Ever wondered how many many small-and-medium-sized businesses that operate in Canada? The answer, 1.14 million small businesses and 21,415 medium-sized businesses that were included in the Statistics Canada’s Business Register as of December 2015. Among these businesses we can count sole proprietorships, partnerships and corporations. You may opt to incorporate your company at certain times from a variety of factors. As with many businesses, incorporation has advantages and disadvantages. Below, we cover the benefits of incorporating in Ontario and explore other elements to consider.
What is a corporation?
By definition, a corporation is a legal entity that is distinctly separate from its owner(s). A small business operating as a sole proprietorship company or a partnership can become incorporated. A corporation can also be established at the creation stage of your business. A corporation in Canada must follow certain guidelines for tax payments, filing GST/HST returns and the assessment of responsibility for the corporation’s debts.
The primary advantages of incorporation
The primary benefit of incorporating is the limited liability of the incorporated company. As the business owner, you will be treated as a separate entity from the business. Corporations have the same rights as individuals; that is they can own property, conduct business activity and enter into contracts, they can also raise capital and sue. Corporate governance consists in protecting the business owner of the corporate debt and obligations – inside certain limits. The corporation is considered an artificially created legal entity, separate than the individuals who created it and conducts its own operations.
Protect your personal assets
You are protected when you incorporate the business for the purposes of reducing business debt through establishing C or S corporations or limited liability companies (LLC). If your business goes through tough times, your personal property typically cannot be held for collection agencies. Similarly your home won’t become worthless since you missed paying your business loan.
If you file a business bankruptcy then your company could become something you can easily liquidate to repay your debt. These might include your home, cars investments or even any property that they acquire later on. Incorporation protects your company against all these scenarios and protects your assets along with withholding you from being personally liable.
As a corporation that can control its own assets, do business, incur liabilities and seek damages. A corporation has its own financial resources when it pays its own debts. Creditors generally can pursue payment only on the business’s asset. Sole proprietorships and partners can be held liable for personal assets and business assets in unlimited circumstances. Business owners have an option of selling their business for ten per cent cheaper than a conventional business.
Protect your personal assets from lawsuits
Without incorporation, your valuable assets could fall victim to another business suit against you. Some of them can collect based on judgments by taking control of possessions such as homes. Incorporation creates a firm barrier between your personal and household property and legal claims against a business. In case your business goes to litigation, your valuables will never be in any risk. If you take legal action against a customer for damage you can be personally liable.
Limits of limited liability
While being incorporated creates a solid separation between the owner and the business itself, there are certain limits that apply, it is always best to consult an accountant to see how limited liability affects your particular scenario and what would be covered for you. This is another reason why small businesses should consult a professional account.
Taxes and personal income
Small business owners tend to incorporate because it provides them tax benefits which cannot be afforded for unincorporated entities. The benefits can help a small business owner save money every year. These taxes benefits include income tax splitting, benefits from reduced corporate tax rates, income tax deferral and capital gains exemptions. Additionally, multiple options are available to claim personal income at a time where it would have the least impact on your taxable income.
Corporate and personal taxes are separated
Incorporations separate your personal tax and business income. Your tax advisors will study what your corporate tax rate might be when you incorporate and compare that rate to your own effective tax rate. If it is lower, incorporation may be beneficial, it may be more beneficial to the individual as the corporation’s income and tax returns are not merged with their own, providing a tax advantage in some scenarios. The business receives income and the Canada Revenue Agency will treat the tax bill separately than that of unincorporated businesses.
Lower corporate tax rates – Less tax
Having a business in place allows for lower rates for taxation compared to taxes charged for an individual. Federal tax rates for corporate incorporated businesses range from 15% to as low as 9%. Small business owners have an advantage of the small business deduction. This reduces corporate income tax that you need to pay in a tax year. The reduced rate is available to those who earn business activity if the business cap is maintained for this year. Currently the federal business limitation is $5,000. The small business tax rate currently stands at 15% for incorporated businesses and is lower than the personal tax rate of an individual who operates in a sole-proprietorship and partnerships.
Tax savings and deferral
Incorporated business owners are faced with a multitude of tax issues and factors which can be included and considered as such in determining the tax advantages of incorporating. With a corporate entity you can make a business more flexible and earn more. It could reduce tax. Deferred tax dollars are effective in helping you grow your corporation. You also gain the capacity to plan personal income to benefit from lower tax rates.
A company incorporation will also give your child and their spouse interest in receiving money. These tactics offer great flexibility for an incorporated company given that the distribution amounts payable can vary from year to year. The money is allocated to lower taxable incomes. There is an additional income splitting strategy available to Canadian taxpayers but you should consult a tax professional to be sure this strategy is correct for your situation. In addition you can divide the dividends evenly between relatives to avoid your tax burden.
