Summary: Unfortunately, this one isn’t so clear cut. Under the majority of cases, dividends are not income for IRB purposes. However, they may be a sign of other income sources.
So, why do we care about dividends when calculating Income Replacement Benefits (IRB)? Let’s look first at when an individual might receive dividends.
When would an individual receive dividends?
If a corporation earns a profit, they have the choice of either reinvesting in the company — retained earnings — or sharing that profit with its shareholders — dividends. Dividends are distributed from after tax income, and as such the business does not report it as an expense on the business income statement. This is different from employment income paid to an insured from the same business. Wages are a pre-tax distribution and reported as an expense on the income statement.
In the case of an insured who is not actively involved in the operations of the business, the dividends they receive are likely based on the amount of shares they own, at a rate consistent with all other shareholders. This is considered a return on their investment (profit sharing), and as such the dividends do not meet the definition of gross employment income in s.4(1) of the Statutory Accident Benefits Schedule (SABS). Because of this, they are not considered in the calculation of an IRB.
In the case of an insured who is actively involved in the business as an owner, co-owner, family member of the business owner, or many other situations, the dividends may represent much more than just a return on investment. In these types of situations, dividends can often be a form of distributing profits with reduced tax consequences in the hands of the recipient. This type of dividend is the focus of this blog.
Are dividends considered income in an IRB calculation?
Let’s first discuss self-employed individuals. Calculations for self-employed individuals are based on the profits of the business, with occasional adjustments (see our self-employed person blog for further details). As dividends are an after tax distribution of profit, they reflect only how the insured withdraws the profit from the business, not the amount of profit. For self-employed individuals, dividends are not considered income for IRB purposes.
For employed individuals, it is a little more complicated. Let us start by saying that in most cases, dividends will not be considered. As indicated above, dividends themselves do not meet the definition of gross employment income pursuant to s.4(1) of the SABS, or the criteria in s.2(5) of the prior legislation (O. Reg. 403/96). For the balance of this post, we will be talking only about employed individuals.
What decisions provide guidance on dividends as employment income for IRBs?
In Bonitatibus and Wellington Insurance (OIC A-000082 (no.2)), the arbitrator excluded dividend income, stating:
“The very nature of dividend income is that it is derived from investment. I find that, without evidence that the Applicant’s occupation involved investing, I cannot consider this income as being “income from … occupation or employment” to determine the Applicant’s gross weekly income under the No-Fault Benefits Schedule.
In Spohn and ING (FSCO A04-000279), the arbitrator stated the insured had not met his burden of proof to support the dividends were received as a “contributing member of the company’s staff”, but “were actually distributions of corporate profits.”
These decisions both support the fact that dividends are a distribution of profits, and as such should not be considered gross employment income. They do, however, leave the door open for consideration of dividends as income when the insured’s employer, whether a family owned business or not, has structured payments for actual work performed to be received in the form of dividends.
In Swain v. Zurich Insurance (FSCO A97-002019), the arbitrator commented that “[the applicant] is not required to establish that the draws/dividends were directly related to her particular efforts at the company. It is sufficient that she demonstrate that she received the draws/dividends as a contributing member of the company’s staff, not simply as a financial investor in the business.”
In this case, dividends were deemed to be part of the insured’s remuneration package. Although the insured was a 40 per cent owner in the business, with her husband owning the balance of the shares, she was deemed to be employed and not self-employed. As a result of her non-controlling ownership, the dividends were considered to be a part of her compensation from employment.
This type of situation is likely the exception, but it is important when you see the insured received dividends that you understand the employment agreement under which they were paid, and the resulting impact.
How else can dividends influence an IRB calculation?
As indicated above, dividends are generally not included in the income of an insured, but they may be an indicator of employment status.
In the case where an individual is reporting a substantial level of dividends, there exists the possibility the dividends represent more than just return on investment. For example, the insured may have a significant ownership position in the business, or family members may own the business. In these situations, the dividends may be a form of remuneration (a potential sign of employment income as discussed above), or a sign of self-employment. To read more on determining employment status, head on over to this blog.
Dividends may also be a sign of employer paid benefits for an employed individual. For example, if someone is employed for a company from which they received a dividend, it is a good idea to ask whether their employer contributed to a profit sharing plan. This could indicate the employee received shares at a lower than fair market value, which could be considered an employer paid benefits. For a further discussion on employer paid benefits, we refer you to our related blog.
What does this mean for you?
Dividends are most often investment income, because it is merely a distribution of profits. Typically, dividends are neither income nor other income replacement assistance, and therefore not considered in the IRB calculation. That said, dividends have the potential to be a sign of:
- Self-employment income;
- Employer paid benefits; or,
- Remuneration from an employer structured for tax planning purposes.
If an insured is receiving dividends, as evidenced on their personal income tax return, a few questions may help provide you with guidance on your next steps:
- Are the dividends from a related business?
- If so, does the insured work for or own the business?
- Are the dividends intended to reflect the insured’s continuing contribution to the business, or a return on investment?
- Did the employer contribute to a profit sharing plan?
As always, we are here to answers any further questions you might have. We can be contacted at answers@adsforensics.com or 1-800-380-7908 ext ASK (275).