It also opens the door to disability insurance programs, whether obtained individually or through an employer. This serves as a financial safety net for entrepreneurs in cases of illness or long-term disability.
In contrast, dividends do not grant access to any social safety nets. Therefore, shareholders who opt for this form of income must consider taking out private insurance if they wish to protect themselves against life’s uncertainties.
Tax considerations and Cash Flow Management: a unique advantage of dividends
The Refundable Dividend Tax on Hand (RDTOH) is a Canadian-specific tax mechanism that allows a private corporation to recover a portion of the taxes paid on investment income when it distributes taxable dividends to its shareholders. This represents a powerful tax optimization tool.
Additionally, entrepreneurs may benefit from administrative simplicity. Since dividends do not involve contributions, T4 slips, or complex calculations, they are often viewed as a more straightforward method of income distribution.
Lastly, in terms of asset protection, dividends offer an advantage: unlike salaries, they are not subject to seizure in the same manner by creditors under certain conditions.
Is it possible to receive both a salary and dividends?
There is no one size fits all answer when it comes to choosing between these two forms of compensation. The most appropriate option always stems from a nuanced analysis of personal, fiscal and organizational circumstances. However, it is entirely feasible for a business owner to receive both a salary and dividends, provided this combination complies with current tax regulations.
How to strategically combine salary and dividends?
Blending salary and dividends is not only possible but often advisable for entrepreneurs. Québec’s tax system notably allows incorporated business owners to draw both employment income and dividends derived from their company’s after-tax profits. Still, it is crucial to understand the implications of such a strategy.
In practical terms, salary is tax-deductible for the company, thereby reducing its taxable income. It also enables contributions to the Québec Pension Plan (QPP), grants access to higher Registered Retirement Savings Plan (RRSP) limits and provides a stable income—an important factor when seeking personal or mortgage credit.
Dividends, on the other hand, are not considered earned income. They do not qualify for QPP contributions or RRSP room, but are typically taxed at a lower personal rate, particularly if they originate from corporate profits already taxed at a lower rate. As such, combining both forms of remuneration can result in tax optimization.
For instance, an entrepreneur might choose to draw a sufficient salary to maximize RRSP contribution room and supplement it with dividends to reduce overall tax liability. Nevertheless, adopting this kind of financial strategy requires a thorough understanding of the company’s tax landscape, the entrepreneur’s personal plans and long-term objectives.
Why seek support from a financial services firm?
The complexity of Quebec’s tax system, coupled with ever-evolving legislation, makes decision-making particularly challenging for entrepreneurs without specialized expertise. A financial services firm thus becomes an indispensable partner, helping secure financial choices, maximize tax benefits and structure compensation with a focus on long-term growth.
Engaging an expert goes beyond merely ensuring compliance with tax laws. It’s about gaining access to a comprehensive and strategic outlook. This advisor assesses the entrepreneur’s personal situation, the company’s financial performance and growth objectives to design a tailored strategy. They may, for instance, determine how best to optimize compensation to fund a real estate project, prepare for a business acquisition, or develop a robust retirement plan.
The expertise of such a firm lies in its cross-disciplinary knowledge spanning taxation, accounting, estate planning and investment management. With an integrated approach, they can recommend a balanced salary/dividend mix aligned with your current circumstances while anticipating future tax implications.
Need greater clarity on your own situation?
Mathieu Routhier is a recognized expert in financial planning for incorporated entrepreneurs. With a deep understanding of the fiscal, legal and personal dimensions of compensation, he helps you craft a customized plan that supports your ambitions, safeguards your assets and maximizes every dollar earned. Whether you opt for salary, dividends, or a strategic combination of both, you can rely on a rigorous, tailored and forward-thinking approach.
