Advantages and Disadvantages of Incorporation in Canada

Dec 6, 2023

Numerous owners of small enterprises contemplate at some juncture the prospect of incorporating their businesses. Incorporating in Canada comes with its share of benefits, yet it’s not without its drawbacks, which we’ll delve into throughout this piece.

It’s important to understand that your business’s legal formation isn’t set in stone. As your enterprise expands, you have the flexibility to alter its legal framework. Initially, small businesses often operate as sole proprietorships or partnerships, with many choosing to incorporate as they evolve.

So, is it prudent for your small enterprise to undergo incorporation? We shall examine both the advantages and disadvantages to help you decide.

 

Advantages of Incorporating in Canada

Limited Liability

Incorporating a business introduces the significant benefit of limited liability for the company. This contrasts with sole proprietorships, where the owner bears all the company’s liabilities. Once a business is incorporated, the financial risk to individual shareholders is restricted to their investment in the company.

For sole proprietors, personal assets like homes and vehicles are at risk for settling business debts. Conversely, as a corporation shareholder, your liability for the company’s debts is eliminated, unless you’ve committed to a personal guarantee.

Corporations Carry On

Moreover, corporations possess similar rights to individuals, including owning property, conducting business, acquiring liabilities, and the ability to engage in legal actions, either suing or being sued.

Another perk of incorporation is its perpetuity. Differing from sole proprietorships, a corporation’s existence isn’t hampered by the death or departure of shareholders, or changes in ownership, leading to easier business transfers compared to sole proprietorships.

Easier Access to Funds

Financial accessibility is another advantage for corporations, possibly facilitating business growth and development. Corporations often enjoy lower interest rates on loans and may secure equity financing more readily from investors like venture capitalists.

Income and Tax Optimization

Incorporating your small business allows you to strategically manage your income and achieve tax benefits. Rather than drawing a salary tied directly to business income, incorporation lets you choose more tax-efficient times and methods for income withdrawal. Opting for dividends over salary can additionally reduce your tax obligations.

Deferred Tax Benefits

Incorporation can also defer taxes for those with higher personal income levels. With corporate tax rates being substantially lower than personal ones, earnings left in the business to be withdrawn at a lower personal tax rate offer significant savings.

Consider a Canadian business with $300,000 post-expense earnings:

Withdrawn entirely as salary in 2019, with no deductions, results in $78,296 in personal taxes at a 29.6% marginal rate. Drawing $200,000 as salary incurs $45,711 in personal taxes at a 22.9% rate. Leaving $100,000 in the company subjects it to a 15% corporate tax, totaling $15,000. Thus, total taxation amounts to $60,711, saving $17,585 over extracting the full amount as salary.

Small Business Tax Deduction

Incorporation might qualify businesses for the small business deduction (SBD), reducing the corporate tax rate to 9% on the initial $500,000 of taxable income—offering a significantly reduced tax rate compared to personal income taxation.

Corporate Perception and Opportunity

Having designations such as Ltd., Inc., or Corp. in your company name could enhance business prospects through perceived stability over unincorporated entities. Contractors might find greater opportunities as some businesses prefer or require engaging with incorporated entities for liability and formal relationship reasons.

Business Name Protection

Incorporation at the state, provincial, or federal level secures your business name exclusively in your jurisdiction or across the country, contrasting greatly with the lack of name protection in sole proprietorships and partnerships, where name duplication is a risk.

Though incorporation appears advantageous, it’s important to weigh these benefits against potential downsides.

 

Disadvantages of Incorporating in Canada

 

Another Tax Return

Incorporating Your Small Enterprise
When you decide to incorporate your small business, it becomes necessary to file two separate tax returns annually: one for your personal earnings and another for the corporation itself. Naturally, this leads to higher costs associated with accounting.

Increased Paperwork

Operating a corporation involves significantly more administrative work compared to running a sole proprietorship or partnership. Corporations are required to keep detailed records such as a minute book that includes the company’s bylaws and meeting minutes. Essential documents that need to be regularly updated include the list of directors, the record of shareholders, and the documentation of share transfers.

No Personal Tax Credits

Incorporation might not always work in favor of your business’s tax situation. Unlike individuals, corporations can’t take advantage of personal tax deductions, meaning every cent earned by the corporation is subjected to taxation. As an individual business owner, you have the potential to benefit from tax deductions unavailable to corporations.

Less Tax Flexibility

Corporations lack the flexibility that sole proprietorships and partnerships enjoy when it comes to managing losses. As a sole proprietor, you can offset business losses against other personal income in the same tax year. For corporations, losses can only be applied to adjust income in different tax years, either in the past or future.

Liability May Not Be as Limited as You Think

The main benefit of incorporation, limited liability, may not be fully guaranteed due to the need for personal guarantees or credit agreements. The celebrated protection of limited liability means little if creditors refuse to extend credit to the corporation without personal assurances. Consequently, if the corporation fails to fulfill its financial commitments, the personal liability of the business owner comes into play despite the corporate structure.

Registering a Corporation Is Expensive

Setting up a corporation is pricier than forming other types of business entities due to its complex legal requirements. The process of incorporating a business, either federally or provincially, incurs substantial costs, generally amounting to hundreds of dollars.

Closing a Corporation Is More Difficult

Dismantling a corporation involves more steps than ending other business types. It requires an official corporate decision to dissolve, settling any payroll accounts, and notifying provincial authorities or the Canada Revenue Agency by submitting a certificate of dissolution. Additionally, the corporation’s final tax returns need to be filed.

 

Should You Incorporate on Canada?

Before making any decisions, it’s crucial to consult with your accountant and lawyer regarding your specific circumstances. They can provide a clearer understanding of how forming a corporation might advantage your business and assist you in determining if the complexities and costs associated with the process are justified for your situation.

 

 

 

You can find Contracts and Documents for Business Owners in Canada here https://www.businessdocs.ca/

 

Need more information? CBES is here to assist you; feel free to contact us for expert guidance.

 

 

 

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