Think about your business in the long term
Although it is not necessary for all businesses to incorporate, most businesses will benefit from entering into the incorporated act. Your business structure will largely benefit from this as you look to expand or bring more people on board. Other factors to consider for the long term are:
Stronger record keeping
As corporations are treated separately from the owner(s), strong record keeping is in order to make sure that there is a clear distinction between what relates to the business and the owner. Corporations will have their own bank accounts, credit cards and expense accounts. As a sole proprietor or an individual in a partnership, you may be operating from your personal accounts or cards, bills may be in your name and such. Incorporating makes it so that your business can have its own set of bills and expenses that are tied only to the business. This type of legal structure makes it easier to keep track of anything that would get the attention of the Canada revenue agency. The business name will appear on every statement, record, tax returns, bank account and other paperwork involved.
Improved access to capital and grants
Attracting the eye of investors, angel investors and startups is much easier when your business is incorporated. Several credit-based programs are provided by the Canada’s government only to corporations. This can help boost the credibility of your company, which helps you find financing or negotiate with a supplier. This may also make it much easier to raise money and obtain grants. The idea adds credibility and gives you easier access to funds.
Lifetime Capital Gains Exemption (LCGE)
Lifelong capital gains exemption (LCGE) might save you money on tax for all or part of a sale. In a business, the cap for annual profit is $8893,824 for the 2019 year and will be $891,818 for the 2021 tax year. Farmers can claim a maximum exemption to $1 million and you can still use the exemption until the limitation is reached.
The LCGE is not a one-time exemption but it is cumulatively limited throughout the lifetime. There are often businesses incorporating just for the tax advantages. You could be able to use LCGE to avoid paying tax on half of your profit.
Your shares may qualify for a capital gains tax deduction when sold
If your shares are deemed Qualified Small Business Corporation shares and meet certain other requirements, you may be ineligible for an 880,000 life income tax exemption if you sell them. This means avoiding any additional tax liability after your retirement is completed.
Flexibility & Global recognition
Your official business address can be anywhere in Canada and meetings are held online and anywhere on the globe. Federal companies can be recognized worldwide. Incorporating your business can give it more notoriety compared to other business structures.
Estate and succession planning
In the event that the owner passes away or can no longer continue to operate, shareholding could then be transferred from the shareholder to his heirs. This stability gives you a better possibility of planning on a long term basis. It’s more flexible for transferring assets.
Corporations with all its relationships and contracts could survive the change in owners based upon the planning process. Having corporate shares transferred gives an advantage in time for succession. While incorporation is beneficial, it’s crucial to speak with your advisory team before proceeding, especially in tax free situations such as selling ownership rights to a person with no intention.
Other things to consider when incorporating your business
Costs related to incorporation
There may be higher administrative costs because of setup fees, more paperwork or the need to seek the assistance of specialists handling more complex tax filing requirements. Assessing your business and personal goals against the costs – both financially and through money – can help you to decide whether this structure will suit your need.
There’s annually legal filing fees payable and fees required to have an accountant filing an annual company tax return. The company requires one or more filings to retain good stead with government authorities. Losses that are difficult in a corporation but in a proprietorship are used only for short-term benefits of a reduction and tax credit.
If the company expects its own losses at the start, it can also be helpful for a sole proprietor or the company to delay or not register as an entity. If it was lost by a sole proprietorship this individual may claim the loss against his other financial income and reduce personal tax burdens. The business could also be incorporated once it saw profits. If the business was incorporated, the loss could only be assessed against future corporate income. Incorporating limited liability may not outweigh the effects on income taxes and it is possible that a tax deferral would not benefit your particular case.
Real Estate Rental Businesses
In many cases operating an estate rental business as a corporation offers no tax advantages. Until the business becomes larger, the rent earnable by the organization is categorized as income from investment. Investment income is treated more heavily than business income because small business exemption doesnt apply. It is sometimes easier to obtain a mortgage personally than a corporation and If you live in the property prior to or after renting it you could use the Principal Residency Exemption to reduce certain capital gain tax upon the sale of the property.
Pay more taxes
Sometimes you could even have to pay more tax for operating a corporation. It usually happens when the small company business deduction aren’t available to corporations. In other cases individuals with the right to personal tax credits can be eligible for a lower rate for their personal business ownership. It is less common for a corporation to pay higher taxes overall but the situation can exist.
Administrative burden of incorporating your business
Each business is a separate entity and means that they must be updated regularly. If you want to cut down the company, there’s an additional checklist you must go through to do the job properly. If you are allergic to filings, you may want to avoid the extra overhead of a corporation. You should also ensure that the business operates and remains in a proper standing with the authorities before letting it down.
While business incorporation offers many advantages, many small business owners jump into the process too quickly without seeking advice from a professional accountant. There are instances where incorporating your business could still leave you with all the liability, business debts and financial losses much like that of a sole proprietorship. Having a discussion with a FinanTech accountant will help you understand if this is the right time for incorporating your business and help you through the entire process.