Corporation

A corporation is a separate legal entity incorporated under provincial or federal law. The scope of the company's operations will dictate the choice of a federal or provincial charter. For example, if you intend to restrict your operation to one province, a provincial charter will suffice. A federal charter allows a company to operate anywhere in Canada without the need to register in each province in which it does business. As a corporation is an entity separate from its owners (called shareholders) it can provide protection from both creditors and lawsuits. This idea is called limited liability (i.e., limited to the net assets of the corporation and the share capital of the shareholders). This limited liability will be restricted to the extent that financial institutions or suppliers require personal guarantees from the shareholders to transact business.

Your accountant and your lawyer should help with the formation of the corporation. Where there are several shareholders you should consider a Shareholder's Agreement, which sets out guidelines if a shareholder wishes to sell out or purchase the share of the other shareholders.

As with a partnership, assets can be transferred to the corporation on a tax-free basis, if the appropriate income tax elections are filed. Typically, proprietorships or partnerships are incorporated after they have grown to a level where the benefits of limited liability and lower corporate rates of income tax outweigh the costs of incorporating. The corporation must file annual T2 Federal Corporation Tax Returns within six (6) months of the business year-end. Ontario, Alberta and Quebec require that separate provincial income tax returns be filed for corporations that are incorporated or doing business in the province.

To incorporate or not?

That is the question. Actually, it is several separate questions rolled into one.

In theory the decision to become a registered corporation should be relatively simple to make. Nevertheless, in practice it seldom is. Professional advice is vital to ensure that you understand all legal and tax implications before proceeding. Still, start by understanding what sort of decision you are making.

"The decision should be made from both a legal and a taxation viewpoint," says Wayne Makowecky, tax advisor for Edmonton Roper in Abbotsford, BC. "Most people are interested in incorporating if it saves them income taxes and will limit their liability- which in essence means legal protection from creditors."

However, a corporation is a separate legal entity and so must file an annual report with the Registrar of Companies. This means that both accounting and legal costs will be incurred annually, warns Makowecky. Also, there are the initial legal costs of incorporating. This can run between $1,000 - $1,200 and more if you are in a hurry- although several publishers provide inexpensive self-incorporation kits which walk you step-by-step through the paperwork.

"One of the most important reasons for incorporating is the income tax rate applicable to active business income earned within a corporation," suggests Makowecky. "In BC for example, it is approximately 22% on the first $200,000 of active business income earned each fiscal year. This rate is lower than the lowest personal rate of tax of about 27%." (This amount is based on 1991 figures, check with your accountant for current percentages).

However, he warns this should be regarded as a deferral of tax rather than an outright saving, since there is an additional tax cost when the shareholders remove such after tax corporate earnings from the corporation - such as when the corporation pays dividends.

"If you need all of the business income to live on, there is no tax incentive to incorporate because all of the income withdrawn from the company would then be taxed at the personal level anyway." says Makowecky.

Of course, a corporation provides important legal protection for its shareholders (the owners). This can be very reassuring if someone sues you for damages - because the amount you could lose is limited to the assets of the business which probably won't include your house and its possessions. Unfortunately though, banks and trade suppliers often demand personal guarantees from you before doing business. Being incorporated won't protect you from these creditors should you run into trouble.

"If you are both a shareholder and a director of a company, you will be at risk for any amounts owed to Revenue Canada, the Workers' Compensation Board and the GST people." Added Makowecky.

Other tax liabilities may also be incurred. The transfer of business assets to a corporation may result in some GST and PST costs, to say nothing of property transfer and other taxes levied in some provinces if real estate is involved.

One less well-known aspect of incorporation is the tax advantage which may stem from an estate freeze. "In this estate planning mechanism," says Makowecky, "the cost base of the shares of a corporation can be limited to an amount equal to the fair market value of your shares at the time the freeze is entered into. This can be used to pass along the future growth in share values to other family members or to business associates. This is accomplished on a tax-deferred basis only through a corporation."

If some of this sound complicated, it is. Still, much of the information may not apply to your business at all. Advisors like Makowecky always stress to clients the importance of seeking expert assistance, but they usually also emphasise the need for most home-based businesses not to worry about the decision to incorporate. If you run a food- preparation business, for example, you probably should consider incorporating to protect yourself from ruin, if sued. Yet many home-based businesses, especially ones with incomes of less than $50,000 (after all deductions) have little need to bother about incorporating. Remember, you can always revisit the decision as your business grows, anyway.

*For specific advice about the decision to incorporate your business, contact your accountant and lawyer

Incorporation Advantages

• You get protection against creditors suing for access to your personal assets to pay loans or damages.
• A lower rate of tax is paid by corporations with net incomes above $50,000.
• Selling the business is easier because the owner and the company are separate
• entities. There is an impression of long term stability because the company continues upon the death of shareholders.

Incorporation Disadvantages

• Paperwork and government regulation increases.
• Operating losses, tax credits and other potential deductions against income tax are no longer available to you as the owner.
• Limited liability is less valuable if you are forced to co-sign loan applications and guarantee the company's debts.