July 24, 2020

The Complete Guide to Incorporating in Canada

Learn (almost) everything you need to know about incorporating your small business in Canada. Should you set up a sole-proprietorship or corporation? Read more before deciding.

Free comprehensive Incorporation Checklist included.

What’s a Canadian Corporation?

A corporation is a separate legal entity (another ‘person’). Each corporation has its own CRA business number (equivalent to a Social Insurance Number), pays its own taxes, owns assets (cash, vehicles, equipment etc) and has liabilities (bank loans, money owing to suppliers etc). Each corporation should also have a minute book, which is an official record of the corporations activities.

There are several types of Corporations – we’ll be talking about Canadian Controlled Private Corporations (small businesses).

What’s a Sole Proprietorship?

Sole proprietorship is the simplest and cheapest business structure. If you make over $30,000 then you’ll need to register for GST, otherwise there’s no real registration process to set up a sole-proprietorship with the CRA (you may have municipal or other licensing requirements). As a sole-proprietor, you need track income / expenses (retain your receipts) and report these on your personal tax return each year as self-employment income. You can take a deduction for vehicle expenses (keep a mileage log) and can depreciate (expense over time) business assets.

Pros and Cons – Should You Incorporate?

Legal Benefits

Creditor Protection

This is the primary legal reason a lot of people incorporate their business. If your company is sued, your personal assets are protected. However, you’re still personally liable for CRA debts (taxes, GST, payroll) and any other debts covered under a personal guarantee. Customers and other parties can ‘pierce the corporate veil’ (go after your personal assets) under certain circumstances like when fraud is committed or if it wasn’t clear that they were dealing with the corporation.

Perpetual Existence

Corporations continue to exist until dissolved (voluntarily or involuntarily). The corporations value is taxed at death on the owners final tax return (taxes can be deferred if there’s a surviving spouse), but the corporation will continue to exist and can be operated by successors such as children. There are several estate tax planning strategies to minimize tax at death.

Ownership Flexibility

Setting up a corporation doesn’t, by default, make you the ‘owner’ of it. Shares need to be issued. The owner of these shares becomes the shareholder of the company. Each corporations articles of incorporation will specify the classes (types) of shares that are authorized to be issued. There’s a lot of flexibility in what kind of shares can be created and issued. Typical share classes include common and preferred shares. Common shares increase in value as the company grows. Preferred shares are usually a fixed value and take priority over the common shareholders. Shares can be classified as voting or non-voting.

Share Ownership Example

Bob and Mary want to set up a company. Bob’s mom, Veronica, will contribute $100,000 in startup cash. Bob and Mary could each subscribe to 50 voting common shares and issue Veronica 100,000 preferred non-voting shares. Bob/Mary would then each own half of the value and votes of the company (they would control business decisions). Veronica has no votes and her shares don’t increase in value. She can redeem her preferred shares for $100,000 cash once the company starts making money. If she wanted to get paid some interest, then those preferred shares could specify an interest-rate. If the company went insolvent (bankrupt), Veronica would get paid from any remaining assets before Bob/Mary because her shares take preference over their common shares.

Tax Benefits

Tax Deferral

Small Alberta corporations (< $500,000 taxable active business income) pay a low tax rate of 11%, whereas Alberta personal tax rates are upwards 48%. This means that you can defer up to 37% in taxes (2020) within a Corporation. You will still pay these taxes in the future, but not until you pull the money out of the Corporation. You can reduce taxes by spreading income out over several years at lower tax brackets.

Corporations are taxed both federally and provincially, so the maximum deferral depends on which province your company earns money in.

Tax Deferral Example

Gross Taxable Income (before owners salary)
$210,000
Salary Paid to Business Owner
$97,000
Net Taxable Income
$113,000
Tax Deferred
$32,600

In this example, the business made $210,000 before paying anything to the owner. If the business were a sole-proprietor, then personal taxes would be paid on the full $210,000, resulting in around $68,000 personal taxes. Total tax paid under a corporate structure would be closer to $35,400 ($23k taxes on $97k personal income plus $12.4k corporate taxes on $113k corporate taxable income). Total tax deferred in one year by operating under a corporate structure: $32,600 ($68k – $35.4k).

This is a simplistic example using Alberta 2020 tax rates and ignores deductions/CPP/tax credits. Your specific tax deferral will depend on how much money you keep in the company (because you pay personal taxes on any money you pull out), what tax bracket you’re in and what province you live in.

