A corporation is a separate legal entity that is owned and presumably controlled by one or more shareholders through shares or a legal entitlement to the profits that a corporation produces. A Corporation is a separate entity from its creators, owners and operators and is given separate legal rights. Although most commonly set up to run profit oriented businesses, corporations can also be set up for not-for-profit initiatives.
Corporations Canada oversees and manages the registration or incorporation of businesses. It is important to note that there are a number of advantages and disadvantages to incorporating a business, and the decision to do so should not be undertaken lightly.
As mentioned in the types of income, a corporation is taxed much differently than a business ran in a sole proprietorship or partnership. Given that a corporation is a separate entity, it must report separate income, calculated at the corporate level and reported on a T2 corporate tax return. This after-tax income can then be distributed to shareholders in the form of a dividend.
There are many considerations that must be made in the decision as to whether to incorporate or not.
Limiting liability from a separate entity
As a separate legal entity, there may be opportunities to limit your liability by separating yourself from the business. If you're a sole proprietor, your personal assets for instance your house or your car can be seized to pay the debts of your business. The corporation can limit this liability. As a shareholder in the corporation, you cannot be held responsible to pay the debts of the corporation, you can only lose what you put into it the corporation.
Income distribution, continuance and planning
With a corporation there may be opportunities to set up more complex income distribution schemes, allowing more freedom in the amount of income removed from the business. It may also allow for some succession planning, the corporation can continue to operate the business after its shareholders leave, retire or even die.
Additional opportunities for tax planning and tax deferral
There are a number of opportunities to defer tax through a corporation. Although corporations will pay tax each year, if you do not require the income personally, you can leave it in the corporation, deferring the personal tax that will be paid until you need it.
Additional financing opportunities
Just like you, a corporation can go to a bank or credit facility and secure debt, however a corporation may also raise capital through issuing shares.
Additional administrative costs
In addition to upfront legal and registration costs, the corporation will be required to file an annual tax return or T2. The costs and additional administrative requirements can be expensive and time consuming.
When your business suffers a loss as a sole proprietorship, that loss can be used to offset or reduce your personal income. When a corporation suffers a loss, it is trapped within the corporation and is not available to offset personal income.
No real limited liability
A common misconception is that the corporation will remove any liability from its owners. However the limited liability is often undercut by personal guarantees and other credit arrangements. Just because you have a corporation doesn’t mean that banks and credit facilities won’t still want a personal guarantee. When you’ve offered a personal guarantee to obtain corporate financing, or any other transaction in the business, you have lost any limited liability from the corporation.
As mentioned, it’s important to realize that there is never a definite yes or no answer to the question as to whether to incorporate or not. It is a decision that requires major consideration, and should not be taken lightly. Often the advantages and disadvantages should be discussed with a professional and the process itself should be undergone under the guidance of both legal and financial advice.