Of the various forms of business organizations, the business corporation is the most sophisticated and common form of business ownership for most Canadian business owners. The following represents an overview of the key benefits and costs of incorporating a business corporation.
Limited Liability for Owners
A corporation is treated as a separate legal person from its owners. In many respects, a corporation has the same legal status a natural person. For example, a corporation can sue and be sued, borrow and lend money, enter into contracts in its own name, and become accountable for taxes. Unlike sole proprietorships and partnerships, the owners of a company are not generally personally liable for the actions of the business. A properly incorporated business can be a highly effective tool for protecting a business owner’s personal assets from the liabilities of the business.
Flexible Ownership Structure
A business corporation offers the most flexible means of shared ownership. Unlike other forms of business organizations, ownership of a corporation is evidenced by shares. The Business Corporations Act provides a comprehensive framework within which shares of a Corporation may be issued, transferred, sold or repurchased by the corporation. This framework provides owners with a great deal of flexibility in sharing ownership, raising capital or changing the ownership structure of a business.
Carrying on business as a corporation can offer business owners a variety of tax advantages over simpler forms of business organization. Among these advantages are the ability split income with family members, defer income and take advantage of the Lifetime Capital Gains Exemption if the business is sold for a profit.
At the time a corporation is incorporated, family members may be issued shares in the corporation for nominal value. As shareholders of the corporation, these family members are entitled to profits from the corporation, even if they do not actively participate in the business. This ability to allocate profits from the corporation to family members in lower marginal tax brackets can produce significant tax advantages for the business owner and his or family.
Unlike other forms of business organizations, income from a corporation is taxed in the hands of the corporation, not the owners. Owners of a corporation do not pay any income tax until the profits of the corporation are actually distributed in the form of dividends. Although the corporation must pay tax on its income in the year it is earned, the owners may generally determine the timing of distributions of profits from the corporation, allowing owners to defer the payment of tax until such a time as it suits them.
Lifetime Capital Gains Exemption
Generally owners of shares in a small business corporation will be entitled to a capital gains deduction, which may be used by the owner to claim against any capital gain arising from the sale of the business. The deduction limit is currently $375,000 for an individual’s lifetime, which effectively provides for a tax free capital gain of $750,000. Other forms of business organizations do not qualify for this type of deduction when the business is sold.
Costs of Incorporating
While corporations are face higher start-up and annual maintenance costs than other forms of business organization, the long term benefits to business owners will quickly make up for these costs.