What rules govern when an Ontario corporation can pay a dividend to shareholders?

Under the Ontario Business Corporations Act, a corporation can only pay a dividend if the board of directors determines that after the dividend is paid, the corporation will be able to pay its liabilities as they come due (the liquidity test) and the realizable value of the corporation's assets will not be less than the sum of its liabilities and its stated capital after the payment (the solvency test).

Directors who authorize a dividend without meeting these tests can be personally liable to restore the amount of the dividend to the corporation. This protection exists to prevent corporations from stripping assets to the detriment of creditors.

For practical purposes in a small corporation, the owner-manager typically pays themselves through a combination of salary and dividends. Salary is a deductible expense for the corporation and subject to source deductions; dividends are paid from after-tax corporate earnings and are taxed differently in the hands of the recipient. The tax treatment of dividends in Canada depends on whether the source is eligible or ineligible dividends under the Income Tax Act. The interplay between salary and dividends, and the right mix for your situation, is a planning question best addressed with a tax accountant.