Small Business Archives

Introduction

Before you begin the incorporation decision making process, and weighing the advantages vs. the disadvantages of incorporation, a business owner may want to reflect about his or her company overall. Starting your business can often be somewhat overwhelming. Initially, you may focus on your business’s viability, the company’s vision and growth for your proposed business. For example, is there an unresolved or under fulfilled need in the market, a void or a gap, or a customer service issue which you can address and resolve. Another important factor, can this business provide you with a livelihood and grow based on your needs?

Other areas of focus may include the availability of resources. Does your company have both people and financial resources to help your business get off the ground and grow. There are many business development areas to focus on before you consider starting your own business.

The Different Ways to Structure Your Business

Once you have a grasp and understanding of your business development areas, you will need to research the legal and business structures of your business.

Essentially there are three common types of business or legal structures available to start your company.

Corporation (federal or provincial)
Sole Proprietorship
Partnership

At the very beginning stages of starting your company or along your business development path, you may become interested in the benefits of incorporating your business. This interest may also be piqued during initial discussions with your business colleagues, or during meetings with your lawyer or your accountant.

Advisory Resources

There are many benefits to working with a lawyer and accountant who have also helped individuals like yourself with setting up a new company. Once your lawyer or accountant understands more about you and your needs, they can help you decide which business structure best suits your needs.

Blog Post Objective and Audience

The objective of this blog post is to provide selected high-level topics that may be of assistance to those thinking about incorporation. It is is written for business owners or prospective business owners who are researching the benefits and advantages of incorporation of their business.

The post is not written for the ‘do it yourself’ approach. Although, for those readers who are considering incorporation without the assistance of an accountant or lawyer, they may find value within the blog post, and the potential perils of the ‘do it yourself’ method related to incorporation.

The sections focus on where the business owner is now, from a business structure perspective, and why they may be considering or need to incorporate. In addition, the post will include alternatives to incorporation, business structure, the steps to incorporate, along with the role of a lawyer and accountant and how they can assist you with incorporation, specifically in areas of tax, legal, provincial, and federal requirements.

1. Where Are You Now?

This section will focus on the business owner’s current situation, their business environment and where they are now in the incorporation decision making process.

First Things First

One of the first things to understand is the business owner’s business. For example, what is their business status? Is the business growing, adding partners, and involving family stakeholders, experiencing growth, and awareness of risks and liabilities?

What resources are available to the business owner? Budget for external resources?

Corporate Best Practices

Incorporating a company will require the resources (internal or external) and work effort to support numerous ‘corporate’ best practices. These best practices include:

Working with your professional services partners like your lawyer or accountant to ensure you are compliant with government statutes, taxes (H.S.T and Corporate) and laws
Creation and management of the corporation’s bank accounts. Limited use of personal accounts for business and an audit trail when personal accounts are used
The maintenance, storage and upkeep of your companies records and documentation. These records will be required by government and financial institutions, and in some cases business partners or associates
Resources that are compliant and responsible for the documents and notices that you will receive from financial institutions or governments (e.g., Canada Revenue Agency – CRA). These resources will need to ensure they are proactive with these notices, and that they read and understand the importance of these notices and documents
Money borrowed from the company is paid back promptly and within the CRA accepted rules
Processes and resources that are accountable for all corporation taxes. Operating an incorporated company requires discipline and diligence when it comes to your record keeping, especially taxes
Specific to GST/HST, your company works on behalf of the CRA and must collect these taxes and must report and submit these funds to the CRA on a regular basis. These taxes should be collected and deposited into a separate bank account, these funds should be separated from your corporation’s revenue and cashflow
Precise record keeping and due diligence related to business expenses. Business expenses must be reasonable be related to the operation of the business

Once you have a thorough understanding of ‘Where You Are Now’, the next step is to understand ‘what’ incorporation means.

2. What Exactly Does Incorporation Mean?

Corporation Identity

Incorporation of your business also identifies your business activities to government authorities and allows you to conduct your business within the jurisdiction of your incorporation, which has distinct advantages and disadvantages.

A corporation is a distinct and separate legal entity, which is separated by law from its founders or the people that have created the corporation.

The people within the corporation act on behalf of the corporation, including the corporation’s board, officers, management, and its employees. The corporation must adhere to and be compliant with federal and provincial statutes.

Business Owner Benefits

When the objectives, motivations and needs of the business owner are understood, the next steps are to understand how incorporation will benefit the business owner. What are the specific advantages and disadvantages of incorporation for the business owner and possible alternatives to incorporation?

