Weighing the Benefits and Costs of Incorporating Your Business
Read time: 4-5 minutes
There is a lot to think about when deciding whether to incorporate your business. In order to make this decision, it is important to balance the benefits and costs.
A corporation is a separate legal entity from its shareholders. This means that shareholders are not responsible for the debts of the corporation and can only lose the amount of money they have invested, in the event that the corporation goes bankrupt. The corporation has the same legal rights and obligations as a natural person. This means that the corporation can sue, be sued, enter into contracts and acquire a loan.
Corporations have increased flexibility with their tax rates. This creates the opportunity to lower the amount of taxes paid compared to other business models. In a sole proprietorship or partnership all profits of the business are taxed as personal income. The following are some ways that corporations currently have flexibility:
- Corporations can choose the most tax-efficient way to pay shareholders and employees, such as dividends, salaries, bonuses, or a combination of these options;
- The corporation can incur some non-deductible expenses, such as entertainment expenses;
- Some earnings can be left in the corporation. This avoids having to claim all earnings as income and can lower taxes because corporate earnings are currently taxed at a lower rate than personal income; and
- Income can be split among family members in the form of dividends on shares, if those family members are shareholders. This creates flexible options of transferring income to family members who are in a lower tax bracket.
- Capital and Grants
Corporations have increased access to capital and grants. Funds can be raised by issuing bonds or share certificates. Corporations also have access to lower interest rates for loans because they are often viewed as less risky by financial institutions.
- Continuous existence
In the event of the death of a shareholder, the shares are transferred to the shareholder’s heirs. In contrast, in sole proprietorships and partnerships, the business will cease to exist on the death of the owners.
Although the corporation is a separate legal entity, there are still some situations that require shareholders to be liable for debts incurred by the corporation. Sometimes shareholders are required to provide a personal guarantee in order to secure a loan or lease for the corporation. Creditors may want some extra security that they will be paid back in the event that the corporation goes bankrupt.
- Costs and Inconvenience
There are significant costs and time requirements associated with starting and running a corporation, including:
- It is more complex and expensive to start up a corporation. There is significantly more paperwork that needs to be filed and there are considerable costs, such as legal and accounting fees;
- More paperwork is required to run the corporation. All major activity and transactions, such as shareholder or board meetings, annual returns, and changes of directors need to be documented; and
- Taxes need to be filed separately for the corporation each year.
- More complex structure
A corporation is made up of the following personnel:
- Shareholders, who own the corporation, make decisions by voting and passing resolutions at shareholders meetings and are responsible for electing the directors;
- Directors, who supervise the management of the corporation’s business and are responsible for appointing officers; and
- Officers, who are responsible for managing and carrying out day-to-day business.
Current Trends and Changes to Think About
With respect to limited liability, many courts have “pierced the corporate veil,” meaning, holding shareholders personally responsible for wrongs they commit, while carrying out the corporations business, especially in cases of fraud, wrongful conduct, unpaid taxes, or for hiding behind the corporation for an improper purpose.
There is a trend in recent cases, such as Mitchell v Lewis, 2016 ONCA 903 (CanLII) and Shoppers Drug Mart Inc. v 6470360 Canada Inc., 2014 ONCA 85 (CanLII), where the judge will apply a wider test to determine if the corporate veil should be pierced. The test is applied from 642947 Ontario Ltd. v Fleischer (2001), 2001 CanLII 8623 (ONCA), 56 OR (3d) 417 at para 68, and states that the corporate veil will be pierced in two types of situations:
- Where the company is incorporated for an illegal, fraudulent, or improper purpose; or
- Where those in control of the corporation expressly direct a wrongful thing to be done. 2. Proposed Changes to Tax Benefits
Some of the tax benefits of incorporation are up in the air based on the current Liberal government’s proposed changes to the Canadian Controlled Private Corporation (CCPC) tax scheme. This could be harmful for small business who may have been relying on the current tax scheme. Some of these proposed changes include:
- Limiting the ability to split income with family members in lower tax brackets and ensuring that income is proportional to actual contributions to the corporation; and
- Increasing the tax rate on earnings from corporate income that has been reinvested in passive investments.
While these changes have not yet been implemented, it is important to consider the possible implications they might have in the future if you decide to incorporate your business.
Incorporating your business means more than filing Articles of Incorporation, which many companies offer at a competitive price. The other key aspect of incorporating, and the most important part, is the organization of the entity – ensuring shares are issued correctly and setting out the key rules by which the company may operate.
Please contact Michael Paiva for more information about incorporating, or if you require assistance with incorporating a business.