Episode 196: The Playbook for Balancing Taxes, Retained Earnings, and Passive Income in Canada

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Are you a Canadian business owner sitting on retained earnings but unsure how to invest them without losing half to taxes?

You’ve worked hard to build a profitable corporation, but the moment you try to grow wealth inside it, the tax system feels like a trap. Between passive income rules, dividend categories, and the dreaded 50% tax on investment earnings, it’s no wonder many entrepreneurs hesitate. The truth is, the system isn’t broken—it’s just designed to be complex. And without the right strategy, you could miss out on powerful opportunities to grow and protect your wealth.

In this episode, you’ll discover:

• Why the refundable dividend tax on hand (RDTOH) account can be your secret weapon against the 50% passive income tax rate.
• How structuring corporate-owned investments—like real estate or insurance—can create long-term tax efficiency and flexibility.
• Practical steps to balance retained earnings, leverage, and wealth transfer strategies so your money compounds instead of stalls.

Press play now to learn how to turn retained earnings into a tax-smart wealth engine for you and your family.

Resources:

• Ready to take a deep dive and learn how to generate personal tax free cash flow from your corporation? Enroll in our FREE masterclass here. 
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
• Discover which phase of wealth creation you are in. Take our quick assessment and you’ll receive a custom wealth-building pathway that matches your phase and learn our CRA compliant tax optimized strategies. Take that assessment here.
• Dig into our Ultimate Investment Book List
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX.

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting cordporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Canadian business owners face unique challenges when it comes to passive income, Canadian taxation, and retained earnings, but with the right corporate structure optimization and tax planning, wealth can grow more efficiently. Whether through real estate investing in Canada, RRSP optimization, or leveraging RDTOH for smarter dividend strategies, entrepreneurs can design a Canadian wealth plan that balances today’s needs with tomorrow’s goals. From salary vs dividends Canada decisions to integrating insurance policies for protection and estate planning Canada for legacy, every choice impacts long-term success. By using proven wealth building strategies Canada, such as the investment bucket strategy, corporation investment strategies, and capital gains strategy, business owners can move toward financial independence Canada, pursue an early retirement strategy, and create a lasting system for modest lifestyle wealth and financial freedom in Canada.

Transcript:

On today’s episode, I want to introduce you to David, a successful incorporated professional who on paper has done everything right. He’s built a thriving business, kept his expenses lean, and even started investing the retained earnings inside the corporation instead of taking them out and paying a hefty personal tax bill to boot. But like many of you Canadian wealth secret seekers, all of this talk about earning passive income

or what we might call investment income inside of his corporate structure has him worried about where he might make his next big investment. When you hear about passive income and how it’s taxed at about 50 % across Canada, it can certainly make you want to pump the brakes. Now, he’s not alone. This is the reality for thousands of Canadian business owners who earn passive income inside a corporation.

In this episode, we’re gonna unpack why the system works this way, the difference between eligible and non eligible dividends, and why the refundable dividend tax on hand account is the key to keeping Canadian tax integration fair. However, just because the system’s designed where you could pay less than 50 % on that passive income, the real question becomes, will you pay less than 50 % on those investment earnings?

At the end of the episode, we’re going to wrap up where we talk about steps David and his family can take to get ahead of these rules and structure their wealth in a balanced, flexible, and efficient manner. All right, my friends, let’s dive in. So I had the pleasure with meeting with David, again, using a different name, making some modifications to the situation just slightly, but really getting at the core of some of the questions that he had.

on the call on a discovery call. And again, if you’re interested in a discovery call, head on over to Canadian wealth secrets.com forward slash discovery, and you’ll answer a couple of questions. And then you can book a call just like David did here. So we can go through your specific situation. He’s a successful incorporated professional. He’s built a solid business in the consulting space, and he’s gained some significant retained earnings inside of his corporation. Now,

He does have a spouse, his spouse works a T4 job and also has a defined benefit pension plan. So his spouse actually isn’t a shareholder of this corporation or part of this structure yet. It might make sense to at some point in the future, but because there’s gonna be a pension coming in at some point down the road, it could actually make sense where maybe she isn’t a…

shareholder of that company. Again, that would be something more specific for your scenario that we’d really have to dig into here. Now, like many business owners, once you have reached a level of success where there are enough retained earnings inside your corporation, first off, the first step is protecting them, right? So at first he’s thrown them into GICs and other types of high yield savings account, but then quickly recognize that at the end of every year,

He was actually getting taxed on that interest at a much higher rate than the active rate that he was paying on the active income he was earning in the business in the first place. Now, that’s kind of painful to see, right? So you see about 50 % of the interest that you’ve earned or, you know, if you’re dealing with rental properties, any type of rental profit that you’re making, the rental income would be considered passive as well.