When you first create the corporation, shares are issued to the owners based upon the proportion of the percentage of ownership. A corporation can be public or private. Public corporations can issue shares which can be traded on stock exchanges.

3. What’s Involved”? The Incorporation Process.

This section will outline the different steps and the ‘high level’ process involved with incorporating a business.

The Process of Incorporation

The process of incorporation usually starts with some internal reflection and business planning by the business owner.

There may also be a compelling reason why the owner wants to incorporate, perhaps something about the business has changed where additional risk may be involved, risk the business owner may want to avoid. A business owner usually starts the process by having a discussion with their lawyer and accountant.

Initially, the lawyer and accountant will ask for background information about the company, some high-level history and the current situation, and their future plans. They will probably ask for the name of the proposed company to be incorporated.

The process will include the type of company to be incorporated:

Basic Incorporation.Less flexible option to the Custom Incorporation below with this type of incorporation, your company adapts to the pre-determined basic provision provided by the government. No custom set-up. You adapt the government form. You will get a numbered name, and only one class of common shares.

Custom Incorporation. Much more flexible than the above Basic Incorporation. Custom Incorporation allows you to customize your incorporation structure and set-up. This option allows a worded name (not numbered as in Basic Incorporation). In addition, Custom Incorporation allows different classes of shares. When you provide your name, you will need to ensure it is distinct to limit any confusion with other companies.

Not For Profit. If you want to set up a ‘Not-for-profit’ incorporation, this is the option. You will have the option for either worded or numbered names.

In addition to guidance about the three previous business structure types, your lawyer and accountant will help you with the remaining steps with the government, including:

Contact Information
Company Name Options. Your lawyer may even help you search for a name that is not in conflict. The lawyer may also help you register the company name, get business licenses etc.
Articles of Incorporation
Document Signatures. Review, print and signing of the document. Submission to federal and provincial authorities.
Payment of set-up and registration fees, along with accountant and legal fees.
Compliance. Help manage on-going business notices required of the company

Articles of Incorporation

Your lawyer and accountant will help you create a legal document called the ‘Articles of Incorporation’. This is a legal document submitted to Provincial and Federal Governments, which establishes your business within Canada, and separates the individual from the business. Lending and financial institutions may ask you for this document, along with your provincial business license.

The Articles of Incorporation describe who and what the corporation is, including:

The precise name of the corporation
The primary registered office address
The number of directors
Any business restrictions, if applicable. A description of what your business does. Some corporations must be precise (e.g., lawyers, doctors, accountants)

Articles of Incorporation Preparation

Prior to meeting with your lawyer or accountant, these are a few suggestions to be prepared for:

Although you can choose to operate a corporation as a numbered name, choosing a unique company name may offer name recognition and branding advantages
The number will be assigned to your company from the government agency (federal or provincial) you decide to use. Numbered companies are not usually used for client-facing or public facing companies
Numbered companies are usually the fastest to get approved as no name search is required. Your company name can be as simple as the Corporation number (you were assigned), and the Jurisdiction (e.g., Canada or Ontario) or the legal name ending, for example 12345678 Ontario Corporation. Numbered companies usually set up a DBA designation, ‘Doing Business As’
Your lawyer will help you search your business name to ensure there are no companies that have the same or similar names. You should also check to ensure that the domain name is available online
You may want to have a few company names in mind, some company names may not be available, they could also be restricted or not available
Your company name will need to be distinctive, as to not be confused with another registered name
Your lawyer can also assist in the legal ending of your company name, whether your company name should be Incorporated, Limited or a Corporation. Essentially all three are the same, with no legal difference among the three endings
Share structure and class of shares. The types of shares you will issue
Conditions of the shares (e.g., voting, non-voting, dividends etc.)
Other terms or conditions you may have for the corporation

Incorporation Checklist

We have included a ‘possible’ check list for your incorporation journey with your professional services advisor (lawyer or accountant). It’s not 100% comprehensive as everyone’s needs and objectives are unique, there may also be steps that you may not need to complete:

