Salary vs Dividends in Canada 2025: How Business Owners Should Pay Themselves Under the Income Tax Act

Every incorporated business owner in Canada faces one big question each year: should I pay myself a salary or dividends? The right choice can save you thousands in tax, improve your RRSP room, and protect you from CRA penalties. Under the Income Tax Act (ITA), how you pay yourself determines your personal tax rate, CPP contributions, and future planning options. This guide breaks down both strategies, the legal framework, and the smart hybrid approach accountants use to maximize wealth while staying fully compliant with Canadian tax law.

Understanding Salary vs Dividends

Paying Yourself a Salary

A salary is treated as employment income under ITA s.5(1). It is deductible to the corporation (ITA s.18(1)(a)) as an expense incurred to earn income, and fully taxable to you personally under graduated tax brackets.
With salary, the corporation must withhold and remit CPP, EI, and income tax to the CRA. Advantages: creates RRSP contribution room (18% of earned income up to the annual limit), builds CPP entitlement, and counts as “earned income” for several credits/deductions (e.g., childcare, spousal support).
Case: Singleton v Canada (2001 SCC 61) confirms deductibility turns on purpose—salary is deductible when incurred to earn business income.

Paying Yourself Dividends

Dividends are paid from after-tax corporate profits. They are not deductible to the corporation, but benefit from the dividend gross-up and credit system (ITA ss.82(1), 121). For CCPCs taxed at low small-business rates, integration often keeps combined corp+personal tax roughly in line with personal tax—while allowing timing flexibility.
Case: Neuman v The Queen (1998 SCC 82) — dividends are distributions of profit based on share ownership, not employment income.

Income Tax Act References

Salary: ITA ss.5, 18(1)(a), and 67 (reasonableness).
Dividends: ITA ss.82, 83, 121.
CRA IT-73R6 stresses salaries must be reasonable relative to services (ITA s.67).

The Hybrid Strategy

Many owners blend salary and dividends to balance pros/cons: ensure CPP participation and RRSP room via a base salary, then use dividends for flexibility and potential rate advantages. Example modeling: $120,000 total income split as $80,000 salary + $40,000 dividends may minimize combined tax (facts matter).
Penalty note: Late/insufficient payroll remittances can trigger interest (ITA s.161) and penalties (ITA s.162).

Practical Scenarios

When Salary Makes Sense

• You need RRSP contribution room.

• You want steady CPP benefits later.

• You need stable income for mortgage/financing.

• You want to reduce corporate income with a deductible expense before year-end.

When Dividends Make Sense

• You have other personal income and want to manage brackets.

• You prefer flexible, on-demand payments.

• The corporation has cash flow but doesn’t need salary deductions this year.

• You want to minimize payroll administration costs.

When Hybrid Wins

• Pay a modest base salary for CPP/RRSP room.

• Top up with dividends at/after year-end for flexibility.

• Remember: ITA s.125 small business deduction applies to active business income, enabling deferral inside the corporation.

Common Mistakes and CRA Penalties

• Missing or late source-deduction remittances (10% first failure; up to 20% for repeated/egregious).

• Unreasonable salaries disallowed under ITA s.67.

• Declaring dividends without proper corporate minutes/share-class review.

• Failing to issue T5 slips for dividends (late-filing penalties under ITA s.162).

Jurisprudence Summary

• Singleton v Canada (2001 SCC 61): tracing & deductibility.

• Neuman v The Queen (1998 SCC 82): dividend characterization.

• Symes v Canada (1993 SCC): business vs. personal expense.

• Bronfman Trust (1987 SCC): interest-expense tracing for owner withdrawals.

• 65302 British Columbia Ltd. v The Queen (1999 TCC): reasonableness of compensation.

Frequently Asked Questions

Q1. Should I pay only dividends to avoid CPP?

A1. Possibly, but you lose RRSP room and CPP benefits. Many owners take a small salary for long-term value, then use dividends.

Q2. What if I pay salary but forget to remit CPP/tax?

A2. CRA can assess penalties up to 20% plus daily-compounded interest (ITA ss.161–162). Set up remittances in CRA My Business Account.

Q3. Can I switch from salary to dividends mid-year?

A3. Yes—issue a T4 for salary and T5 for dividends, with proper board minutes and documentation.

Q4. Do dividends create RRSP room?

A4. No. Only earned income (e.g., salary) creates RRSP contribution room (ITA s.146(1)).

Q5. How does Quebec tax affect the choice?

A5. Rates/credits differ slightly, but integration remains similar. Model both federal and Quebec outcomes before deciding.

Authorship
Written by Manik M. Ullah, CPA, Auditor, Member of CPA Quebec and CPA Alberta. 20+ years in corporate taxation, CRA audit defence, and business structuring. Reviewed by senior Mackisen tax-law advisors.