We can get into an argument with the CRA about how most rental investment is not passive at all. There’s a lot of work to be done there. But in this regard, though, there’s a little bit of confusion where this 50 % is taken. And the impression that a lot of business owners might get is that you’ll never see that money again. Now, that

could be true, but it’s actually not. OK? And there’s a couple different scenarios. We’ll talk about them as we unpack this episode. So as he’s built up this retained earnings, he’s put the retained earnings into safe assets, GICs, short-term type of savings accounts, and things like that, just to earn a little bit of income, but then keeping it liquid enough should he need it in the business. And then typically as a business owner, what will happen is you’ll hit a point

where that emergency fund, that safety bucket, that cash flow account, whatever you wanna call it, hits a level where you’re now ready to actually make some longer term investments. And in his case, he’s looking at buying multifamily property. And he’s looking to do so through the CMHC MLI Select program.

That program’s great. We’re not gonna dig into the program a whole bunch. Actually, Matt Bigley and I are actually gonna be utilizing that program potentially on a building conversion that we’ll be doing over this next year. Great program to check out because what it does is it allows you to have a very long amortization up to 50 years. That will stretch out the mortgage and bring the payment down. And it also allows you to pull up to 95 %

of the value of the building out. Now, not recommending you take 95 % out. That’s quite a bit. That’s not leaving much there for market volatility and such, but what a great program that you can potentially utilize when you’re looking to make multifamily purchases or a new build in the multifamily space. His problem is, is that when he thinks about this and says, if I buy this multifamily building, of course we’re hoping that over time it will appreciate.

that appreciation is going to be a capital gain at some point down the road. If they sell or if there’s a deemed disposition, that capital gain is gonna be taxed very differently than the actual rental income, which will be considered passive income inside the corporation. So as many of you might be wondering is like, why would anyone want to buy real estate inside a corporate structure if it’s going to be taxed at about 50 % if there’s any type of profit?

So we’re gonna dig into that a little bit here today and we’re gonna talk about how we can take what he’s got in the corporation and still make wise moves around it. Now, I wanna get a few things out of the way. First off, there is the liability reason why you want to buy real estate in particular inside a corporation. There’s many of you out there that are maybe newer on the journey or maybe you bought an investment property and you’re looking to buy more.

and you’re wondering when do I incorporate? Usually the time to incorporate, and we have an episode about this, I’ll put it in the show notes so that you can actually go and listen to this episode about when should I incorporate. Typically you’re incorporating for liability reasons or potentially lending reasons. So the lender might not actually give you any more leverage at a personal level. So you might actually get forced into incorporating in order to buy that real estate.

In this case, David’s thinking, listen, if I’m not worried about liability, why wouldn’t I just buy this thing in my personal name? Well, here’s the problem. If David’s got a bunch of money stuck inside as retained earnings, he’ll have to take that money out of the corporation, get taxed at a personal level. He’ll then lose his small business tax credit, which is allowing his business to pay a very low tax rate of around 10-ish percent, depending on your province.

and he’ll have to take it all on at a personal level. That means he might take, let’s say it’s a million dollars and it might turn into something like 600,000 if he takes it all out at once in order to invest outside of the corporation. Now, here’s the other nuance that’s really important. If this building or if this real estate investment is generating enough income where the actual income is gonna be problematic,

from a tax purpose is a good problem to have, of course, right? If it’s going to become problematic from a tax perspective, you’re probably going to be paying a high tax rate, whether you own it personally or corporately. So let’s talk about what’s really going to happen here, because early in the early goings, when this building just starts to show profit at some point, which might not be in the first year, it might not even be in the first five years, you might start to pull profit.

And then you say, well, I’m paying 50%. I would much rather take a little bit of this profit at a personal level. This is where integration takes over and you actually have more freedom than maybe you recognize. All right. So while at the start of all of this, you might pay 50 % in passive income tax inside the corporation. What happens is you actually get a credit for about 30% in a notional account known as the refundable dividend tax on hand credit, okay, or account.

What you’ll actually get is a credit to a notional account known as the refundable dividend tax on hand account. A lot of people use the acronym RDTOH. Okay, lots of words, lots of letters, and it’s hard to remember. But this refundable dividend tax on hand account is actually going to track, much like the capital dividend account does, the CDA, they are both notional accounts. It’s gonna track how much

you’ve actually earned in passive income and you’re gonna get a 30-ish percent credit to that account to track along the way. So let me give you an example here. What ends up happening is basically if I earn $100,000 in passive income, I’m gonna pay 50 % in tax-ish, depending on your province, to the government on that passive income.

