Tax Tips

Converting dividends to capital gains – Perhaps the last available significant opportunity

So what’s left? That the question that business owners and their accountants have been asking themselves following the implementation of aggressive new tax measures including the end of income sprinkling with family members (TOSI), the end to the multiplication of the small business deduction (SCI rules), and new passive income rules for investment income in corporations. More restrictions are sure to come as governments increase spending while simultaneously fights deficits.

Indeed, what significant tax planning opportunities remain for the business owner? The answer is surplus stripping – but it won’t be available for long.

What is surplus stripping and how much do you save?

Surplus stripping, or capital gains stripping, is a method to extract corporate surplus at capital gains rates, or in other words, to convert dividends into capital gains.

Consider the following: The highest dividend rate is 47% in Ontario while the highest capital gains rate is 27%. If a business owner could extract corporate retained earnings at capital gains rates, it will result in a whopping $20,000 tax savings for every $100,000 of cash extracted. If you need to take out money from your business, a few other strategies even come close.

Other viable alternatives to gain access to capital gains tax rates include “drop-down” strategies and making intercorporate dividends taxable.

Why Now?

Before TOSI, income sprinkling was an easy and cheap way to split income with low-income family members and effectively achieve similar tax savings. Surplus stripping strategies were used mostly by larger businesses or where income sprinkling was not feasible.

However, the main reason why surplus stripping was not widely used in the past was that CRA continuously challenged these strategies in court, trying to apply the General Anti-Avoidance Rule (GAAR)

So what changed? Recent court cases issued rulings in support of the basic surplus stripping strategy. In the words of the Ministry of Finance[i]: While the CRA has traditionally applied the general anti-avoidance rule (the GAAR) to such conversions, it has narrowed its application in light of recent court cases. The courts have even suggested in at least one case that surplus stripping is not, in general, an abuse or misuse of the scheme of the Income Tax Act.”

In response, in 2017, the government tried to change the rules to block this type of planning but did not end up implementing its proposals, because of very significant pushback by the business community – the mechanics underlying surplus stripping is used in post-mortem planning to avoid double tax on death, and the purchase and sale of businesses.

Avoiding the anti-avoidance

Surplus stripping does not trigger sec 84.1 of the Act because the transaction creates “hard cost base” and the capital gains exemption is not used in the transaction. In truth, however, this transaction is quite complex, with many tax traps to be considered. The particulars of each situation have to be carefully considered.

The Future of Surplus Stripping

The future of converting high tax dividends into low rate capital gains is bleak in indeed. It’s been on the Ministry of Finance’s radar since 2017, and with the newly re-elected progressive minority government,  what is likely the last remaining significant tax minimization opportunity is sure to close or be significantly restricted.

At Sloan Partners, we are experts at corporate reorganization and tax advisory. We work directly with business owners as well as small and medium accounting Firms to implement surplus stripping strategies and achieve the most favourable tax results for small business owners and their families.

Roman Belenky CPA, CGA is an associate at Sloan Partners LLP specializing in tax planning and advisory for business owners and their families. You can reach Roman at


Disclaimer: This article is intended for educational and informational purposes only. It is not intended in any way whatsoever to provide tax advice. The reader should be aware that legislation and administrative policy are subject to change at any time. None of the persons involved in the preparation of this article accepts any responsibility for its contents or the consequences that arise from its use.


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