A corporation is a separate legal entity, distinct from its shareholders and management, that can hold property, carry on business and incur contractual and legal obligations. Corporations may also be incorporated without share capital, generally for not-for-profit purposes.
One of the greatest features of setting up a corporation is that it has the ability to be flexible with respect to the design of its share structure. For example, shares can be voting or non-voting, they can have limited or unlimited participation in equity and they can be redeemable for a fixed price at the option of the corporation or the holder. The articles of incorporation also referred to as “constitution” can specify the permitted classes of shares and their key terms. The incorporating documents may attach various conditions to the payment of dividends and can stipulate rights on dissolution of the corporation.
Federal or provincial corporation
The key distinction between the two types of corporations is that a federal corporation may carry on business in any province or territory provided that it complies with the applicable registration and reporting requirements of each province. In contrast, a provincial corporation is required to obtain an extraprovincial license and register in any other province where it carries on business.
Some of the advantages to incorporating your business:
1. Limited liability
A corporation is a separate and distinct legal entity from its owners unlike a limited partnership, partnership, trust, co-ownership or joint venture. Shareholders are not personally liable for the acts of the directors, officers or other shareholders with some exceptions. The shareholders do not own the property of the corporation, and the rights and liabilities of the corporation are not those of the shareholders. Thus, the maximum amount of your capital at risk will generally be the capital you have contributed to the company.
2. Tax advantages
The tax advantages to incorporating your business in some situations include a lower corporate tax rates and the carrying forward of losses from previous years to offset profits in later years (“tax deferral”).
3. Capital acquisition
The securities of a corporation are generally more readily marketable. As a result, corporate shares (and debt instruments) are often seen as attractive investments than some of the other business vehicles.
4. Perpetual existence
The existence of the corporation is not affected by a change in the people that own and/or manage the corporation. The shareholders, directors and officers may retire or sell their shares, but the corporation continues in existence.
5. Mergers and acquisitions
A corporation has the option to merge or amalgamate with another corporation.
6. Methods of payment to the shareholder(s)
There can be different methods of payment to the shareholder(s) depending on the structure of the corporation (e.g. salary, shareholder dividends, management bonus) which will be taxed differently.
A corporation can distribute its earnings to its shareholder(s) by paying a dividend. Dividends are paid out of corporate surplus after income taxes paid by the corporation. Under the Income Tax Act, a shareholder who receives a dividend from a Canadian-controlled private corporation is entitled to a dividend tax credit. The purpose of the dividend tax credit structure is to provide full integration between corporate and personal income taxes. The magnitude of the dividend tax credit will depend on whether the dividend is designated as an “eligible dividend” for purposes of the ITA by notifying shareholders of such designation at the time the dividend it paid to the shareholders.
Did you know dividends can be received tax-free (because of the inter-corporate dividend deduction) by a corporation resident in Canada from either (i) a taxable Canadian corporation, or (ii) another corporation resident in Canada. To qualify, the dividends are typically paid from either – the after-tax business earnings of a corporation (free from Part I income tax under the ITA); or – the after-tax investment income (earnings) of a corporation, provided the recipient shareholder corporation meets certain conditions.
Interest is generally deductible when computing the income of a corporation for tax purposes, while dividends are not. However, there are tax rules that limit the deductibility of interest paid to non-resident shareholders. These “thin capitalization” rules provide in general that where the debt owing to certain non-resident shareholders exceeds 1.5 times the equity investment of those shareholders, interest on the excess debt will not be deductible for tax purposes. Such denied interest expense will also be deemed to be a dividend paid to the non-resident and subject to Canadian withholding tax.
Some other concepts to keep in mind about a corporation:
When the financial year-end should be. Business income is reported to the Canada Revenue Agency based on the calendar year. The financial year-end for the business entity will be December 31st unless the corporation applies for permission to do otherwise.
Depending on the type of business that is being conducted, additional registrations/ licences may be required, such as tax registrations (GST/HST or employer tax ID numbers), operating licences (including municipal licences/permits), and workers’ compensation accounts.
Employment laws to keep in consideration:
In addition to salary paid to employees, other costs may include: required employer contributions (e.g. Canada Pension Plan and Employment Insurance), annual vacation pay, statutory holiday pay, overtime pay, paid leave (e.g. for illness, compassion or bereavement, religious observances), payroll administration costs, benefits (e.g. health or dental plans, gifts/bonuses, parking, etc.), employee training and development costs.
A Business Number is required to open a payroll account. If you have employees, you must apply for and obtain a payroll account to file any source deduction remittances (e.g. Employment Insurance, income tax, Canada Pension Plan) on behalf of your employees.
Employers must also consider various employment related information, such as policies for hours of work and overtime, statutory holidays, religious observances, sick days, vacation, leaves of absence, employment benefits (e.g. medical or dental), travel, payroll, etc.
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question please consult with our lawyer.