Here’s the thing- Canada has over 1.3 million businesses with employees, and that makes it a competitive landscape for your business. So, it makes sense you are looking for ways to cut through the noise. Are you thinking of incorporating rather than being a sole proprietorship? If you are in this dilemma, let us tell you the advantages and disadvantages of incorporation so that you can make an informed decision.

Before we move on, you should know the definition of sole proprietorship and corporation.

Sole Proprietorship: Sole proprietorship is the simplest form of business. If you are the sole proprietor of your business, you are also personally responsible for any debts and obligations because, in the eyes of the law, you and your business are the same legal entity.

Corporation: Corporations on the other hand, count as  a separate legal entity from it’s owner or owners. This means you, as the owner of a corporation, have limited liability. In other words, your personal assets are generally protected from business liabilities.

Advantages of Incorporation

Should you incorporate your business? As with all things legal, it depends. But the first step is knowing the advantages and disadvantages of incorporation vs sole proprietorship.

So let’s look at some advantages of a C corporation vs an S corporation to get things started.

I. Tax Benefits

A corporation is a separate entity from you for tax purposes. Incorporating may help you save on taxes in several ways. Corporate tax rates are generally lower than personal tax rates, but your company has to generate a substantial profit before this becomes an advantage.

Canada’s current federal corporate tax rate is 15%, lower than the personal income tax rate for high-income earners. Additionally, corporations may also be eligible for other tax deductions, such as deductions for business expenses, capital cost allowance, and research and development expenses. These deductions can further reduce your tax liability and provide more cash flow for your business.

Plus, if your spouse or children are shareholders in your corporation, you can redistribute income from family members in higher tax brackets to those in lower tax brackets. This is a process known as income splitting.

In contrast, sole proprietors and partnerships are taxed at the personal income tax rate, which is significantly higher than the corporate tax rate. By incorporating your business, you could pay less in taxes and keep more of your hard-earned profits.

II. Limited Liability

Limited liability is the legal concept that shareholders or owners of a corporation bear no personal liability for the corporation’s debts or legal obligations. Instead, the corporation is a separate legal entity whose liabilities are limited to its assets. This means that your personal assets, such as your home or car, are protected in case of a lawsuit or bankruptcy.

This protection is a significant advantage because it allows you to take calculated risks without risking your assets. It also makes it easier to attract investors to your business, as they are more willing to invest in a business when their assets are not on the line.

III. Ease in Raising Capital

It is challenging to attract investors for a small business. But, if you incorporate it, you will easily attract these. As we saw above, with limited personal liability protection, an incorporated business will raise capital quickly. Here is how:

As a corporation, you can sell shares of your business to investors, which will help you raise funds for expansion, research and development, or other initiatives. Some examples of financing options that will be available to you include;

• Issuing shares
• Obtaining loans from banks
• Seeking funding from venture capitalists

By issuing shares, your corporation will raise equity financing from investors in exchange for partial ownership of the business. This option is attractive for businesses with a high growth potential or unique product or service offerings.

Additionally, banks will be more willing to lend to corporations as they have a more established legal structure and can provide more security for lenders. Finally, venture capitalists are more willing to invest in corporations as they typically have a higher tolerance for risk and are more interested in funding businesses with high growth potential.

So, while corporations can obtain additional capital by taking loans, they also can issue and sell shares to raise money. Incorporating your business can provide numerous advantages regarding access to capital, which can help you achieve your business goals and unlock new growth opportunities.

IV. Perpetual Existence

Are you looking for a legal structure for your business to provide long-term stability and continuity? Incorporating your business offers the benefit of perpetual existence. Perpetual existence means that your corporation exists as a separate legal entity that will continue to operate even if the shareholders or directors change over time.

In other words, your corporation will continue to operate indefinitely, regardless of any changes in ownership or management. It will provide your business stability and continuity, which is particularly important if you plan to grow and expand your operations over the long term.

In contrast, sole proprietorships and partnerships have a limited lifespan and are dissolved if the owner(s) dies or decides to leave the business. Such an occurrence creates uncertainty and instability for the business and its stakeholders.

V. Flexibility

Incorporating your business can offer greater flexibility than sole proprietorships and partnerships. Flexibility means the corporation can have a wide range of ownership structures, including different classes of shares with different voting rights and dividends. As a result, you will structure your ownership in a way that best suits your business needs.