Decision process to incorporate. Federal or Provincial. A discussion with your lawyer and accountant will be beneficial
Business name selection, if applicable. Business name search and NUANS report (Newly Upgraded Automated Name Search)
Business location and address. Official email address of the company.
Selection of director(s) and officers of the corporation, and their roles. Minimum and maximum number of directors
Corporation registration. The Articles of Incorporation will be completed and filed
Corporation Bylaws and internal rules description
Corporation shareholders and share structure
Company signing authority
Select a ‘Year End’
Set up separate corporate bank accounts. You will need your CRA business number
Discuss accounting best practices and principles with your accountant, including billing and Account Receivables processes, record keeping and necessary financial statements
Accounting software considerations
Creation and Maintaining of a corporation ‘Minute Book’
Obtain Business License(s)
Obtain Business Number
Open GST/HST account(s). Create process for record keeping, filing and payments submissions
If applicable, register with the WCB/ Workplace Safety and Insurance Board (if you have employees or planning to hire)
If required, the preparation of a ‘Shareholders Agreement
Annual Meetings. If required, schedule and have annual ‘Shareholders Meetings’
Annual Returns. e.g., any changes in the corporation’s directors, company status, addresses,
Ensure that local, provincial, and federal taxes have processes for record management, taxes filing/submission and payment. Ensure processes are in place to ensure that all company transactions are recorded and properly stored

Owner Remuneration. How Does the Owner Get Paid?

One question that will quickly come up is how the business owner eventually gets paid?

Business Owner Repayment

Depending on the success and income of the business, the incoming incorporated business income may only cover the investments made by the owner. The business may initially only have enough income to repay or partially repay the business owner for the start-up or operating costs while the company is in its ‘start-up’ stage. Over time, as the company’s revenue and income should increase as the business grows, and the owners’ investments are paid out, then the owner can consider how they can be paid.

Business owner remuneration with a corporation is a bit more complex and formal than a sole proprietorship or business partnership. If you have set your company up as a corporation, you have the options of paying yourself a salary, paying yourself with dividends, or a mixture of both. If feasible, most business owners pay themselves enough to cover their basic living and household expenses, that being said corporations can pay whatever salary they want to employees. The business owner’s salary will be listed as a business expense on the company’s books and financials.

Business Owner Salary

There are benefits and advantages of an owner taking a salary, which include income track record of income when applying for mortgages or credit, RRSP contributions, and other benefits which your tax advisor can review with you. If the owner does opt for a salary, they will have to pay and contribute to the Canada Pension Plan (CPP) and pay both the employer and employee CPP contributions.

Business owner salary and dividends are taxed differently. A business owners’ salary (active income) is taxed as personal income. Dividends are paid out to shareholders and are usually taxed at a lower rate; these are tax questions which are best discussed with your lawyer and accountant.

Business Owner Blended Remuneration

As the company grows, a potential benefit of a blended remuneration (reasonable salary and dividends from profits), the business owner can keep the business under the Small Business Deduction first $500,000 active business income tax threshold, which can reduce the business tax rate.

Borrowing From Your Corporation

Another way to withdraw funds from the corporation is borrow money from the corporation. Although this an option, the Canada Revenue Agency has strict rules which must be complied with. Borrowing from the company is called a ‘Shareholder Loan’. In addition to strict account record keeping (balance sheet liability), the Shareholder Loan must be repaid in the same fiscal year in which it was borrowed.

4. Why Should You Incorporate? The Advantages and Disadvantages of Incorporation?

Once the business owners’ needs are understood, and the fundamentals of incorporation and its alternatives are outlined, the next step and topics will outline why a business should be incorporated.

There are both mandatory start-up costs, and on-going costs associated with operating a corporation. If you are considering incorporation, are these costs feasible for a company of your size? If your company has low income, you may want to re-consider setting up an incorporated company at an early stage, unless you have compelling reasons for incorporation.

Is Incorporation a Fit for Your Specific Business Needs?

The decision of incorporation and if it’s a fit or not for a business is dependent mostly if the business is earning sufficient income to justify the start-up and carrying costs of incorporating.

These costs include paying an annual fee to accountant to file corporate tax returns. Filing a corporate tax return is much more expensive than filing a personal tax return for a sole proprietorship. Does the business have enough income to pay these expenses, or will these expenses erode the net income being earned?

One of the primary reasons that businesses incorporate is to avoid liability. For the most part, business owners cannot be held responsible for debts, or the acts or obligations of the company. There are inherent risks when operating a business. The business may incur debt and losses or be sued. Unlike a sole proprietorship, if your business in incorporated, liabilities are limited to the incorporated company’s assets.

