Should I incorporate my business?
As a lawyer who represents business owners, I am often asked the question, “Should I incorporate my business?”. Sometimes it is a client who is in the process of starting a new business venture and sometimes it is someone who has been operating their business for a period of time and is now planning for the future. The answer to this question involves an examination of the client’s specific needs, including a consideration of the type of business, how the business is currently operated, the client’s family situation, future business plans, business financing that may currently be in place or is anticipated to be put in place, etc. The answer is very fact specific, and I find it often involves a detailed discussion between the lawyer, the client and the client’s accountant to find out what makes the most sense for that particular client.
While every situation is unique, there are some advantages to incorporating which apply to most business owners:
- Limited Liability. A company is a separate and distinct legal entity. This means it has the ability to contract with third parties, carry on business, own assets and incur debt. The debts incurred in the business are the company’s liabilities, not the liabilities of the shareholders or directors of the company. A shareholder’s assets are generally protected from the creditors of the company and the shareholder’s risk is limited to the amount invested in the company. This being said, there are particular situations where shareholders and directors may be liable for company debt, such as where the individual gave a personal guarantee, certain environmental liabilities or amounts owing by the company to CRA for unpaid GST/HST or employee payroll deductions.
- Flexibility in Raising Capital. There is the ability to create different classes of shares with different attributes (i.e. voting or non-voting, different dividend entitlements, etc.). This provides flexibility to attract investors to purchase shares in the company (note that relevant securities legislation needs to be considered).
- Lower Tax Rate. The corporate tax rate is generally lower than the personal tax rate. This leaves more money available for the business’ needs.
- Tax Efficiency. With a company, a business owner has more flexibility in structuring how to receive income. Money can be paid as dividends, employment income or a combination of the two. As well, there is the potential for income splitting with a spouse or other adult family members by setting up different classes of shares or a family trust. Tax advice must be sought and considered, but incorporation opens the door to such possibilities.
- Benefit of the Capital Gains Exemption. The current lifetime capital gains exemption is in excess of $800,000. If the sale of the business down the road is structured as a sale of shares, there is the potential that the shareholder may be able to claim the capital gains exemption on the sale of his/her shares. Tax advice would need to be obtained by the business owner to determine if the subject shares qualify. This is a planning piece that should be addressed as early as possible when a potential sale of the business is on the horizon.
- Estate Planning Options. There are options for transitioning the business to children over time. Again, this requires tax planning. It should be noted as well that an incorporated company continues to exist and carry on after the business owner dies, unlike a business which is run as a sole proprietorship.
- Multiple Owners of the Business. If there are several individuals who are carrying on business together, incorporating a company together can increase efficiency in contracting and carrying on the business. As a simple example, instead of needing each individual sign all contracts, one person can be authorized to sign. For this type of a business model to succeed, and to minimize the potential of future conflict between the owners, we always recommend that the shareholders enter into a carefully planned and structured shareholders’ agreement.
Like anything, there are also potential drawbacks to incorporating. For example, business losses in a company cannot be offset against personal income, so sometimes a start-up business may delay incorporation until the business model has stabilized. There are initial start-up costs to incorporation. As well, there are annual tax returns which must be filed for the company, and annual reporting requirements and fees with the applicable corporate registry. Quite often these costs are outweighed by the benefits of incorporation; in particular tax savings. But again, it all depends on the business owner’s specific situation.
It is also important to keep in mind that, as a business grows, and as a business owner’s family changes and grows, the business’ needs change. So if incorporation does not make sense right now, it may make sense down the road.
If you are a business owner and this is a question you have been considering, I encourage you to call one of the lawyers within our corporate department. We would be happy to discuss your business needs further.