However, that account is gonna be credited about 30%, which is about $30,000 in this example. $100,000 of passive income, 50 % goes to the government, but we get a credit of 30 % to the RDTOH account. Now, this isn’t a real account. There’s no money sitting there. It’s just a ledger to keep track. And what that keeps track of is when you do plan to take a dividend out at a personal level,

your corporation will get that chunk back. So if a let’s say you took the full $50,000 that’s remaining after the government took $50,000, you take the other 50 and you declare an ineligible dividend, okay, or non eligible dividend and you take it personally, what’s going to happen is you’re going to pay tax at a personal level on that dividend and therefore

the corporation’s going to get that 30 % credit gifted back from the government. So let’s unpack this for a second. The goal here is that the government wants what they call integration, right? So the CRA is saying, listen, we don’t actually want to punish corporations any differently than we’d punish a person at a personal level. Like, we can argue all day whether it’s a punishment or not. I would say our tax system feels very punishing regardless of its personal.

or corporate. But basically what they’re saying is that a business owner shouldn’t actually have an advantage over top of someone at a personal level, you know, because they don’t have a corporation set up or they didn’t start a business. So what they’re trying to do is they’re trying to make it fair so that everybody is going to pay around the same amount. So really what happens in the early goings here, if you do show profit from this investment, maybe it’s a real estate, for example,

As long as you’re taking that profit and you’re taking it out personally, your corporation is going to get that 30 ish percent credit back. So you’re going to get that money back here, but now you’re taking it on at a personal level. set another way. What’s going to end up happening if you were to do this year after year after year is you’re eventually just, you’re basically going to be paying whatever anyone without a corporate structure would be paying on that investment income at a personal level.

Of course, we’re not talking about any type of registered accounts here. We’re just talking at a personal level. So that’s not all that bad. So you’re not going to get punished harder than someone at a personal level. But imagine if there was a way that we could do this a little bit better so that we maybe don’t have to pay as much. And that’s really what this tax planning and these strategies and optimization is all about. So in this particular case, what we’d recommend is

that you do have a mortgage on corporate owned investments. I would argue you wanna have a mortgage on pretty much any of your investments that you have personal or corporate. Why? Will show less income. So the same issue we have at a personal level, if you show too much income on paper, you’re gonna pay more tax. Well, the same is gonna be true here inside the corporate structure. If I have no mortgage on this building and I say I pay a million dollars for a building and I’m making all a bunch of profit on it,

The profit, the profit unfortunately is gonna be taxed. We’re gonna pay 50 % upfront. And then unless I pay it out as a dividend to the shareholder personally, I’m actually going to be stuck paying 50%. And of course, that’s not gonna be very helpful from a compounding standpoint. So if you’re in a lower tax bracket, this can be a really helpful way to stay in lower tax brackets. You’re not gonna pay the full 50%. However, as you get more and more successful,

you get more and more income maybe inside the business, more and more retained earnings and more and more investments, you get a good problem to deal with, which is too much income coming in to the corporation. And this is where planning really takes hold. So when we talk about the refundable dividend tax on hand account, basically,

In a perfect world, any credit that you’re getting to that account each year, you wanna be actually taking a dividend out so you can clear that out so that you’re not compounding your investment income at 50 % tax rates, meaning you’re only gonna get to invest 50 % of that income for compounding. So there are some ways that we can do that. Again, if we intentionally keep our personal income low, we can do that a little bit, but once that…

passive income gets to a place where it’s too large, you’re going to essentially end up in a 50 % tax bracket, be it corporately or personally. And this is where so many of our corporate leverage strategies come into play. We’re trying to get ahead of planning here so that we can not only grow our assets and grow our tax problem, but also have some tools in place so that we can deal and manage the taxes that we do pay.

Keep in mind here, tax has to be paid. We totally understand that. But we wanna utilize the Income Tax Act here in Canada so that we’re maximizing the opportunities that we have. So one of the scenarios that we had recommended here for David, first off was, you know what? You do wanna keep those retained earnings inside of your corporate structure, okay? We don’t wanna rip the cord, pull it all out, pay a huge amount of tax in order to reinvest it personally.

because first of all, it’s actually going to hold you back from getting to a place where the income generated is actually gonna have you at a 50 % tax rate. So it’s gonna help you on a tax rate perspective, but your net worth’s gonna stay lower for longer, right? So we wanna keep that money inside. If we have money inside of that corporation and we’re not planning to top up the RSPs, or maybe you are topping it up at the same time, top up those RSPs, or if you have an IPP, we’re not against doing those types of things as well.

