Thinking ahead to paying your tax bill through the year is very important. It’s easy when bills are coming and you need to pay yourself as a business owner to forget that taxes are owing at the end of the year.
The Reality of Taxes
When you start a business in Canada, you will, in virtually all cases, owe taxes on your profits. Whether a sole proprietorship or corporation, you will owe tax on your profits. At the same time, as a business owner you need to pay yourself out of those same profits. In this case I’m going to assume salaries are not being paid as I don’t want to over-complicate this post. We’ll deal with salaries vs. dividends another day.
So you’re paying yourself dividends or taking out a shareholder loan – both of which are NOT deductible and coming out of after tax cash. This is a critical concept. After tax cash is exactly what it sounds like – the remaining money after you’ve paid your taxes. But you only pay taxes once a year?
What To Do?
The best thing to do is actually set up a separate bank account (preferably one that bears interest) and set aside a reasonable percentage of your accounting net income plus the GST off each invoice. And then never, ever, touch that balance until tax is due. That way you’ll always be sure to have enough cash on hand when your taxes/GST return are filed in order to pay, with no interest.
What Not to Do?
Ignore tax and start paying dividends. You’ll end up short on cash for corporate tax and personal tax. In the case of a sole proprietorship, you’ll likely be short on that business tax portion as once you start spending that money personally the expenses aren’t deductible (therefore you’re spending cash but still owe the original tax amount).
What if I Need the Money?
Assuming you don’t make the mistakes above, this can still happen – commonly if your customers aren’t paying promptly you will owe taxes on those sales regardless of the fact that they haven’t yet paid you. See BATT#9 for tips on how to deal with this.
In the early days you may want to take deposits to ensure you have at least enough cash to pay your tax bill. Failing that, you may want to apply for a line of credit. This way, your worst case scenario is dipping into the line of credit to pay CRA. Better to pay some interest to the bank than be late with the Government. Obviously this is still not an ideal scenario, so that leads us to our topic for tomorrow. The importance of cash flow forecasting.