Tax Advantages of Incorporating your Business in Canada

Incorporating your business may lead to lower taxes depending on your particular situation and the province in which you operate. Incorporating can save you money once the business generates more income than you need for your living expenses.

Disadvantages of incorporating include the cost and the additional paperwork.

Often, it’s not worthwhile to incorporate when you’re just starting a business, but incorporation can offer several significant benefits once that business is profitable.

The Process of Incorporating in Canada

You can incorporate either federally or provincially.

Which one you choose depends mainly on whether or not you intend to do business in more than one province. If you incorporate provincially, you may register and file additional paperwork before doing business in another province.

To set up a corporation, you have to apply to the federal or a provincial government and submit a unique name, proposed bylaws, and the first directors’ names.

You can save the cost of finding a unique name by asking the government to assign a unique number (to create a numbered corporation). The government issues a certificate of incorporation, making you the owner of a separate legal entity that pays taxes in its own right.

How Tax Savings Work

Corporate tax rates are generally lower than personal tax rates, but your company has to generate a substantial profit before this becomes an advantage.

Suppose you’re relying on money your company earns for your living expenses. In that case, your company has to pay you enough to live, and you have to pay personal income tax on that amount, eliminating the tax advantages.

In simple terms, if you’re earning more than you need to live on, incorporation can be advantageous. For example, a business earning $100,000 and the owner needing $60,000 to live on; in this case, that owner can leave $40,000 in the corporation and pays reduced income tax on that amount.

Income Splitting and Dividends

• Incorporating your business and splitting your business income with family members can result in significant tax advantages beyond those available under reduced tax rates for corporations.
• If you hire your spouse or children, the corporation can deduct the amount it pays them as an expense, and your family members pay tax at their own personal income tax rates, often substantially lower than your own.

Even if you can’t hire family members to carry out work, you can make them shareholders and pay them dividends, which are taxed at a reduced rate. The corporation still pays taxes on this money, but there may be an overall tax saving depending on your family members’ incomes and your province of residency.

Your best bet is to perform rough calculations on the tax due to various possibilities and decide on the most favourable course of action.

Dealing with Losses

When you start a business, you often incur losses initially.

• If you delay incorporating, you can apply these losses against other income (for example, from continuing to work at a salaried position while starting your new venture).
• If you incorporate right away, such losses remain with the corporation, to be applied against future income.

Depending on your situation, carefully examine whether you want business losses to reduce your personal income tax or remain in your business, and time your incorporation accordingly.

When It’s Time to Sell the Business

One of the most significant tax advantages of incorporation occurs when you want to sell your business.

• When you sell a corporation, you sell an independent entity with its assets and liabilities as a unit.
• When you sell an unincorporated business, you sell the property and assets that form part of your business.
• In either case, you pay tax on the proceeds.

For a corporation, as of 2021, you can claim a one-time capital-gains tax exemption of $892,218 on the sale of a Canadian-controlled private corporation that uses at least 90 percent of its assets to do business in Canada.

This tax advantage alone can make it worthwhile to consider incorporation, should your business qualify.

Source: TurboTax

For more information about the advantages of incorporating your business in Canada, don’t hesitate to contact RGB Accounting at (416) 932-1915 or email at [email protected] and get One-hour Free consultancy for new incorporators and startups.