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I'm trying to learn about financial statements and taxes in Canada. And I'm curious if I understood something correctly when a business has zero revenue, but still pays the sole share holder a salary.

Let's assume the business is incorporated in Ontario, Canada, and I am the only shareholder. At the beginning of the fiscal year, I have the following financial statement:

Assets

  • Cash: $100 000

Liabilities: $0

Share Holder's Equity

  • Retained Earnings: $100 000

Let's say I am supposed to pay myself a monthly salary of $5000 ($1k to tax deductions and $4k for net pay). I am the only employee in the company. And the fiscal year was terrible because I couldn't bring in any revenue. Is this what my financial statement will look like at the end of the fiscal year?

Assets

  • Cash: $100 000

Liabilities

  • Salary Tax Deductions: $12 000

  • Due to Shareholder: $48 000

Share Holder's Equity

  • Retained Earnings: $40 000

If that's the case, does that mean that by simply putting myself on salary, I've paid the government taxes even though the business made no money at all during the year? I just gave money away?

  • Most of your bs is incorrect. If you paid yourself 60k in salary, this must come from your cash account. Also, when the salary has already been paid, there is no need to record a liability. I think you meant to record expenses. – ApplePie May 6 '18 at 3:11
  • Also, what if the $100k cash is my own invested capital that I put into the company. And when I withdraw a salary, I lose the $12k to the government, and there's no way for me to claim it back on the basis that "I made a mistake and realized later the company had no revenue and had a really bad year?" – John May 6 '18 at 4:22
  • You'll record 48k as salary and 48k as tax expense. – ApplePie May 6 '18 at 11:27
  • Can't edit my comment but obviously meant 12k tax expense. – ApplePie May 6 '18 at 23:08
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If you pay a salary to an employee, then of course there are income taxes and possibly other taxes to be paid. That includes the case where the employee is you.

Your company will have to pay the tax. The company may or may not pay the salary to the employee/shareholder. The company will end up with $40,000 cash and no liabilities, or with $88,000 cash and $48,000 liabilities to the employee shareholder (or anything in between, if the company pays out some of the salary). The shareholder equity will go down from $100,000 to $40,000.

But that's just what happens if you pay salaries and make no money. If your sole employee is so bad that he doesn't create any revenue, then you might discuss with him whether the salary is justified.

  • OK, I guess there's no way to undo or reclaim that tax that's owed to the government? IN reality, what happened was no one was keeping an eye on the profitability of the company, the company had other expenses, the company had cash flow issues, and so I wasn't able to withdraw the salary that I already told the government about. If I had paid more attention, I should have just paid myself a dividend instead of salary? – John May 5 '18 at 23:36
  • because a dividend would not have been subject to the taxes? – John May 5 '18 at 23:42
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    Paying yourself a dividend when your business is losing money is frowned upon. I don't know the precise US laws; in the UK it is criminal to pay yourself dividends when the business cannot pay it's liabilities. – gnasher729 May 6 '18 at 14:58
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    Again, in the UK the employee would tell HMRC (roughly British IRS) that $12,000 was paid in taxes, but no actually money to the employee. If the employee is not able to recover the money, then the actual income was $12,000, tax would have to be owed on $12,000, and HMRC would refund the rest of the taxes to the employee. Just the same as they would do with any employee that doesn't get paid. On the other hand, since the company still has cash, the IRS might have none of that and tell the employ to sue the company for the salary. – gnasher729 May 6 '18 at 15:01
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    @gnasher729 This would be similar to Canada - exact rules depend on jurisdiction, but typically dividends can only be paid out of 'retained earnings' [accumulated net profit over the years]. So in the OP's scenario, dividends likely could not be paid from a legal perspective, but an alternative could be a 'return of capital' [ie: relinquishing some shares in the company for cash, or similar]. – Grade 'Eh' Bacon May 6 '18 at 15:30
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Money a company deducts from an employee's pay (including shareholder employees) and sends to the government labelled income tax does not constitute the company paying taxes. (Some of the deductions are the employer's share of EI and CPP, and can be so interpreted, though as the sole shareholder you should be EI exempt.) Think of it as the company sending some of the employee's salary to the government for safekeeping. All of it was technically income to the employee.

Now when that employee does their personal taxes, perhaps they owe nothing - an income of 60k and some deductions, it could be possible. In that case, they will get a tax refund from the government of the part of their salary the employer sent along throughout the year. Or if the person owes less than the tax deducted by the employer, there will be a refund. The company isn't paying taxes on the employee's salary, they are sending some of the salary to the government to be used by the employee to pay their own taxes.

Check with your accountant, but if the company genuinely did not pay you any salary, it should issue you a T4 that says so, along with saying what was sent for tax withholding. With no income, you'll pay no tax, and get a refund of all the withheld money (but perhaps not the EI or CPP.)

Now, how did you get here? How, every month, did you decide to fill out the form that said you paid yourself, and to send or owe the government some of that money, when you didn't pay yourself? You have two weeks after month end to do that paperwork, so if you don't pay yourself, don't tell the government you did. There is no "supposed to" when it comes to paying yourself. When the money isn't there, skip your paycheque. We've all done it. Don't go telling them you paid yourself when you didn't, and creating a personal income tax liability, for no reason. A year without salary doesn't need to be made worse by owing taxes on imaginary income.

  • Thank you Kate. To reply to your last paragraph, I made the mistake because of A. We had bad cash flow issues B. I have poor financial literacy C. Somewhere I got it in my head that government wants to see me pulling a salary or else I would be subject to an audit. The other items you mentioned above makes sense. – John May 7 '18 at 16:37
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Yes, you would owe the taxes. This is why many startups do not pay the founders a salary if there is no revenue. Why throw capital into the project if you're really just buring through your own savings to buy groceries?

Once there's proft, then yes, definitely pay salaries to sweat equity partners. And of course non-equity holding employees need to get paid.

  • In the UK, it is much more tax efficient to pay dividends rather than salary. (If a shareholder has no other income then it is optimal to pay about £10,000 salary per year and the rest in dividends. – gnasher729 May 7 '18 at 18:55
  • What I'm confused by is why are you putting capital into a firm that you're expecting to withdraw as taxable income to yourself? – Glen Pierce May 7 '18 at 22:04

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