Incorporating a Company
Should I Incorporate a Company?
There are many things to consider when assessing whether to incorporate a company. The most important one is, does it make financial sense? Although there are several financial advantages to incorporating, there are some disadvantages as well.
Incorporating – Advantages
Corporations offer the opportunity to defer tax, and with proper planning, to save tax. Tax rates for Canadian- controlled private corporations (CCPCs) are lower than for individuals at higher tax brackets, especially those corporations which qualify for the small business deduction (SBD), which applies to the first $500,000 of active business income earned. But this is only true if earnings can be left in the corporation and invested at higher returns than can be achieved by the individual shareholder. If personal needs require all of the profits to be paid out, then the financial advantage is lost.
When it’s time to sell the business, the sale of the corporation’s shares might qualify for tax-free treatment to the shareholder. In contrast, the sale of a sole proprietorship or partnership would be subject to tax.
With proper planning, income tax can be reduced through income splitting and the annual optimization of the salary/dividend ratio.
Finally, the ability of corporations to have non-calendar year ends allows for additional tax deferral.
On top of the tax-saving measures, there are also non-tax advantages to incorporation. The most widely known is the liability protection for shareholders of corporations. Since corporations are treated as their own entities, shareholders are not held liable for the obligations of the corporation. The most a shareholder can lose is what they have put into their business.
Corporations have infinite life. This facilitates the transfer of ownership from one generation to the next more easily than the transfer of ownership of a partnership or sole proprietorship.
Incorporating – Disadvantages
The costs of incorporating and managing a corporation are higher than that of maintaining a sole-proprietorship. However, our firm offers a unique program for start-ups that can make the administrative costs manageable.
Although many people are aware of the liability protection afforded shareholders, many people are not aware of the possible liability exposure of directors. Directors may be liable for unremitted amounts for source deductions on salaries, unremitted GST/HST amounts, and all penalties and interest imposed on these unremitted amounts. You should consult with a business advisor on the best way to assign directorships in order to limit the extent of liability.
BE WARNED; if your employer wants to switch you to contractor status AND insists you incorporate, you might be taking on more risk with CRA than you anticipate. If it appears to CRA that your business could be classified as an employee of another corporation, CRA can classify your corporation as a personal services business (PSB). If classified as a PSB, the small business deduction and the general rate reduction would be lost - you would be subject to DOUBLE taxation and possibly to gross negligence penalties. Consider contacting a business accountant or business lawyer for advice on your particular situation.
The table below summarizes the advantages and disadvantages of incorporating a company. The weighting of these items differs from situation to situation, and some of these items may not apply to your circumstances. It is always advisable to consult with your accountant to discuss your personal situation .
- Small Business Deduction
- Capital Gains Exemption
- Deferral of Taxes
- Splitting Income (Salary/Dividend Planning)
- Reduced OAS Clawback*
- Liability Protection
- Non-Calendar Year
- Additional Accounting/Legal Fees
- Additional Reporting Requirements
- Alternative Minimum Tax
- Increased OAS Clawback*
- Personal Services Business Rules
- Director’s Liability
- Trapped Losses
*The OAS (Old Age Security) clawback is included on both sides of the table for the same reason; apart from covering life necessities, the amount of remuneration paid out by the corporation is mostly under the control of the shareholder(s). By limiting the compensation, OAS clawback can be reduced. By increasing the compensation, OAS clawback could be worsened.