At Emerge Law’s Startup & Business practice, clients often ask us the question: Should I incorporate?
The simple answer to this question is…..it depends. The decision on how to structure your business will depend largely on your current needs and future goals. Every situation is different, and that’s why it makes sense to sit down and discuss your options with a lawyer.
That being said, we want to use this legal insights article to tell you a little more about incorporations and provide you information that will hopefully help you answer that question.
i. What is the main difference between a sole proprietorship and an incorporated business?
A corporation is a legal entity, whereas a sole proprietorship is not. Once incorporated, a business becomes a distinct legal entity is completely separate from its owners and/or shareholders. So, if your business goes south then your personal finances and assets are protected. This is different than being a sole proprietor. When you are a sole proprietor, you are legally attached to your business, which comes with many risks including personal liability.
ii. Federal Incorporation versus Provincial Incorporation
It is worth noting that all businesses in Canada have the option to incorporate federally or provincially.
Provincial incorporation means you can incorporate your business in a single Canadian territory or province. Each provincial incorporation is a stand-alone process.
Federal incorporation lets you do business under the same name in all provinces and territories and wider rights to carry on business throughout the entire country.
iii. What are benefits and drawbacks to incorporating?
- Liability Protection: Your business is a separate legal entity and as such, creditors or legal actions go against your corporation and its assets, not your personal assets. (Please note that there are exceptions, such as personally guaranteed loans and government tax obligations, among others.)
- Taxes: Incorporating a company may assist you to reduce your taxable income. How does this happen? Incorporated companies are taxed at a lower tax rate than individuals however to access this tax benefit, you must be able to keep money within the corporation instead of drawing the money over to yourself personally. There are also significant tax savings available to you as a business owner if you are able to maintain net revenues within the corporation.
- Tax Flexibility: Your business has tax flexibility from which you may personally benefit, such as tax deferral and income splitting. If you sell shares in your Canadian-controlled private corporation (CCPC), capital gains could be tax-free up to $750,000. You can also choose the most tax-efficient way to pay yourself, including dividends, salary, bonus or a combination.
- Name Protection: If you are using a business name to operate your business, completing an incorporated company provides name protection for that business name within the jurisdiction you incorporate
- Continuous existence: if you sell the business or shareholders die the business will continue to exist. In other words, a corporation has an unlimited life span.
- Ownership of the business entity is transferable: Because the entity has an unlimited life span, you can sell your business or plan its succession easily.
- Increase your credibility and business-worthiness: Some businesses won’t enter into sales or contract agreements with un-incorporated businesses. In which case, incorporation can improve your credibility and growth potential.
- More Access to Capital: As an incorporation, you have an exponentially higher likelihood of acquiring funding to help you grow and scale. Venture capitalists are much more likely to invest in an incorporated business.
- Added costs. There are upfront costs to incorporate.
- Administrative work: Incorporated entities must file more paperwork, such as separate tax returns, an annual return, one-time articles of incorporation and notifications of share sales, moves or changes of directors.
- Taxes: It can also be a tax disadvantage to incorporate since you can’t claim any of the personal tax credits that you otherwise would as a non-incorporated business.
- Losses in an incorporated company can’t be personally claimed. A failed startup can only be “written off” personally to the amount you had invested, not the accumulated negative earnings.
Remember, incorporation requires careful planning and the right advice. Not all businesses need to take this step and not all will incur the perceived tax benefits. At Emerge Law, we determine the type of business entity to operate your business through. Business entities include incorporated corporations, partnerships, limited liability partnerships, joint ventures, and sole proprietorships. We recommend the most suitable structure that that minimizes your tax to the CRA. We also ensure that your new business is firmly established with corporate bank accounts and an excellent accountant.
If you would like to speak with a lawyer, schedule an initial consultation at Emerge Law. To speak with a startup lawyer in confidence, contact us at 416-238-5527 today!
The content of this article is written for general information purposes only, and does not constitute specific legal advice. This article should not be used as a substitute for competent legal advice from a licensed lawyer.