While there doesn’t seem to be statistics on how many small businesses are incorporated in Canada, in the US it’s something like 20%. As of June 2016, there were 1,143,630 small businesses in Canada (97.9% of all businesses are small businesses). In Canada, a small business is defined as businesses that have fewer than 100 paid employees. In Canada, when you incorporate, you can use Limited, Ltd., Incorporated, Inc., or Corporation after your company name. Why are small businesses choosing to incorporate their business at the start?
With a sole proprietorship or partnership, you have unlimited liability, however, a corporation limits your liability to your investment in the company. The debts and other legal judgements against the company do not affect your personal assets.
You can also protect the name of your corporation, at least in the Province you’ve incorporated, or Canada if you do a Federal incorporation. Though if you have something good, it may be worth trademarking it.
If you are a sole proprietorship, and family wish to invest, then you have to make them partners, which then dissolves the proprietorship, and creates a new entity. Otherwise, it’s just a loan that you pay back. For the corporation, you raise capital by selling shares, and you can have different share structures, such as non-voting or preferred shares where they get their investment back first.
The corporate tax rate for small business, if it’s a Canadian Controlled Private Corporation, is 10.5% at the moment, and the provincial tax rates varies on your province. In BC as of January 2017, it’s 2.5% for a total rate of 13% on net income below $500,000. Over that amount it jumps to 11%, and a federally it’s 15% for a total of $26%.
The advantage to incorporation is you can play with your income. You can take all the net income out as wages, or divide it between wages and dividends, or leave some net income get taxed at 13% on that, and take some as salary and/or dividends. You need to keep in mind if you have a personal mortgage, the banks like to see a higher personal income. I have found the banks don’t like all dividends when it comes to income.
The sole proprietorship dissolves once the owner dies, and the partnership may dissolve if there’s no agreement in place on the occurrence of a partner’s death, otherwise, it becomes a proprietorship or a new partnership. Corporations, on the other hand, continue until they are liquidated.
Ease of Ownership Transfer
As ownership in a corporation is through shares, this makes it much simpler to transfer said ownership. The purchase of shares allows the company to merge or be sold without having to start the business from scratch.
To future investors or customers, having the suffix Limited, Incorporated, etc. after you name makes you seem more legitimate in their eyes. For some people, it just seems like your more invested in your business if you’re incorporated, especially to the banks.
Also, being incorporated allows foreign investors to invest in your company as there are not the limitations to invest like other forms.
There are Drawbacks to being Incorporated
Maintaining a corporation does have its additional costs over the sole proprietorship or partnership. Corporations have an annual filing fee with the province for provincial corporations and for federal corporations too. Federal incorporations may have two filings as they file federally as well as provincially depending in which province it operates. Of course, if you operate in more than one province, you have to register the corporation in each province, and then pay annual fees.
Also, many provinces work with the Canada Revenue Agency, and are informed when you incorporate, so you may be required to register for Workers’ Compensation depending on the province.
Since corporations are separate entities from the owners, there is increased documentation account setup, and filing demands, such as:
· Articles of Incorporation
· Corporate Minutes
· Certificates of Good Standing
· Separate Bank Accounts
· Greater tax compliance
There are some requirements for corporations when they reach a certain revenue milestone or the number of shareholders that they need to register with the TSX. And, maybe the SEC in the US.
The one advantage of incorporation is taxes; however, it can be a double-edge sword. The reason is that the corporation is taxed on its earnings, and the owners pay taxes on any earnings received from the corporation, such as dividends. Dividends though are taxed at a different rate than employment income.
When entrepreneurs consider starting a business, the corporation isn’t the first type of entity they think about. Corporations are a viable choice for a business startup, and have advantages over the other forms.
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