Other potential benefits and advantages include:

Business structure benefits
Personal assets protection
Business name protection within Canada
Income optimization
Raising money. Shares and bond issue options
Access to capital and lower interest rates
Income tax optimization
Legal entity and company continuity. The company can sue (or be sued)
Estate planning advantages
Transfer of ownership interests, after death
Small Business Deduction (if applicable)
Adding Inc. to the name of your business adds credibility. Your clients or financial institutions may require you to incorporate
Some companies may only do business with incorporated businesses
Potential and limited income splitting advantages
Potential for small business capital gains exemptions
Credibility of incorporation for doing business in your business segment
Incorporation is required for your business segment

Potential Disadvantages

Incorporation costs. Incorporation and shareholder agreement fees
Ongoing costs (legal, annual tax returns)
More paperwork
Additional tax return
Complexity may require additional on-going resources, e.g., lawyer, accountant
No personal tax credits
Less tax flexibility compared to a sole proprietorship or partnership
Liability protection has limits, lending institutions may still require personal credit guarantees
Registration fees and additional registration processes
If you close the corporation, there are closing and tax requirements and processes for the government. Accounting and or legal resources may be required

Why Incorporate? Should You Incorporate?

Although there are other advantages and benefits, for the most part, most business owners consider incorporating their business for the following two primary reasons:

1. Liability Protection

Once you incorporate your business, your business becomes a separate entity, a separate persona from the owner. The business can enter into contracts, open its own bank accounts, secure loans, and own property, among other factors.

Incorporating your business protects the owner and their personal assets from the liabilities of the business.

Although there is liability protection, if you make personal guarantees for the incorporated company’s business loans, then you will be responsible and liable for those loans. This liability also applies to any personal guarantees you make on behalf of the company.

2. Tax Deferral

A corporation is a separate entity and pays separate income taxes. For many small businesses in Ontario the first $500,000 (Small Business Deduction) of business income is taxed at a much lower rate than personal income for the owner, if the owner withdraws income from the company.

Tax Benefits

If the owner takes income from the company, that income is taxed at the applicable personal income tax rate for that individual. If you don’t need to withdraw personal use income from your company, that personal use income can be deferred (and taxed) until the income is required.

Deciding whether you should incorporate may include many factors. Essentially, the primary decision factor is whether your company’s income can sustain the costs required to both start-up and operate an incorporated business. Will the costs of operating a business, including accounting (filing a corporate tax return vs. a personal tax return) and legal expenses, erode the company’s income? The decision process should be considered when evaluating the primary benefits of Incorporation, Liability Protection and Tax Deferral.

Canada Revenue Agency (CRA) Caveat

If you are a contractor who is considering incorporation to suit the criteria for a single major client, who requires you to be incorporated rather than your being an employee, be aware of CRA self-employment rules and criteria. This would be a good example of seeking advice from your lawyer and accountant.

CRA Preparation

Be prepared if the CRA questions your relationship. The CRA will want to know if the relationship with your client is a ‘Contract of Service/employer-employee’ relationship, or a ‘Contract of Services’ business relationship. The relationship will need to be well defined for the CRA.

CRA questions may include (including but not limited):

Does worker/contractor have more than one client?
Is the contract or relationship exclusive?
Does the worker/contractor invoice the client for their work effort?
Can the worker/contractor work on other client engagements?
How much control the client has over the worker/contractor activities? Does the client have specific control over the worker/contractor’s daily activities?
Does the worker/contractor work independently from the client?
Does the worker/contractor have specialized skills?
Does the worker/contractor pay for their own tools and equipment
Can the worker/contractor subcontract client work effort or hire assistants or their own employees?
Is there financial risk for the worker/contractor?
What is the degree of responsibility for investment and management of the worker/contractor?
What is the return on investment or profit opportunity for the worker/contractor
Relevant factors of the relationship, including formal written contracts
Does the worker/contractor work solely at the client site? Or more out of their own company office?

5. Professional Services Best Practices; The Role of an Accountant and Lawyer

At some point during your ‘incorporation’ decision you will need to decide which resources you will need to help you with the incorporation processes and the operation of your incorporated company.

Most companies, even the smaller ones, have a need for legal and accounting advice. Even if it’s on a part time, annual or occasional basis.

Provincial and Federal Compliance

Incorporated companies must comply with provincial and federal reporting, statutes, and regulations, which can be complex and will require focus and work effort.

Working with a professional services advisor, like a lawyer and accountant will allow you to focus more on your business priorities. It’s difficult to know, keep up-to-date, and be compliant with incorporation requirements, that’s the role of the professional services advisor.

Due Diligence

There are a few reasons why you will need a lawyer and accountant involved. The primary reason is that you will want the incorporation done right. Lawyers and accountant have performed incorporation services for many companies previously. They understand your business, so they have a repository of the best ways to set up a business based upon your needs.

