In previous Legal Guides we have covered Different Types of Business Structures in Canada and The Incorporation Process. This Legal Guide will look specifically at the advantages and disadvantages of incorporation in Ontario or Canada.
Advantages of Incorporation
The distinct legal status of a corporation offers a few key advantages over a sole proprietorship or partnership, including: (1) limited personal liability, (2) ease of raising capital, (3) perpetual existence, (4) transferable ownership, (5) prestige and (6) tax advantages.
1. Limited Personal Liability
Unlike a sole proprietorship, a corporation is generally not liable for the acts, duties or liabilities of its members or shareholders. This means that you would not be personally liable for the debts and obligations of the corporation since it is its own legal “person”. Instead, your liability would be limited to the amount of money that you invest in the corporation. In the event that your business would sustain high losses or bankruptcy, your personal assets would be shielded from liability. This may be of considerable interest to you when considering your potential concern with liabilities to clients, employees and/or your lessor.
Please keep in mind that there are a few exceptions to the rule of limited liability where personal liability may be extended to shareholders. For example, some transactions may require you to personally guarantee the obligations of the corporation, such as when a bank or other lending institution provides a loan to your business. This reduces some of the benefits to limited liability, as you may become responsible for that loan. Further, directors of a corporation may be held liable for unpaid wages to employees, unpaid taxes, and criminal activities including fraud.
2. Ease of Raising Capital
There are generally three potential sources of capital for any business, whether incorporated or not, which include funding from the owner, from business profits, and from external lenders. However, unlike a sole proprietorship, a corporation can generate additional funds by publicly selling shares of the company to investors. A share is legally defined as an ownership interest in a corporation that allows the shareholder to claim a right to a portion of the capital and profits of the corporation. After you receive a business valuation, you can issue new “shares” of your corporation and sell them to new shareholders in exchange for funds.
A private corporation (one not listed on a stock exchange) cannot sell shares to the public at large, but can only sell them privately. Before selling shares, it is important that you obtain additional legal advice on the requirements and restrictions imposed by applicable corporate, securities and other laws. It is also important to note that by selling shares, you would be reducing your percentage of ownership of the corporation and may be relinquishing control of your business to shareholders, as shareholders may be given voting rights. Accordingly, among other things, a shareholders’ agreement may be required to protect your interests. This is a complex document that would require further legal advice and discussion which is outside the scope of this memo.
3. Perpetual Existence
A corporation exists until it is dissolved. This means that a corporation continues to exist beyond the life of the shareholders and directors or the sale of company shares by the shareholders. Upon the death of a shareholder, ownership of the business would generally transfer to the shareholder’s heirs. This allows a corporation to have greater stability and to financially plan over a longer period of time.
4. Transferable Ownership
Ownership in a corporation, as mentioned above, can be transferred by the sale or transfer of shares. In the context of a private corporation, restrictions on the transfer of shares are generally specified in the articles of incorporation, the by-laws of the corporation and the governing corporate statute of the corporation.
Corporations generally benefit from a higher degree of public prestige and legitimacy when compared to sole proprietorships. This makes a corporation more credible in most forms of business dealings as a corporation is a common and easily recognized form of business organization. It may also be easier to establish subcontracting relationships through an incorporated business.
6. Tax Advantage
There may be several fiscal advantages to incorporating your business. Similar to limited liability, corporations have a separate liability to pay taxes from the owners and shareholders and other potential tax benefits include the utilization of losses, possible tax deferral and possible income splitting.
Many private corporations may also qualify as a Canadian-controlled private corporation (the “CCPC”) under the Income Tax Act. CCPC status allows a corporation to take advantage of several important tax advantages, such as a low effective tax rate on the first $500,000.00 in business income and a lifetime capital gains exemption in the sale of shares. However, CCPC status may not always be available for a corporation due to the substantial restrictions on corporate control by non-residents of Canada, public corporations or a combination of the two.
Please note that there may be many ways to structure a corporation in order to reap tax benefits; however, many of the specifics of taxation lie outside the scope of this Legal Guide and we recommend that you seek the advice of a professional advisor for further guidance on tax matters if you seek to incorporate in the future.
Disadvantages of Incorporation
There are two key disadvantages to operating as a corporation: (1) costs of incorporation, and (2) significant record-keeping and filing requirements.
1. How Much Does it Cost to Incorporate in Ontario or Canada?
Incorporating a business is not free and may potentially involve significantly higher start-up and maintenance costs when compared to operating as a sole proprietorship. Generally, more complex businesses are advised to employ legal services to complete the incorporation process. However, the process is relatively straightforward and can be completed on your own to avoid this cost.
For Federal corporations in Canada, costs include filing fees for the incorporation documents (approximately $200.00 for online federal incorporation and approximately $250.00 for incorporation by email or mail).
For provincial corporations in Ontario, costs include filing fees for the incorporation documents (approximately $300.00 for online provincial incorporation and approximately $360.00 for incorporation in person or by mail) and name search costs (approximately $59.00).
Additionally, there are further administrative costs that may include the cost of a corporate minute book (approximately $42.00 or greater) and the filing of a mandatory annual return (approximately $20.00 if filed online and approximately $40.00 if filed by paper).
Please note that these costs are not an exhaustive list of all the costs that may be involved in incorporation. There may be additional costs, such as those arising from filing a separate tax return for the corporation.
2. Extensive Record-Keeping and Filing Requirements
Since a corporation is a separate legal entity, there are certain filing and reporting requirements that must be met each year as required by the OBCA and the CBCA. With these ongoing obligations are certain costs, including recurring legal and accounting costs, which may place an administrative burden on your business. The requirements include, but are not limited to, the following:
(a) A Corporate Minute Book: You must keep a record of company meetings and documents related to the corporation in a minute book. This must be stored in the registered office of the corporation. Please note that you are not required to have office space. Instead, your “registered office” can be whichever address you provide as the “registered address”. Required documents in a minute book include: registration documents, directors’ registers, officers’ registers, share registers, share certificates, by-laws, meeting minutes, and financial statements.
For more information on corporate minute books, see our Legal Guide on The Incorporation Process.
(b) Annual Tax Returns: You must file an annual corporate tax return that is separate from your personal tax return. As noted above, this is because corporations are legally considered to be independent and separate legal persons. A corporate tax return will be calculated based on the revenues and expenses of your business. The preparation and filing of this tax return may increase your annual tax filing costs.
(c) Annual Returns: You must file an annual return containing up-to-date information about your corporation, such as information about its directors and officers. In Ontario, the annual return is filed in conjunction with the corporate tax return of the corporation. Additionally, in Ontario there is no fee for filing an annual return. As noted above, there is a filing fee for annual returns for federally incorporated corporations of approximately $20 if filed online, or $40 if filed by paper.
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