Corporate Law
Should I incorporate?
There are a number of legal structures available for carrying on business in Canada. Most small businesses are carried on either as a sole proprietorship, a partnership or as a corporation. Obviously, each form of ownership has benefits and risks. In choosing the best form consideration should be given to the type of business being carried on, the number of owners and its financial situation. Each should be considered prior to determining the preferred method of carrying on business. What follows is a brief overview of the advantages of incorporation.
1. Separate legal entity
Under Canadian law, a corporation is a separate legal entity and has the same rights and obligations as a natural person. This means a corporation can acquire assets, incur liabilities, enter into contracts and sue or be sued separate and apart from its shareholders.
2. Limited liability
Incorporation limits the liability of the shareholders. In most instances, a shareholder’s liability is limited to the amount of money he/she invests in the corporation. If properly handled, a shareholder is not responsible for the debts of the corporation, unless he/she has given a personal guarantee.
3. Continual existence
Unlike some other methods of carrying on business, a corporation has an infinite lifespan if properly administered. Because it is a separate entity, it continues to exist even if a shareholder leaves the business or if ownership of the business changes. In addition, a shareholder’s ownership interest may pass to his/her heirs upon death. Specific plans may be implemented to ensure that any share transfers occur in the most tax efficient manner possible.
4. Tax advantages
Because it is a separate legal entity, a corporation and its shareholders are taxed separately. This often results in substantial savings because corporations are generally taxed at a lower tax rate. For example, in the most recent budget, the amount of small business income available eligible for the lowest 12% tax rate has been raised to $400,000.00. Further, when a corporation pays out dividends they are taxable to the receiving shareholder, at that shareholder’s personal tax rate. If the corporation does not pay any dividends in a given year, the corporation’s earnings will be taxed at the lower corporate rate.
Another advantage is the ability to redistribute income or ‘income splitting’. A spouse or child(ren) can be a shareholder in the corporation, even if they are not actively involved in the corporation’s business activities. As a shareholder, they may receive dividends, thereby allowing for the redistribution of income from family members with higher incomes that are taxed at a higher tax rate to those in lower tax brackets.
Finally, because a corporation can set its fiscal year, there is potential for tax deferral and a further realization of tax savings to its shareholders.
5. Business credibility and financing
Incorporation lends an air of stability to a business. Not only can it attract more clients but also financial institutions consider corporations to be better loan risks. Finally, it also leaves a business owner with more options for raising capital. For example, corporations can raise capital by issuing share certificates to new or existing shareholders.
Conclusion
Carrying on business by way of incorporation has many advantages. It is important to discuss with your advisors these advantages to determine whether incorporation is the best option for you. In many instances, the combination of limiting personal liability and the lower tax rates available to a corporation make the decision an easy one.
If you have any questions or wish to discuss any of these matters further please do not hesitate to contact us at your convenience.