The frustrations of getting employed in Canada are often particularly severe for new Canadians, a group that often sells most or all assets in their jurisdictions of birth in the hope of a new life in Canada. Often times, whether by design or compulsion, new Canadians are driven to starting a business as a source of livelihood. While the success stories from such opportunities are many, the decision to start a business has legal ramifications and a business should be commenced with as much planning and legal advice as possible. At the forefront of the business decision is a determination of the appropriate vehicle to use for such purposes.
This article focuses on the use of a corporation as a business vehicle and canvasses some of the basic issues to be considered in this regard. This article is for informational purposes only and should not be construed as legal advice.
Benefits of a Corporation
A corporation is often the first vehicle of choice for entrepreneurs. While carrying on business as a sole proprietor (i.e., without any formal business vehicle) is often the easiest option, a sole proprietor is personally liable for the liabilities and obligations of the business and may unknowingly expose his/her savings and assets to creditors and any other person having a right of action against the business.
The use of a corporation allows an entrepreneur or new business owner to protect personal assets and savings from the liabilities arising from the business. It provides a corporate veil that may not be pierced otherwise than in egregious circumstances. It also allows for the conduct of the business through a proper business vehicle, allows for sophisticated tax planning if the business is successful, and may enable the business owner to access outside funds (whether through loans or investments) more efficiently.
Incorporation Basics
Incorporating a corporation in Canada is a simple yet complicated task. On one hand, a corporation can be incorporated without legal or accounting help. On the other, a proper incorporation done with the help of sophisticated advisors can be effective and a cost-saver in the long run.
A corporation may be incorporated federally or in any of the Canadian provinces. Some provinces like Nova Scotia also allow for incorporations of unlimited liability companies, a tax planning vehicle not considered in this article. The key distinction between a federally incorporated and a provincially-incorporated corporation is that the former may carry on business in any province or territory (provided that it complies with the applicable registration and reporting requirements of each province) whereas a provincial corporation is required to obtain an extra provincial licence and register in any other province where it carries on business.
Incorporation is done by filing articles of incorporation along with the preparation of the relevant by-laws. The corporation should issue shares on incorporation (although technically it may be possible to incorporate a corporation without share capital). Shares are issued to shareholders in return for consideration that could include cash or property (a contribution of property in return for shares may require a tax election to ensure that the contribution may be made without any immediate tax consequences).
A corporation must choose a name for incorporation purposes. If no specific name is chosen, the relevant incorporating agency will issue a default name (usually a name identified by a unique number). If an actual name is sought for the corporation, a search for the particular name must be conducted in order to determine if the name (or extremely similar versions thereof) is already in use, in which case the name may not be available. Different jurisdictions provide different levels of protections for names, and depending on the jurisdiction of incorporation a name may or may not be available for use. It should be noted that the availability of a name for incorporation under a federal or provincial statute does not usually provide protection for that name from an intellectual property standpoint. Appropriate intellectual property registrations must be considered for such protection.
A corporation must also provide for a minimum number of directors and have at least that minimum immediately after incorporation. Most Canadian statutes require a minimum number of Canadian directors for corporations incorporated under such statute. For example, Ontario requires that at least 25 percent of the directors of a corporation incorporated in Ontario be resident Canadians. It should be noted that there is no such requirement for the shareholders of a corporation (except in protected sectors).
Generally, a corporation has the capacity and, subject to its governing statute, the rights, powers and privileges of a natural person. A corporation is usually not restricted by its articles from carrying on any business or businesses or from exercising any power or powers. A corporation must choose a financial year-end in its by-laws. The initial by-laws usually also provide rules for a host of other major issues relevant to the operation of the newly incorporated corporation (e.g., annual proceedings, notices and returns, shareholder meetings, proxies etc.).
Tax Registrations and Rates
A corporation must register itself for tax purposes. Generally, the act of incorporation should result in an automatic business number from the Canada Revenue Agency (“CRA”). Otherwise a business number may be obtained by completing Form RC1 (available on the CRA website). A corporation that makes taxable supplies must also register for the Harmonized Sales Tax. Where appropriate, payroll accounts and/or import/export accounts must also be registered.
A corporation is required to file an annual tax return within six months of its year-end. Under certain circumstances (e.g., an amalgamation or an acquisition of control), the taxation year may terminate early, in which case, the corporation must file a tax return within six months from the date of such termination. Harmonized Sales Tax Returns must be filed annually, quarterly or monthly depending on the volume of the corporation’s taxable supplies.
Corporations are taxed at different rates than the rate of tax on individuals. To this extent, incorporating a business allows the incorporator the opportunity to defer tax if the income of the corporation is not passed on to the shareholders immediately. A simple example illustrates this point. An individual resident in Ontario and carrying on business as a sole proprietor will pay tax at the highest marginal rate of 46.4 percent and may end up paying tax at that rate on part of the business income in the year in which such income is earned. On the other hand, if the business is carried on through a corporation, the rate of tax on the corporation will vary from 15.5 percent to 28 percent (discussed immediately below). If the corporation does not pass on its after-tax income to its shareholder immediately as a dividend, the difference in the rates of tax allow for deferral of the additional tax that would have been paid had the individual earned such income directly. It should be noted that the combined rate of tax on corporate income and on income received as dividends by an individual shareholder will be similar to the rate of tax imposed on an individual earning business income as a sole proprietor, and hence, the deferral is only available if a corporation retains its income and does not pay it out immediately as a dividend.
As noted above, a corporation is taxed at rates varying between 15.5 percent and 28 percent (these are combined federal-provincial rates applicable to a corporation paying tax in Ontario at the time of writing). The rates of tax applicable to a Canadian-controlled private corporation (i.e. a corporation not controlled by non-residents or public corporations) are 15.5 percent for active business income up to $500,000, 28 percent on active business income in excess of $500,000 and 46.2 percent on investment income. A corporation that is not a Canadian-controlled private corporation pays tax at 28 percent on active business income and investment income and 26.5 percent on general manufacturing and processing income. Generally, income taxed at normal tax rates can be paid out as dividends to individual shareholders resident in Canada at a lower rate of tax than income taxed at the lower tax rate.
Conclusion
This article is a simple discussion of the benefits of the use of a corporation as a business vehicle and the advantage of using a corporation from the commencement of the business. It is not an exhaustive discussion of corporate and tax issues surrounding a corporation. Readers should consult a legal advisor about the exact issues pertaining to their unique business and individual circumstances.
Ron Choudhury is a partner and member of the firm’s Tax and Mining Groups and Estates and Trusts Litigation Team.