1. Limited Liability
Any individual may carry on a business as a sole proprietor. If you choose this structure, you must be prepared to accept all of the risks incidental to your business because you are personally liable to the full extent of your property for all liabilities incurred in the conduct of the business, including any wrongful acts of your employees. You have unlimited exposure to liability.
In a partnership, the partners are jointly liable for all debts and liabilities of the business. If the business is sued, all the business and personal assets of each partner are at risk. An exception to this is a Limited Partnership. Limited Partners, who contribute capital but do not participate in the management of the business, will have their liability limited to the amount of capital that they have invested. The partners who manage the business are called General Partners and have unlimited liability.
The main advantage to incorporating is the limited liability of the incorporated company.
As mentioned, a corporation, unlike a sole proprietorship, has a separate legal existence apart from its shareholders. The corporation, not the shareholders, owns the assets of the business and it is the corporation, not the shareholders, that is subject to whatever liabilities might be incurred. A shareholder’s liability is limited to her investment.
2. Corporate Status
The incorporation of a company brings into being an entirely separate legal entity with defined powers, duties and rules of procedure. The assets and liabilities of the business will lie with the company and are distinct from the assets and liabilities of the persons who own the shares of the company. Because of this, a corporation has an unlimited life span; the corporation will continue to exist even if the shareholders die or leave the business, or if the ownership of the business changes.
A proprietorship, however, has a lack of permanence - if the owner dies, the business assets pass to the heirs, but valuable leases and contracts may not. With partnerships, the death or retirement of a partner will not end the partner’s liability for debts and obligations of the partnership that were incurred prior to the death or retirement.
3. Borrowing Money & Raising Capital Is Easier
A company’s ability to create a floating charge over its assets enables it to offer a form of security not normally available to individuals and proprietors.
Further, corporations have more ability to raise money, which may make it easier for your business to grow and develop. While proprietors and partners can also borrow and incur debt like a corporation, only a corporation can sell shares and raise equity capital, thereby creating a huge advantage because equity capital generally does not have to be repaid and incurs no interest. Of course, by issuing shares to third parties, you dilute your ownership in the company.
The ability to issue shares to third parties leads into the next two advantages of incorporating flexibility and control.
The minimal denominations in which shares can be issued, the ease and simplicity with which the ownership of such shares can be transferred and, above all, the variety of capital structures available to companies provide for considerable flexibility. The rights attaching to shares can be arranged to suit individual needs, thus allowing greater flexibility in estate planning, employee participation schemes, shareholdings in other corporations, mergers, reorganizations, etc.
If your business is successful you may have commercial, family or other reasons to divest yourself of the ownership of part of your business, allowing you to realize part of the value of the business while still retaining control over it.
As the ownership of a company is represented by shares it is very easy to sell a portion of a company simply by selling a certain number of shares to third parties. By retaining 51% of the shares, the owner can dispose of nearly half her interest while still retaining control of the company. By the use of non-voting shares she can retain control while disposing of the major part in value of her interest.
Neither proprietorship nor partnership can rely on the advantages of flexibility and control as neither structure is formed on a “share capital” model.
6. Tax Advantages to Incorporation
Incorporation provides for certain tax advantages through deferral of tax, income splitting and levelling of income level fluctuations.
(a) Tax Deferral
The Income Tax Act allows corporations to defer paying some tax until a later time, so you may be able to realize tax savings when you are in a lower tax bracket, or if the tax rates have fallen.
Also, income tax rates are lower for corporate income than for personal income. Corporate tax is imposed at the combined Federal and Provincial rate of 13% in Saskatchewan on the first $500,000.00 of a small business’ income (27% after $500,000). To the extent that a proprietor or a partners personal tax rate exceeds 13% there will be an advantage to incorporation since less tax would be payable by the corporation. However, additional tax is payable when dividends are paid by the corporation to its shareholders. As a result, if a shareholder takes all after tax income out of the company each year there will be no deferral advantage.
(b) Income Splitting
The term “income splitting” in this context refers to the organization of income of a company so as to reduce the total tax burden by having the income earned by several individuals rather than one person. For example, rather than have income earned by a taxpayer who has a personal marginal rate of tax of 44%, less tax would be paid on that income if the individual’s spouse or children who each have personal marginal tax rates of 26% earned some of that income.
One method of income splitting that has been commonly used is to distribute the corporate shares to family members. After-tax corporate income could be distributed by way of dividends to the shareholders. A shareholder does not have to be actively involved in the corporation’s business activities to receive dividends. Lower taxes will be paid on such income if the other family members fall in lower tax brackets than the original taxpayer.
(c) Minimization of Income Level Fluctuation
If the profits of your business are subject to annual fluctuations, the use of a corporation would allow you to minimize the effect of such fluctuations on your personal income. You would be able to control the distribution of after-tax corporate earnings. Instead of getting your income when it is received (as is the case with proprietorship), being incorporated allows you to report your income at a time when you will pay less tax.