How to Incorporate in Canada and its Tax Advantages

Depending on your situation and the province in which you operate, incorporating your business may result in cheaper taxes. Incorporating your business once it generates enough revenue to cover your living expenses can save you money.

The cost and increased paperwork are two disadvantages to incorporating.

When you’re just establishing a business, it’s often not worth it to incorporate, but if you’ve established a profitable company, incorporation can provide numerous major benefits.

The Process

You can incorporate either federally or provincially.

Which one you pick is mostly determined by whether you plan to do business in more than one province. You may need to register and file additional papers before you may do business in another province if you incorporate provincially.

The distinctions between provincial and federal incorporation are frequently exaggerated. Both choices allow the organization to operate in all provinces and provide services to clients all over the world.

The biggest advantage of becoming a federal corporation is that it gives your business greater name protection. Your company name will be registered across Canada (rather than just one province).

Another distinction between a federal and provincial corporation is that the corporation’s directors must be Canadian residents. A minimum of 25% of the directors of a federal corporation must be Canadian citizens or permanent residents. Alberta, British Columbia, Ontario, and several other provinces and territories have no residency restrictions for Canadian directors.

To establish a corporation, you must submit a unique name, proposed bylaws, and the names of the first directors to the federal or provincial government.

You can save the cost of finding a unique name by requesting that the government provide you with a unique number (to create a numbered corporation). A certificate of incorporation is issued by the government, designating you as the owner of a separate legal entity that pays its own taxes.

Tax Advantages

Corporate tax rates are generally lower than personal tax rates and there are further tax breaks accessible to incorporated businesses but before this becomes an advantage, your company must make a significant profit first.

If you rely on money earned by your company for personal living expenses, your company must pay you enough to live on, and you must pay personal income tax on that amount, negating the tax advantages.

When possible, leave some money in the corporation rather than transferring it to your personal account to lower the amount of taxes you pay. You also have the option of how you want to get paid. You can pay yourself a salary, dividends, or a combination of the two, whichever results in the lowest tax burden.

Income Splitting and Dividends

  • Incorporating your business and splitting your business income with family members can provide considerable tax benefits in addition to the lower tax rates available to corporations.
  • If you hire your spouse or children, the corporation can deduct the money you pay them as an expense, and your family members pay tax at their own personal income tax rates, which are generally much lower than yours.

You can make family members shareholders and pay them dividends, which are taxed at a lower rate, even if you can’t engage them to do work. The corporation must still pay taxes on this money, but depending on your family’s personal income and the province in which you live, you may be able to save money overall.

Your best opportunity is to do some rough estimates on the tax due for various scenarios and then choose the most advantageous option.

Dealing with Losses

When you first start a business, you often lose money initially.

  • If you postpone incorporating, you can use these losses against other revenue (for example, from continuing to work at a salaried position while starting your new venture).
  • If you incorporate right away, such losses are retained by the corporation and can be utilized against future income.

Depending on your personal circumstances, carefully consider whether you want business losses to be deducted from your personal income tax or retained in your business, and plan your incorporation accordingly.

When It’s Time to Sell the Business

When you want to sell your business, one of the major tax benefits of incorporation comes into play.

  • When you sell a corporation, you are selling an independent entity with its own assets and responsibilities.
  • When you sell an unincorporated business, you are selling the property and assets that comprise your company.
  • In either scenario, you must pay tax on the proceeds.

As of 2016, a corporation can claim an $800,000 one-time capital-gains tax exemption on the sale of a Canadian-controlled private corporation that uses at least 90% of its assets to do business in Canada.

Should your business qualify, this tax advantage alone may be reason enough to consider incorporating.