Canadian economic growth is the main purpose behind this tax deferral. The government wants businesses to reinvest in their companies (hire more employees, buy more equipment). You can hold investments (real estate, stocks etc) inside of a corporation, but tax rates are high on passive investments and there can be further adverse tax consequences. Consult with your accountant before investing within a corporation.

Lifetime Capital Gains Exemption

You can shelter up to $883,384 (2020) capital gains tax when you sell your corporate shares. Generally, to qualify for this exemption:

  • Your company needs to be a small Canadian corporation.
  • You must have held the shares for two years before you sell them (unless you started the company).
  • Substantially all (90%+) of the business assets must be used to carry on an active business in Canada. This means that you can’t have a bunch of passive investments (real estate, stocks, bonds) or cash in your company.

The Capital Gains Exemption qualification isn’t always straight-forward and advance planning often needs to be done to ensure qualification. As such, it’s important to talk to your accountant early on.

Tax Planning

A corporate structure increases flexibility in tax/estate planning. A few common tax strategies include:

  • Income Splitting, which involves paying family member(s) from the corporation. This lowers overall family taxes by spreading income over two or more people. However, the Liberal government came out with complex legislation called ‘Tax on Split Income’ (TOSI) in July 2017. TOSI can result in split income being taxed at the highest tax rate, with no access to any tax credits. As such, it’s really important to consult with your accountant before attempting to split income. You should also set up your corporation correctly in the first place (issue a different class of shares to each family member involved) to avoid excess taxes being assessed.
  • Pipeline Planning – This allows you to extract corporate assets at capital gains tax rates (typically 2 – 24%) versus dividend rates (35-42%) and can result in significant tax savings. This type of planning is expensive and usually only makes sense if your corporation has > $500,000 in cash and investments that you would like to pull out.

Incorporation Disadvantages

The biggest downside of incorporating is the cost. There are higher upfront and recurring annual legal/accounting fees. Maintaining and (ultimately) dissolving a corporation is also more complex than operating as a sole-proprietorship. If you’re uncertain about the viability of your business plan then you may want to start as a sole-proprietor.

So… Should You Incorporate??

Incorporating for the creditor protection may make sense regardless of how much money you expect to make. However, from a tax standpoint, incorporating usually only makes sense if:

  • A chunk of cash/revenue is kept inside of the corporation so that you can take advantage of the tax deferral and/or;
  • You intend to build and sell the business.

I’ll typically advise clients (creditor protection aside) not to incorporate unless they will be making more than $100,000 a year or are planning on hiring employees and growing their business.

How To Incorporate Your Business

Using a Lawyer to Incorporate

Using a lawyer is the most expensive option, but you’ll get custom-tailored advice and it will be done right. Your lawyer should advise on classes of shares, federal vs provincial incorporation, trademarks (name protection), unanimous shareholder agreements and anything else relevant to your situation. Your lawyer will also typically maintain your minute book, file your annual returns and file resolutions as required.

Using an Online Service to Incorporate

There are plenty of online incorporation services. They are relatively cheap and easy, but lack any customized advice. They should provide you with a basic minute book. This option may be okay for a small business owner with no partners or big growth plans. However, you should still understand the basics of incorporation and issue yourself shares.

Self-Incorporation

You can incorporate yourself at any registry office, but you’ll need to provide the registry with the appropriate documents. You’ll need some technical knowledge to properly do this yourself or you can pay the registry for a basic minute book that outlines standard classes of shares and other details required for the Articles of Incorporation. You’ll need to perform a nuans search for your chosen business name, otherwise the registry will assign your corporation a numbered name like 1234567 Alberta Ltd.

Regardless of the option chosen, make sure to file annual returns each year. These keep your corporate address/director information up-to-date with the government. If not filed, the government will involuntarily dissolve your corporation which results in headaches and unnecessary extra costs.

Steps to Take After Incorporating

Incorporating is just the first step. Some important tasks after incorporating are:

  • Issuing shares
  • Selecting a year end date
  • Applying for CRA business numbers
  • Opening a corporate bank account
  • Maintaining a vehicle log
  • Understanding how to pay yourself – salary vs. dividends
  • Selling assets to the company

Happy Incorporating!

Free Incorporation Checklist

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