Advantages of Incorporation
1- Limited Liability
With a corporation, individual shareholders are not responsible for corporate debts or other liabilities. Shareholder can only lose the value of their investments. Without corporation, a sole proprietorship and partnerships put all personal assets of the owners at risk.
It is important to note that the lending institutions may request personal guarantees on loans from the shareholders of small businesses. In this case, share holders will be held liable to ensure repayment. However, personal assets can usually be shielded from corporate creditors for other types of debts.
2 –Tax Benefits
There are several tax benefits that corporations can enjoy. Some of the key benefits are explained below. The extent of these benefits depends on the type of income and individual tax rates of share holders:
a) Lower Tax Rates
Considerable tax rate reduction is enjoyed by Canadian-controlled private corporations (CCPCs). This tax reduction is applied by offering the small business deduction (SBD) on income derived from an active business in Canada. Other preferential tax treatments include the general rate reduction in federal income tax and provincial or territorial tax abatements.
b) Tax Deferral
Owners of corporations can enjoy tax deferrals by leaving excess funds in the corporation. Personal tax is applied at the time of paying out to the owners of corporation. By delaying the payout, higher personal tax rate can be deferred. The extend of benefit depend on how long funds can remain in the corporation. By widening gap between the higher personal tax rate and the corporate tax rate on active business income, the tax deferral benefit of keeping profits in a corporation has increased. Excess fund in the corporation can be invested.
Corporation gives flexibility to the owners to withdraw funds for personal use when needed. Personal tax will be applicable when it is withdrawn, rather than when its earned. This enhances tax planning opportunities.
c) Income Leveling
For businesses that have high and low income periods, leveling of income is important and manageable with a corporation. This can be achieved by controlling the level of salary, bonuses and dividends received during the high and low income years. By managing income, marginal taxes can be minimized.
During high earning periods, the business owner can defer excess income to avoid paying tax at high rates. During the lower earning periods, that same owner can take extra income to the extent of a lower income bracket limit.
d) Succession/Estate Planning
Succession planning is of particular importance for the owner-managed corporations. Succession planning is very effective in the event of unforeseen events such as a terminal illness or even death. Retirement planning can be done by the owner-manager considering
likelihood that family members will take over the business or the business be sold to a third party.
e) Lifetime Capital Gains Exemption
Corporate structure permits access to a lifetime capital gains exemption of up to $892,218 (2021) on the sale of certain small business shares that meet the definition of qualified small business corporation shares (QSBC).
The shares of a Canadian holding company also qualify if substantially all of its assets are shares or debt of other connected small business corporations.
3- Access to Capital
Corporations can raise capital more easily by issuing verity of securities such as shares, bonds and debentures to raise funds. They can also reinvest profits.
4- Continued Existence
Corporation is a separate legal entity. Shareholders may come and go without effecting the existence of a corporation. The corporation continues to exist even when shareholders sell their shares or die. This ensure stability compared to the sole proprietorship or the partnership that relies on the continued active participation of its proprietor or partners.
Disadvantages of Incorporation
The only notable disadvantage is the cost of incorporation. In addition of initial cost of registering a corporation, there is annual cost of filing corporate tax returns. Also, for complicated structures, legal cost will be involved.
For an unincorporated business owner, tax filing is simply filling out the T2125 Statement of Business and Professional Activities form and including it with their personal tax return.
Refer to this link for registering a corporation or call us if you need advice: https://www.canada.ca/en/services/business/start/register-with-gov/register-corp.html