Small business owners often rely on Company vehicles to run their operations. Whether you use a car to visit clients, a van to make deliveries, or a truck out on a job site, a common question comes up – should I buy or lease?
To answer that question, let’s start with why you might choose to lease or buy.
Leasing a car – Under this arrangement, you enter into a lease agreement and pay a monthly amount. You may be required to put a small amount down toward the lease. The agreement typically covers a period of two to three years. At the end of the lease, the vehicle is turned back in. In some cases, you may have the option to purchase the vehicle at its current fair market value at the end of the lease.
Monthly lease payments are typically less than what they would be if you purchased and financed the car. However, lease agreements usually have a limit for the total miles that can be driven. This mileage limit is typically 10,000 – 12,000 miles per year. If you exceed this limit, you will be charged an extra fee for every mile above the allowed amount.
What You Can Deduct – The Canadian Revenue Agency (CRA) allows you to deduct up to $800 plus HST of your lease payments each month. This is limited to the percentage that the vehicle is used for business purposes. The CRA considers any vehicle that is $30,000 or more as a luxury vehicle, which may slightly reduce the amount of lease payments that you can deduct for business use.
Who Benefits Most – For some, leasing a car makes sense. To make that determination, you should consider;
• What type of car you need – If you are looking for a more expensive car, monthly lease payments are typically less than loan payments. If you are limited in funds each month, leasing a car can allow you to purchase a more expensive vehicle. In addition, leased cars typically require less money down than a purchased vehicle which is financed.
• Leasing lets you get a new car every few years.
• If you don’t expect to exceed the mileage allowance, leasing may be a good option for your business.
Buying a car – Most small business owners finance the cars that they purchase, as opposed to buying them outright. Loan payments are made up of both principal and interest. As you make your monthly payment, the principal portion will reduce your total loan balance. Once paid off, you own the car free and clear.
What You Can Deduct – There are two ways to take a deduction for a vehicle that you own. If you have financed the vehicle, the interest portion of your payments is deductible up to $300 per month. In addition, the CRA allows you to take a Capital Cost Allowance (CCA) deduction each year. This is commonly known as depreciation. For the first year that you put the car into use, you can deduct 15% of the cost. In the second and all remaining years, you can deduct 30% of the declining balance of the cost.
To illustrate – Company A purchases a new vehicle for $15,000.
• Year 1, the CCA is $2,250 — calculated as $15,000 x 15%.
• Year 2, the CCA is $3,825 — calculated as $15,000 – $2,250 = $12,750 x 30%
• Year 3, the CCA is $2,678 — calculated as $12,750 – $3,825 = $ 8,925 x 30%
This calculation will continue until the vehicle has been depreciated in full.
With the CRA luxury automobile limitation of $30,000 (before HST), the total CCA is limited to that amount. If you purchase a car for $40,000, you will be limited to $30,000 worth of depreciation over the life of the car. If you have financed the car, however, you can deduct monthly interest paid up to $300. This means that you may be able to deduct interest on the full $40,000 cost of the car, as long as it doesn’t exceed $300 each month.
Both interest and depreciation are deducted based upon the business use percentage.
Who Benefits Most – Purchasing a vehicle is a good option in many situations including;
• You intend to keep the car for several years
• You drive extensively and expect to exceed the mileage limitation that a leased car would have
• Tax deductions can be higher, however, they take longer to realize than leasing
Buying versus Leasing – What Else Should I Consider?
When deciding whether or not to buy or lease a company vehicle, there are a few other matters to consider.
Timing of Transaction – Whether you purchase a car on January 1 or December 1, you are entitled to the 15% CCA. If you lease the car, however, you can only deduct the actual lease payments that you make. If you leased the car on January 1, you would be able to deduct 12 months of lease payments, but if you leased the car on December 1, you would only be entitled to deduct 1 month of lease payments.
Gains and Losses – If you sell or trade-in a purchased vehicle, you could realize a taxable gain or loss if you receive more or less than the car’s book value. Book value is determined by taking the original cost and subtracting the total CCA to date for that vehicle.
Leased vehicles, on the other hand, have no gain or loss when you turn them in as you do not own the vehicle.
Other Vehicle Expenses – Certain automobile expenses are deductible, whether you lease or buy. Repairs and maintenance, gasoline, and fees are deductible in either situation. The amount of the tax deduction is based upon the percentage of business use of the vehicle.
When making the ‘buy versus lease” decision, you should consider what the intended purpose of the vehicle is and how frequently it will be used. In addition, the company’s financial ability to make a downpayment, as well as monthly payments should be determined. Finally, analyze your tax benefit to help you select which option is best for your company. As you can see, there is no definitive answer to the buy versus lease question. Ultimately, the decision is based entirely on your situation.