But for the rest of those retained earnings, what we would recommend that we do is before we take all of those dollars and we put them straight into an investment, first of all, if it’s real estate, we want to make sure that we’re utilizing leverage. We also might consider re utilizing leverage in the future as well. So that means as it’s getting paid down, as the mortgages are getting paid down, we, I don’t want to say never, but we want to be cautious about when we get to a place where the mortgage is completely paid off.

feels amazing, I totally get that. But from a tax perspective, you may be putting yourself in a tough spot unless let’s say you have no other income coming in to you or other shareholders personally, where you can take these dollars, we pay the tax corporately and we get our credit to the RDTOH account, pay them out as dividends and it doesn’t put us into the highest tax bracket personally. So we wanna be cautious about how we do that.

One thing that we oftentimes, I would say most oftentimes make sense is as those retained earnings are accumulating inside the corporation, that we actually consider a corporate owned insurance plan. We do high early cash value. So those who are, know, infinite bankers out there and such, this is like infinite banking on steroids for corporations because we’re able to buy the same policy.

without paying a huge personal tax first before we buy the policy, that policy gets to grow tax-free like a GIC without paying any tax on the actual investment because it’s inside of the insurance policy, which is going to be tax-free as long as we don’t cancel that policy, right? If we do cancel a policy, then there will be tax on the growth of the cash value.

So the idea is we keep this policy in place. We fund it for likely a 10 year period or longer. You can go as long as you’d like. You have the right but not the obligation to fund that policy. And then we use leverage against that policy to do a couple different things. First off, we get interest, which is going to be a write-off against other income inside of the business, which is great. And we reinvest those dollars into some of these income producing assets.

and we create a flywheel here. The most beautiful part is, well, today we’ve been talking about the RDTOH account, which is the refundable dividend tax on hand account. That notional account is helpful for the passive income tax that we’re paying and getting that refund eventually. Well, the CDA, the capital dividend account, is the one that’s going to be rewarded in the long run when a death benefit pays out of that corporate policy.

So this is a huge, huge win here. Now we’re not suggesting that everyone has to take every dollar of retained earnings and put them through a policy, although we can argue and we could show it mathematically why that does make sense. What we would say is having some portion of your strategy, a high early cash value policy inside of your corporate structure, likely you’re holding company. And that’s what David’s going to be doing here for him and his family as he gets ready to

prepare for the purchase of that multifamily property. So just keep in mind here, the system actually isn’t broken. It’s actually just really complex. All right. And it’s complicated as well. I would argue maybe too complicated or more complicated than it needs to be. Now I’m not arguing that our taxes are too high. I do believe that. However, the system itself isn’t broken. There are ways that we can strategize here.

And keep in mind that ultimately at the end of the day, there’s one strategy to pay the personal rate. So you’re not paying 50%. However, as that income, that investment income inside the corporation continues to grow and compound, eventually you will be in the highest tax bracket, whether it’s just in the corporation or to you personally. So that’s where these strategies really can make a huge difference, not only for your net worth while you’re living,

but then also to ensure that your estate value is more like a rocket ship instead of the other way around when deemed dispositions and passing shares and selling capital assets, all of these things happen and your net worth actually decreases without the use of a high early cash value policy. So if you’re a business owner and this is a new information for you and maybe you’re in a situation where you’re wondering some of these same exact things,

you should be hopping on a call with us over at CanadianWealthSecrets.com forward slash discovery. And we can run your scenario and really try to work out a plan that makes sense for you and your family. And finally, if you’re just curious about where you are in the wealth building journey, you can be run through our four stage process by heading over to CanadianWealthSecrets.com forward slash pathways. And you can take our short four stage assessment.

All right, my friends, that’s it for me. I hope you had something to learn from this episode. If you did, give us a thumbs up, subscribe, and hey, if you haven’t yet, we’re over on YouTube with short reels that can be really helpful for you along the way. So head over to YouTube and hit subscribe. All right, my friends, this is a reminder that this is not investment advice. It is for entertainment purposes only and…

You should not construe any such information or material as legal tax, accounting, investment, financial, or other advice. And Kyle is a life licensed and accident and sickness insurance agent. And I am the president of Canadian Wealth Secrets Incorporated.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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