Tips for Incorporating in Canada

Deciding to incorporate your business in Canada involves weighing the pros and cons, understanding why you should incorporate, and being aware of the differences between provincial and federal incorporation.

If you’re considering incorporating, we’ve outlined the essential details.

Why Should You Incorporate Your Business in Canada?

Incorporating a business involves issuing shares and creating a taxable and legal division between the company and its shareholders, which helps to protect them from any potential legal or financial risks.

Establishing a corporation can benefit the owners in many ways, such as protection from creditors, tax deferral and many other benefits, which we will discuss in this article. It also provides some measure of security for the company’s name. But it’s essential to consider the costs associated with setting up and maintaining a corporation - legal and accounting fees may add up over time.

When you’re deciding whether you should incorporate your business, you should consider the following main factors:

● The revenue of your business

● Your goals for your business

● Your personal tax situation

● The type of business you have

● The potential legal liability within the business

Tips for Incorporating a Business in Canada

1. Defer Income Taxes

When it comes to taxation, corporations have a significantly lower rate compared to individuals. For the first $500,000 in profit, companies only need to pay between 12.2% for 2023 (in Ontario (9% Federally and 3.2% for the Province of Ontario). In contrast, an individual would pay up to 53.53% (highest tax bracket for Ontario). This is known as the small business tax rate, also known as the lower tax rate or Canadian-controlled private corporation (CCPC). You must satisfy specific requirements to receive this corporate tax rate. Incorporating can drastically defer your taxes depending on how much funds will be taken personally. This can be a considerable sum of money, and it's essential to get advice from qualified tax experts.

2. Consider Provincial Incorporation and Federal Incorporation

Understanding the pros and cons of provincial and federal incorporation is essential. We’ve covered this in more detail further down the article.

3. Use Separate Share Classes

Incorporating requires differentiating between classes of shares for shareholders, granting them specific rights and obligations according to their share class for more flexibility and control.

Businesses with multiple shareholders can distribute dividends in different amounts by creating different share classes. This system allows more flexibility when declaring and paying dividends. It also means one shareholder in the same class won’t receive more money than another. Incorporating in Canada can be made more tax efficient by setting up classes of shares.

4. Select Board Members Carefully

Careful consideration is essential when selecting board members. Their decisions will shape the future of your business, so it’s critical to choose wisely.

Building trust between board members is essential for business success. Ensure you and your partner are on the same page to create a balanced working relationship.

5. Transfer your Cash to a Holding Company

To protect your assets, consider setting up a holding company.

A holding company is a corporation that owns shares in another company—typically positioned between the operating company and the individual shareholder. In a three-tier structure, the holding company will own the operating company's voting stock and assets and will control its management and policies. The purpose of a holding company is to manage and grow the excess cash. When there is extra cash, it should be used to pay dividends to the holding company.

The dividend distributed to the holding company is tax-free and leaves almost no cash in the operating business. So, in case of a lawsuit, there is minimal risk because the assets (i.e. cash and investments) are stored within the holding company. This is an extremely valuable tax strategy to protect your assets from creditors.

Pros of Incorporating a Business

● Investing in a corporation can help protect individuals against personal financial liabilities. This way, they can manage risk and ensure their assets are secure.

● Companies can benefit from tax deferral in certain conditions, helping to defer their overall tax burden.

● Lifetime Capital Gains Exemption (LCGE) provides an excellent opportunity for tax savings for clients considering selling a business if certain conditions are met. The 2023 limit is $971,190 (2023) for LCGE.

● Estate Planning can be made simpler and more efficient by incorporating. This way, one can easily transfer their assets to the next generation.

● Forming a corporation can make your business appear more reputable and trustworthy for those you interact with. It’s not essential for success, but it adds an extra layer of credibility to your organization.

Cons of Incorporating a Business

● Forming a company costs more than starting a business as a sole owner.

● Operating expenses for a corporation are generally more than those of a single entrepreneur. For example, the cost associated with filing legal and tax documents are typically higher.

● With taxes and legal requirements constantly changing, you could face increasing paperwork yearly.

How to Incorporate a Business in Canada

To incorporate a business, you will need to go through the following procedures:

● Choose whether you’d like to register your business at the federal or provincial/territorial level. Depending on your situation, you may need to incorporate one or the other to benefit from different advantages and legal requirements.

● To get your business up and running, the Canada Revenue Agency (CRA) offers a Federal Business Number and Corporation Income Tax Account number, which are essential for any business.

● If you plan to conduct business in any other Canadian jurisdiction, you must register as an extra-provincial or extra-territorial corporation. This is a crucial step for companies looking to expand their operations nationally.

You can visit Canada’s government page to incorporate at a federal and provincial level.

Incorporating Federally vs. Provincially

Business Name Protection

Incorporating your business at a federal level will give you more name protection, and you must carefully select a suitable name. After being accepted by the federal government, your corporate name will be protected in every province and territory across Canada.

Provincially incorporated businesses are given more freedom regarding their names, with slight variations accepted, and name uniqueness rules are less strict than in other types of companies. Knowing that your business name may not be protected when expanding operations outside the province is essential.

Conducting Business

Federal incorporation allows your company to operate anywhere in Canada without office setup or location restrictions. This can be beneficial and give you more control and access to more potential customers.

Registering your business at a provincial level allows you to do business only in that province and restricts the office location. To conduct business in other provinces or territories, you’ll need to register an extra-provincial or extra-territorial corporation.

Administrative Tasks

Federal companies file documents annually with their Director of Corporations branch and submit provincial applications. They also need to register their company in any provinces they conduct business in if they want to expand beyond the federal level. Companies incorporated at a provincial level must file an annual corporate return with the relevant government authority within 60 days of the incorporation date.

Associated Costs

Incorporating a business Provincially can be more economical and less time-consuming than Federal incorporation.

However, incorporation costs can vary depending on the province.

Should I Incorporate Federally or Provincially?

Depending on your business type, decide if you want to incorporate it at the federal or provincial level. When running a small business with no plans of expanding across other provinces, it would be wise to incorporate within the same province to maximize efficiency.

An alternative to provincial incorporation is federal incorporation if your company regularly engages in business internationally or with multiple provinces. This setup may be the most advantageous if you want to operate a business in more than one province.

Summary

Ultimately, evaluating the pros and cons of incorporating a business is essential. Additionally, it would be best to consider whether federal or provincial incorporation suits your business better. Make sure to follow our tips when incorporating your business and ensure to consult an expert.

The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.

By: Kamal Gawri, CPA, CA