Jamie Kungel, CPA, CA, MNP LLP
In the typical lifecycle of a business, you reach a point during the growth phase when you have proven your business concept and determined, “Yes, I can make money doing this.” That’s often the time when it makes sense to incorporate your business.
Legally, a corporation is a separate entity with the same rights in Canada as an actual person. While the shareholders own the shares of the company, the corporation owns the assets and is responsible for any debts or claims against the company – personal assets become significantly harder for a claimant to reach.
The corporation pays tax at the corporate level on the taxable income from business operations and shareholders are remunerated through wages and/or dividends. Wages are a deductible expense for the corporation and are taxable to the recipient. Dividends are paid from the accumulated profits of the corporation and are not deductible for the corporation. Dividends are then taxed in the shareholders hands at a preferential rate.
- Limited liability – Especially attractive for businesses such in high-risk industries (real estate development/construction/forestry)
- Tax deferral – The first $500,000 of active business income is taxed at a rate of 13.5% (compared to the highest marginal tax rate for an individual of 47.7%).
- Debt repayment – Lower tax rates mean more funds for debt repayment.
- Income splitting – Dividends can be paid to family members who would otherwise pay only a nominal amount of personal tax, thus reducing overall tax liability.
- Capital gains deduction – This is the $824,176 lifetime capital gains deduction that can be utilized on the sale of the shares of a qualifying small business corporation.
- Raising capital – A corporation has the option to raise capital not only by incurring debt, but also through equity financing. This can save on debt payments, but at the expense of giving up a part of future growth.
- Complexity – A corporation is a separate legal entity which requires separate bank accounts, separate books and records, filing of tax returns and other such items.
- Costs – The additional complexity comes with increased costs for professional fees and other services related to the corporation.
- Loss restriction – Losses incurred by the business may get trapped inside the corporation. These losses cannot be used by the individual except in specific circumstances.
As your business grows, incorporating your business usually makes sense. If your business continues to flourish, more complex structures can be introduced to maximize the corporate tax deferral and facilitate income splitting while also multiplying the capital gains exemption among family members.
Jamie Kungel, CPA, CA is a Taxation Specialist with MNP LLP. For more information, contact Jamie at 250.287.2131 or firstname.lastname@example.org. Please consult a tax advisor for advice about how the above information should be applied.