A corporation is a separate legal entity, which is formed by application to either the federal government, or one of the provincial/territorial governments. The corporation issues shares to the owners, or shareholders. The funding of the corporation can be done through the issue of shares, or by borrowing. Instead of investing a large amount in shares, shareholders can lend money to the corporation, and invest only a minimal amount in the shares. This way, when the corporation has available cash, the shareholder loans can be repaid without attracting personal income tax.
Being a separate legal entity, a corporation pays corporate income tax, which is calculated completely separately from the owners’ personal income tax. If the corporation pays wages to the shareholders, income tax and Canada Pension Plan contributions, and sometimes Employment Insurance premiums, must be deducted and remitted to Canada Revenue Agency.
Incorporating your business may lead to lower taxes depending on your particular situation and on the province in which you operate. Once the business generates more income than you need for your living expenses, incorporating can save you money.
No matter where you choose to incorporate, incorporation offers many benefits to your business, including:
- creation of a separate legal entity
- limited liability
- lower corporate tax rates
- better access to capital and grants
- continuous existence.
Other Advantages of incorporating a new company in Canada:
- One of the biggest advantages of incorporating a business is limited liability. This means that the liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation. However, many incorporated small businesses are not able to get bank loans without the personal guarantee of the shareholders, so this eliminates part of the advantage of limited liability. The personal assets of the shareholders are protected from lawsuits against the corporation. However, shareholders who are directors of the corporation can be held legally liable for some debts of the corporation (such as GST/HST and payroll taxes) in certain circumstances.
- Another major advantage for a profitable small business is the income tax advantage. A Canadian controlled private corporation, or CCPC, pays a much lower rate of federal tax (small business rate) on the first $500,000 (in 2017) of active business income than would be paid by an unincorporated business, due to the small business deduction. Active business income generally does not include investment income or rental income, which is taxed at regular corporate tax rates. The combined federal + provincial small business tax rate varies from approximately 10.5% to 18.5% in 2017 for the first $500,000, depending on the province, and from 26% to 31% for income over the threshold. The threshold amount subject to the lower small business rate also varies between provinces. Keep in mind that this tax advantage is mainly a deferral of taxes until the profits are paid out to the shareholder. If all the profits are paid out to the shareholder as they are earned, leaving the corporation with little or no taxable income, then they will be taxed entirely as income of the shareholder, at personal income tax rates.
- Another tax advantage of incorporation is the $800,000+ capital gains deduction on the sale of shares of a qualifying small business corporation. One of the qualifications is that the corporation must be a CCPC with active business income.
- Private Health Service Plans can be used to provide tax-free benefits to employees. This deduction is also available to sole proprietors and partners, but the treatment for corporations is more favorable than that for unincorporated businesses.
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