How to Pay Your Shareholders
If you are an owner/shareholder, you may be wondering how to take out money from your company. Perhaps the company has excess cash on hand or you are in need of funds for living expenses. How you are compensated as a shareholder will impact what expenses the company can deduct, as well as the taxability of the payment to the shareholder. With this in mind, it is important to consider the intent of the payment, as well as its taxable impact on both the company and its shareholders.
Shareholders can receive payments from a company through salary, dividends, or in the form of a loan. A brief discussion of each method follows:
Payments to a Shareholder as Salary
In many cases, a shareholder may play an active role in a company. As such, they may be paid a salary for their services. Salary payments are taxable as income to the shareholder and are tax deductible for the company. The appropriate taxes are withheld from a shareholder’s paycheck and remitted to the Canadian Revenue Agency(CRA) as required. At the end of the year, the shareholder will receive a T4 slip, which will document the amounts paid and taxes or other items withheld from their salary.
Family members of shareholders may also be paid a salary. Amounts paid as salaries to shareholders and their family members should be reasonable based on the services being provided, as well as the amount paid. The salary expense for shareholders or their family members that are considered excessive by the CRA may not be fully deductible by the company.
Many companies opt to pay a salary to a shareholder as a means to keep their overall tax rate in a lower bracket. If you are an owner/shareholder and actively participate in the operations of a company, this may help to keep the company’s taxable income under the small business threshold rate of $500,000.
If you choose to pay a shareholder a salary, however, there are other expenses that should be evaluated.
Expense Payments– If you pay personal expenses on behalf of a shareholder, this is considered taxable income to them. The company would determine the value of the benefit received by the shareholder and include this as taxable income.
In some cases, these expenses can represent a combination of business expense and personal benefit. A company should evaluate the amount for both personal and business expenses and keep proper documentation to support this calculation. Documentation can include receipts, invoices, or other supporting materials.
The CRA can challenge this allocation, which may mean that the shareholder would need to pay more tax on any additional amounts that are considered to be personal expenses paid on their behalf. Therefore, keeping receipts, invoices, as well as any other written documentation is necessary.
Canadian Pension Plan– A company is required to match the contribution made by the employee into the Canadian Pension Plan, or CPP. If a shareholder is paid a salary, the company would be required to match any contribution made. CPP contributions are limited based on the earned income of a shareholder.
Employment Insurance– If the shareholder owns at least 40% of the stock of the company, no contribution is required to be made by the company. However, if the ownership is less than 40%, payment into the Employment Insurance (EI) fund will be necessary.
Family members of a shareholder who owns at least 40% of the company may also fall under this exemption if their position is not considered arm’s length and the job would not have been held by a person that is not related to the company.
Even if the ownership percentage is 40% or more, the company can choose to pay into the EI fund on behalf of shareholders.
Employer Health Tax– Effective January 1, 2019, British Columbia implemented the Employer Health Tax(EHT) provision whereby a company pays in a percentage of its total salaries and benefits into a fund. This tax is required if the total salaries and benefits exceed the threshold of $500,000. The amount that is greater than $500,000 is taxed at a rate of 2.925%. This rate applies up to $1,500,000 in total remuneration. Benefits paid in excess of $1,500,000 are taxed at a rate of 1.95%. All salaries paid by the company are included in this determination, even those paid to shareholders.
In addition to salaries, other payments such as contributions to an individual’s registered retirement savings plan are included in the determination of total salaries and benefits paid by the Company.
Payments to Shareholders as Dividends
A dividend is a payment made to shareholders out of a company’s accumulated earnings. They are paid out according to the percentage ownership that each shareholder has.
The benefit of paying dividends to a shareholder is that they are subject to a lower tax rate at the personal level when compared with the tax rates for earned income. While the company won’t receive a deduction for dividend payments as they are paid out from earnings that have already been taxed, they can receive a credit for the taxes that they did pay on these distributions.
As a shareholder, if you intend to make payments toward the CPP, any dividend income will not count when an individual determines how much they would like to pay in. Keep in mind that dividends are paid out to all shareholders of a company based on their ownership percentage. If your intent is to pay just one shareholder, but the company has multiple shareholders, paying out dividends may not be the best option.
Shareholders may take a loan from the company. There is no taxable impact of taking out a loan, with the exception of any interest charged or if the loan is not repaid. Any interest that is paid by the shareholder to the company on the loan is considered income to the company.
In some cases, shareholders may have loaned money or paid company expenses on its behalf. Repayments received by the shareholder are not taxable income, nor are they allowed as an expense deduction.
Valley Business Centre
If you are an owner/shareholder of a company and are looking to be paid, there are many options available to you. Careful consideration of each option is necessary to determine the tax impact on both the shareholder and the company.
To ensure that your books and records are up-to-date, contact the bookkeeping professionals at the Valley Business Centre. Offering reliable and timely service, Valley Business Centre has served small-to-medium sized companies with their bookkeeping and payroll needs since 1990. We work with clients that are located in the BC area and throughout the region. For more information, contact the bookkeeping specialists at Valley Business Centre today.