Your lawyer and accountant will ask you questions and adapt the process as you provide additional information, these questions will focus on:

Ensuring the structure of the registration is prepared and completed properly
Ensure that the business structure is customized to meet your company’s needs
Deciding between a Provincial vs. Federal Incorporation
Shareholder structure and inclusion. Holding company considerations
Incorporation Directors advisory
Tax integration with incorporation documents and structure, possible income splitting advantage
Creation and updating of ‘minute books’ annually
Transactions management, including financing, payment of bonuses, payment of dividends, investments
Accountant and lawyer communication to ensure you are compliant with government policies and procedures.

Even though your lawyer and accountant operate separately, your lawyer and accountant will work together to get you incorporated and manage the incorporation requirements going forward.

Depending on your situation, you may only need one of these resources, however, due to complexities of many businesses, the lawyer and accountant relationship interaction will be in the business owners’ best interests.

6. Provincial and Federal Involvement

Businesses in Canada have the choice of incorporating under Federal or Provincial jurisdictions.

The decision to incorporate at a Federal or Provincial level is up to you.

If you believe that you will:

Be expanding across provincial borders.
Performing physical and local work effort in different provinces or territories.
Providing products or services across different provinces or territories.
Need name protection across Canada.

Then you may want to consider a federal incorporation, if not then a provincial incorporation may be the best for your company.

There are many factors factors to consider when making your decision. Many of the benefits of federal and provincial incorporation overlap, however there are some distinct differences.

A federal corporation allows you to perform and conduct business across Canada. A provincial corporation can only perform physical work effort within the province. A provincial corporation can perform ‘virtual’ work effort (e.g., online, over the phone) across provincial borders, provided that the work effort is not physically performed in another province
A federal incorporation is usually more complex and expensive than a provincial incorporation. Federal incorporations may need additional registration fees and filings for each province
When you incorporate federally, you will still need to incorporate provincially in the province which you are operate primarily

Both the federal and provincial corporation include:

Additional tax planning strategies
Liability protection
Name protection (if provincial, within that province)
Existence continuity
Annual tax filing requirement
Capital raising

Provincial Corporation Benefits

Most businesses or contractors that work locally within geographic area or within their province, usually choose to incorporate with a provincial incorporation

The provincial corporation does not need a Canadian citizenship; however, the federal corporation requires at least 25% Canadian citizenship. If you are currently a non-resident or have future residency plans, a provincial corporation may be a fit for you.

A federal corporation needs one resident director who is Canadian, not all provinces have this requirement.

Federal Corporation Benefits

Federal corporations have more flexibility if you plan on operating your business across Canada.

If you believe that you may eventually conduct local work effort or sell products from your own locations across Canada, it may be advantageous to incorporate federally. Transitioning from a federal incorporation to a provincial corporation has a higher level of complexity.

Federal corporations only have one Annual Returns filing, whereas the provincial corporation has an additional filing called the ‘Initial Notice’ filing, which must be submitted within 60 days of the provincial filing for incorporation.

7. Next Steps. What information to be prepared with prior to contacting a lawyer or accountant

Prior to meeting or discussing incorporation with your lawyer and accountant, it would be beneficial to be prepared with the following information:

Company name
Stakeholders involved. Shareholder details
Business segment and geography. Future plans?
Type of business
Company history. Current and future growth
Tax background
Family details, dependants
Year end
Account and lawyer contact (for each other)
Banking information

8. Conclusion

We have endeavored to provide a fundamental understanding of setting up and operating an incorporated company.

There are numerous complexities, advantages, and disadvantages of setting up and operating a corporation. Asking for assistance from a professional services advisor, like a lawyer or accountant can help you with this decision process and navigating the on-going complexities and requirements involved with incorporation.

We hope you enjoyed reading this article

If you would like additional information about Nichols Law, please visit our website.

9. Sources and Links

Sources and Additional Information

Disclaimer

Sources and links are provided for source credit and attribution, and for additional information purposes only. Nichols Law is not affiliated, associated, authorized, endorsed by, or in any way officially connected with any of the sources or links provided.

Ontario Small Business Deduction, Ontario Government

Employee or Self-Employed?, Government of Canada

Incorporation Documents, Government of Canada

Articles of Incorporation – Business Corporations Act

The 3 Most Common Types of Business Entities in Ontario, Invest Ottawa

How To Choose the Right Structure for Your Business, BDC

Decide on the Ownership Structure for Your Business, Ontario Government

Business Structure: Which One Is Right for You? , Government of Canada

The Pros and Cons of Incorporation, The Toronto Star

Your Ultimate Guide to Starting a Business in Canada, BDC – Business Development Bank of Canada

Starting a Business, Government of Canada

Corporation Tax Rate, Government of Canada