The decision to incorporate is one that most small businesses face at some point in their lifetime. Incorporation, literally, represents the creation of a new person. Whereas a sole proprietorship is an extension of one's self, a corporation takes on a life of it's own; it can give birth to subsidiary, marry via a merger and die with a dissolution. It has to file it's own tax return, can be sued and has a set of rules that govern it's existence. Below are some of the points to consider when deciding whether to incorporate:
- Limited liability: A corporation, as mentioned above, creates a new person that is distinct from the creator. As such the liability of the company is limited to the shareholders' investment. (This does not apply in the case of personal guarantees or where directors have specific obligations etc.)
- Lower Tax Rates: Corporations, particularly small businesses, benefit from corporate tax rates that are lower than individual tax rates.
- Capital Gains Exemption: Owners of small business shares benefit from a lifetime capital gains exemption of $750,000. This allows a shareholder to sell the shares of qualifying corporations tax free for gains upto $750k.
- Tax Deferral: Excess profits do not have to be distributed, and can be maintained in the corporation, thereby benefitting from lower tax rates. That being said, passive income (investment, rental etc.) do not benefit from the small business corporate rate.
- Access to Capital: Corporations have more ways of raising capital eg. they can issue shares or sell bonds. Additionally banks are often more comfortable lending to corporate entities.
- Income Splitting: Shares of corporations can be transferred (keeping in mind rules relating to transfer of shares to a related party) to family members, which allows them to receive dividends and other distributions from the corporation.
- Value/Continuous Existence: A corporation is easier to value given that it is an self contained entity. It is also to build value in a corporation as it can continue to exist after the death of shareholders.
- Higher Costs: There are costs relating to setting up a corporation and ongoing maintenance including governmental, legal and accounting fees.
- Greater Administration: A separate set of legal and accounting records needs to be maintained. Additionally, a corporation needs to file an annual return and a tax return each year that is separate from each shareholder's personal tax return. Any changes to the corporation structure, address etc must be registered.
- Complex Structure and Taxation: Corporations by their nature are more complex. Additionally there are numerous tax considerations that can arise from corporate transactions including use of assets for personal reasons, transfer of assets to related parties, tax on capital etc.
- Double Taxation: Both the profits and the distributions to shareholders are taxed often resulting in double taxation.
- Losses: Corporate losses cannot be transferred to the shareholder as contrasted with a sole proprietorship where losses can be used to reduce tax liability by reducing taxable income.
More detailed information can be found at Industry Canada. As always with these matters, it is beneficial to obtain the advice and assistance of a lawyer and accountant.