TAX DEFERRAL - Optimizing Business Revenue Legitimately
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Tax deferral is a strategic and entirely legal practice that allows businesses (and their owners) to postpone the payment of income tax to a future date (although it must be structured correctly and in conformity with the Income Tax Act (Canada)). It does not eliminate a tax liability; rather, it shifts the payment obligation from the present to a later period, typically when an asset or income source is eventually liquidated or distributed. This core principle leverages the time value of money, which dictates that a dollar today is worth more than a dollar tomorrow. By deferring taxes, taxpayers keep more money in hand for a longer period, allowing those funds to be invested and potentially grow without the drag of immediate taxation. This strategy forms a cornerstone of effective financial planning (for both corporate enterprises and their owners).
A legally-permissible tax deferral postpones the payment of tax on income or a capital gain from the current period to a future period, thereby leveraging the time value of money and allowing the full, pre-tax value of the funds to grow and compound uninterrupted until the tax is eventually paid. For example, a corporate rollover (such as section 85 election) allows a business owner to transfer appreciated assets, such as real estate or equipment, from themselves (or a sole proprietorship) to a new or existing corporation without triggering an immediate capital gains tax. Instead of being taxed on the gain at the time of transfer, the tax liability is deferred because the transferor and corporation jointly elect for the transaction to occur at the asset's original cost or tax base, and the new corporation simply assumes the original potential tax liability, which will only become due when the corporation eventually sells the asset to a third party [other provisions from the Income Tax Act (Canada) that provide a tax deferral include section 51(1) [share conversion], section 86 [share-exchange] and section 87 [amalgamation]].
The primary objectives of tax deferral at the business level are to increase available working capital and leverage the time value of money to promote greater long-term growth. By legally postponing the payment of taxes on certain income or gains, a business can maintain a larger capital base today. This freed-up capital can be immediately reinvested into critical business operations, such as funding expansion initiatives, acquiring new equipment or assets (often through strategies like accelerated depreciation), investing in research and development, or building a stronger cash reserve for financial flexibility. Ultimately, this objective is to maximize the amount of money compounding within the business, driving higher returns and accelerating growth that otherwise would have been slowed by immediate taxation.
A secondary, but highly strategic, objective of tax deferral is to manage the overall effective tax rate over time. Businesses aim to recognize taxable income in periods when the applicable corporate or shareholder tax rates are anticipated to be lower. For example, a corporation might retain earnings to be taxed at a lower corporate rate today, or for an owner to defer personal income withdrawal until retirement when their personal marginal tax rate is expected to be significantly lower. This strategy gives the business owner or the corporate entity greater control over the timing of tax recognition, allowing for more efficient planning. The delay acts as an interest-free loan from the government, and when combined with potential future lower tax rates, it maximizes the net after-tax wealth for the company and its owners.
The ultimate result of a properly-executed tax deferral in the business context is the increased accumulation of wealth and enhanced financial flexibility due to the power of compounding. By delaying the payment of taxes, a business keeps more capital working for a longer period, allowing the retained funds to generate additional earnings that are not immediately reduced by a tax payment. This strategy allows for larger investment in operations, growth initiatives, or strategic investments, and while the deferred tax liability must eventually be paid, the net present value of that future tax payment is lower than paying the tax today, making the deferral economically advantageous.
Our law firm strives to provide strategic tax-driven legal advice and direction to Calgary businesses looking to optimize their business structures and corporate transactions. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your business' tax structuring and tax planning initiatives.
