Incorporating Your Business

sole proprietorships, proprietorship, partnershipsYou perhaps started off as a Sole Proprietorship or Partnership, and now you are looking at what other alternatives there are  for setting up your existing or new business?  Read the advantages, disadvantages, tax implications and the legal landscape of this Incorporation alternative.

Wikipedia defines a “Incorporation” as

Incorporation (Inc.) is the forming of a new Corporation (a corporation being a legal entity that is effectively recognized as a person under the law). The corporation may be a business, a non-profit organization, sports club, or a government of a new city or town. This article focuses on the process of incorporation; see also Corporation.

A Corporation is a separate legal entity that has been incorporated through a legislative or registration process established through legislation. Incorporated entities have legal rights and liabilities that are distinct from their employees and shareholders and may conduct business as either a profit-seeking business or not for profit business. Early incorporated entities were established by charter (i.e. by an ad hoc act granted by a monarch or passed by a parliament or legislature). Most jurisdictions now allow the creation of new corporations through registration. In addition to legal personality, registered corporations tend to have limited liability, be owned by  shareholders who can transfer their shares to others, and controlled by a Board of directors who are normally elected or appointed by the shareholders.

In Canada

In Canada, the process of incorporation can be done either at the federal or provincial level. Companies which incorporate with the federal government will generally need to register extra-provincially in the province that they elect to do business. Similarly, a provincial corporation may need to register extra-provincially if they are to have offices outside of their home province. Incorporations are effected quite quickly, depending upon the jurisdiction of registration, as several provinces and the federal government have started to allow for electronic filing. Incorporated Canadian companies can generally use either Limited, Incorporated or Corporation in their name, however this may vary province to province.

Tax Implications

Tax Advantages

There are tax advantages to incorporating your business, such as lower income tax rates and the carrying forward of losses from previous years to offset profits in subsequent years.If losses are made in the early years of the business they can be more effectively used if made as a sole trader as opposed to them arising in a limited company. The reason is that as a sole trader they can be set back against the income of the three years before the trade commenced and this usually results in a repayment of tax at this important time when cash flow is crucial.  

Double Tax

Corporate income is taxed within the corporation and money flowed out in the form of dividends is taxed again at the personal level. While there is some measure of integration in the tax legislation to reduce double taxation, some double taxation still remains.

Legal Implications

Despite not being human beings, corporations, as far as the law is concerned, are legal persons, and have many of the same rights and responsibilities as natural people do. Corporations can exercise human rights against real individuals and the state,  and they can themselves be responsible for human rights violations. Corporations can be “dissolved” either by statutory operation, order of court, or voluntary action on the part of shareholders. Insolvency may result in a form of corporate failure, when creditors force the liquidation and dissolution of the corporation under court order, but it most often results in a restructuring of corporate holdings. Corporations can even be convicted of criminal offenses, such as fraud and manslaughter However corporations are not considered living entities in the way that humans are.

Protection Of Personal Assets

One of the most important legal benefits is the safeguarding of personal assets against the claims of creditors and lawsuits. Sole proprietors and general partners in a partnership are personally and jointly responsible for all the liabilities of a business such as loans, accounts payable, and legal judgments. In a corporation, however, shareholders, directors and officers typically are not liable for the company’s debts and obligations. They are limited in liability to the amount they have invested in the corporation.

Advantages of Incorporating

If you’re one of the people considering incorporating your business, here are the main advantages of incorporation:

1. Limited Liability for the Owners

The main advantage to incorporating is the limited liability of the incorporated company. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, when a business becomes incorporated, an individual shareholder’s liability is limited to the amount he or she has invested in the company.

If you’re a sole proprietor, your personal assets, such as your house and car can be seized to pay the debts of your business; as a shareholder in a corporation, you can’t be held responsible for the debts of the corporation unless you’ve given a personal guarantee.

On the other hand, a corporation has the same rights as an individual; a corporation can own property, carry on business, incur liabilities and sue or be sued.

2. Raising Money Is Easier

Corporations have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital. This is a big advantage because equity capital does not have to be repaid and incurs no interest. (Of course, by issuing shares, you are reducing your percentage of ownership in the company.)

3. Corporation Continuance (Perpetual Existence)

Another advantage of incorporating is continuance. Unlike a sole proprietorship, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes. The shareholders, directors and officers may retire or sell their shares, but the corporation continues in existence.

4. Potential Tax Deferral

Becoming incorporated gives you tax deferral potential that is not available under Sole Proprietorship or Partnerships.  Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket, or if the tax rates have fallen. Instead of getting your income when it’s received, being incorporated allows you to take your income at a time when you’ll pay less in tax.

5. Separation Of Ownership

A corporation is a separate legal and taxable entity. This separation allows the shareholder owner to keep personal assets such as the family home, separate from the business. Should the business fail, personal assets are insulated from creditors of the business.

6. Lower Taxes- The Small Business Tax Deduction

If you incorporate your business, it may qualify for the small business deduction. The small business deduction is the mechanism that lowers the income tax for small business corporations. Effectively the rate of tax on business income under $500,000 is only 11%!

7. Income Splitting

Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company’s earnings. A shareholder does not have to be actively involved in the corporation’s business activities to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate.

8. Perception of more stability and therefore Increased Business

Having Ltd., Inc.,  or Corp. as part of your company’s name may increase your business, as people perceive corporations as being more stable and credible than an unincorporated businesses. If you’re a contractor, you may also find that some companies will only do business with incorporated companies, because of liability issues.

9. Transferable Ownership

Ownership in a corporation or  is easily transferable to others, either in whole or in part.

Disadvantages of Incorporating

1. Registering A Corporation is Expensive

A disadvantage of incorporating is that corporations are more expensive to set up. A corporation is a more complex legal structure than a sole proprietorship or partnership, so it’s logical that creating one would be more complicated and costly.

Fees for incorporating a small business either provincially or federally, range in the hundreds of dollars – and that’s just for the set up. There are ongoing increased maintenance and other operating costs such as annual meetings, periodic filings,  increased accounting costs.

2. Increased Paperwork and Record Keeping

There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership. Corporations, for example, must maintain a minute book, containing the corporate bylaws and minutes from corporate meetings. Other corporate documents, that must be kept up to date at all times, include the register of directors, the share register, and the transfer register.

3.  Another Tax Return

When you incorporate your small business, you’ll have to file two tax returns each year, one for your personal income, and one for the corporation. This, of course, will mean increased accounting fees. Unlike a sole proprietorship or partnership, corporate losses can’t be deducted from the personal income of the owner.

No solution is the right one for all people. Take a look at what you are trying to achieve, talk it over with you business lawyer or accountant and choose the solution that is best for you.