Understanding cash damming

01 April 2022 by National Bank
A freelance worker is preparing her Smith Maneuver to save money.

If you’re a self-employed worker or an entrepreneur, there’s a strategy that could help you pay less tax. Learn about cash damming.

What is cash damming?

Cash damming is a strategy to convert personal debt (whose interest is not tax deductible) to business debt (whose interest is deductible). This is done by using a line of credit to pay your business expenses.

Who is cash damming for?

Cash damming is not a strategy available to everyone. There are certain prerequisites. The following people can use this technique:

  • Rental property owners
  • Self-employed workers who are not incorporated
  • Sole business proprietors
  • Partners of a general partnership

Good to know: Additional restrictions apply to cash damming in the case of partners in a general partnership. To find out more about these restrictions, see one of our advisors or a tax specialist.

How does cash damming work?

While cash damming can save you a lot of money, first you need a clear and precise plan.

You must meet certain conditions for this tax strategy to work for you. You need to have:

  1. Significant personal debt, such as a mortgage and/or car loan
  2. Relatively high business expenses
  3. A good taxable income

You also need certain financial products:

  1. A separate bank account for your business income
  2. A second bank account for your business expenses
  3. A loan earmarked solely for your business expenses, for example a personal line of credit

Note: Of course, you need a high credit score to qualify for this type of loan. It’s always to your advantage to make sure your credit history is squeaky clean. It’s not uncommon for your personal finances to have an impact on your professional life.

Once these prerequisites are in place, you simply need to do the following to benefit from the tax savings generated by cash damming:

  1. Use your gross business income to pay your expenses and personal debts, such as your mortgage
  2. Pay 100% of your business expenses with the loan designed for this purpose

What are the advantages of cash damming?

The main benefit is tax savings.

Specifically, this strategy allows you to:

  • Pay down your personal debt faster using your business income and avoid paying non-deductible interest
  • Deduct interest paid on your loan to finance business expenses

To take full advantage of the benefits of cash damming, be sure to check the:

  • Prepayment or accelerated repayment terms of your mortgage
  • Business expenses eligible for interest deduction—when in doubt it’s always a good idea to check this aspect with a tax expert

Good to know: In theory, cash damming may seem fairly simple, but it’s still important to make sure you understand how it works and the different steps. For example, if you separate from your partner during or after the mortgage repayment process, cash damming could create inequities in the division of assets. To avoid unpleasant surprises, it’s advisable to see a financial expert and a tax specialist and explain your situation to them.

Keep in mind that patience is key, as your personal net debt will not change overnight. Generally, bankers recommend cycles of three to five years for this strategy. You’ll need to be disciplined and reorganize your spending.

As a self-employed worker, it’s essential to properly plan and manage your finances to save tax. This is also true for anyone else wanting to use the cash damming technique. Optimize your finances and consult with your advisor to make sure you’re using this technique properly. We’re here to answer your questions.

For more information on taxation and self-employed workers, see our article Tax returns for the self-employed.

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