As most small businesses grow they are faced with a difficult decision of whether or not they should incorporate. The answer to this question depends on a number of factors including but not limited to the size of the business, projected future growth and potential liability/legal risks.
Advantages of Incorporation
Incorporation has a number of advantages as compared to sole proprietorships and partnerships generally related to following five factors (each of which is explained in further detail below):
- Creation of a separate legal entity;
- Limited liability;
- Continuity of existence;
- Tax advantages; and
- Better access to capital and grants.
Separate Legal Entity
Incorporation under Canadian law creates a new legal entity, the corporation, which is separate and distinct from its owners, the shareholders. A corporation has the same rights and obligations under Canadian law as a natural person. This includes but is not limited to the ability to own property, enter into contracts, and sue and be sued.
As a corporation is a separate legal entity, its shareholders are said to have limited liability. This means that a shareholder’s liability with respect to a corporation’s debts is limited to the value of their investment in the company (there are some exceptions to this such as a personal guarantee). It should also be noted however that if a shareholder has another relationship with the corporation, such as being a director, they may in certain situations be held liable certain obligations of the corporation as a director.
Continuity of Existence
Sole proprietorships cease to exist upon the death of their owner. A corporation on the other hand has perpetual existence unless it is dissolved. This makes it much easier to sell a corporation than a sole proprietorship. This stability also makes it easier for corporations to plan over a longer time period compared to sole proprietorships and partnerships.
Better Access to Capital
Corporations can raise capital by borrowing money or by issuing either shares or bonds to investors. There are also many government grants and programs that are made accessible only to corporations. Sole proprietorships and partnerships on the other hand have to rely on their own money or loans to raise capital. This makes it much easier for corporations to grow and develop their business.
As a corporation is an entity distinct from its owners, a corporation is taxed separately from its owners. This can be beneficial as corporate income tax rates are generally lower than personal income tax rates. This also allows the owner to choose the most tax efficient way to pay themselves whether by dividends, salary, bonus, or a combination of all three. However, incorporation can also have tax disadvantages as shareholders cannot claim personal tax credits or use corporate losses to reduce other types of personal income.
Disadvantages of Incorporation
While there are many advantages to incorporating there are also some disadvantages that must be considered including (each of which is explained in further detail below):
- Higher operating costs; and
- Greater administrative requirements.
It is generally more expensive to incorporate compared to carrying on a business as a sole proprietorship or partnership. These increased costs include fees associated with incorporation as well as ongoing professional fees for legal and accounting services required to meet the administrative requirements of running a corporation.
Corporations are often required to file more paperwork than sole proprietorships or partnerships. These documents include articles of incorporation, annual returns, notice of any changes in the board of directors, notice of any changes in the address of the registered office and Articles of Amendment if certain changes to the structure of the corporation are made.
The corporation has become the most popular vehicle for carrying on commercial activities in Canada. A business can incorporate either provincially or federally. However, knowing whether it is time to incorporate your business depends on a number of complex and often competing factors. Before deciding to incorporate it is important to consult with a lawyer to determine which business structure is best suited to your needs.
For more information on the corporations, contact Adnan D. Chahbar at 519-660-7804.
Adnan D. Chahbar is a business lawyer at Siskinds LLP. Kevin Braiden assisted with the preparation of this article.