For example, you could issue voting shares to key employees or investors who have a say in managing the business while retaining non-voting shares for yourself. In addition, you can structure your corporation in a way that allows for different levels of liability protection for shareholders. For example, some shareholders may be liable only for the amount of their investment, while others may be liable for a larger amount.

Finally, unlike sole proprietors or partnerships, money that comes in does not need to always be drawn out. This lets you keep money inside the corporation until you actually need to draw it out. This flexibility allows you to choose when you pay taxes instead of constantly paying taxes when you make money.

VI. Transfer of Ownership

Incorporating offers the benefit of transferrable ownership, making it easier to sell or transfer your business ownership/property to your family or partners.

Transferrable ownership means that new players can buy shares or ownership of the business without affecting the operation or management of the business. So, when you want to retire, you can leave your stake in the business to someone else.

In contrast, S corporations do not have shares of stock that can be easily bought or sold, meaning they are more challenging to sell or transfer ownership to others.

VII. Prestige and Legitimacy

Prestige refers to a business’s perceived status or reputation, while legitimacy refers to the legal recognition of a business as a separate entity. By establishing your business as a corporation, you are sending a message to your stakeholders that you are committed to professionalism, transparency, and ethical business practices under corporate bylaws.

In addition, a corporation is a separate legal entity, meaning it can enter into contracts, sue or be sued, and own assets in its name. This can provide additional credibility and legitimacy for your business, which can be particularly important if you want to attract investors or enter into partnerships with other businesses.

In contrast, sole proprietorships and partnerships may be viewed as less legitimate or professional in the eyes of some stakeholders, as they are not separate legal entities.

Disadvantages of Incorporation

Incorporating has certain advantages, but they must be weighed against these disadvantages.

I. Cost and Complexity

Incorporating a business is a costly and complex process that requires legal and accounting expertise. It includes costs for registering the business. For this, you must file articles of incorporation with the government and pay filing fees. There will be other costs for preparing legal documents and corporate maintenance, such as annual reporting and record-keeping. These costs can be particularly burdensome for small businesses with limited financial resources.

In addition to the upfront costs, incorporating needs ongoing administrative requirements. These include maintaining accurate records and filings, holding annual meetings, documenting decisions, and complying with corporate governance rules. As expected, these requirements are time-consuming and divert resources from the business’s core operations.

II. Double Taxation

C Corporations pay corporate income tax on their profits. In addition, shareholders are subject to personal income tax on any dividends received. So, this can result in the business income being taxed twice, reducing the overall income available to the shareholders.

For example, suppose a C Corporation earns $100,000 in profit for the year. The business would pay the net corporate income tax on this amount, reducing the net income available to the shareholders. If the remaining $85,000 is distributed to the shareholders as dividends, the shareholders would also be subject to personal income tax on this amount.

In contrast, an S Corporation is not subject to double taxation. Instead, the corporation’s income and losses are passed through to the shareholders, who report them on their personal income tax returns. So, sole proprietorships have the advantage of pass-through taxation, which results in a lower tax burden for shareholders.

It is also worth noting that your C Corporation, as it is not a nonprofit corporation, cannot attain a tax-exempt status.

III. Increased Regulation

When you incorporate your business in Canada, you become subject to increased regulation and compliance requirements. This disadvantage includes requirements for maintaining corporate records, filing annual reports, holding annual shareholder meetings, and complying with securities regulations. Failure to comply with these requirements can result in fines or other penalties.

For example, if you plan to raise capital by selling securities, you will be subject to additional regulations and compliance requirements under Canadian securities law. These requirements include issuing prospectuses, complying with insider trading restrictions, and filing certain disclosure documents with the government.

IV. Limited Control

When you incorporate your business, you start a separate legal entity owned by the shareholders. While this will come with many benefits, such as limited liability and access to capital, it will also mean you have limited control over the business.

As a shareholder, you can elect the board of directors responsible for making major decisions for the company. However, once that board is elected, they will make decisions on behalf of the company, even if those decisions do not align with your interests or vision for the business.

Furthermore, depending on the corporation’s structure, there may be limitations on the ability of shareholders to make decisions or take action outside of formal shareholder meetings. Therefore, this limits the ability of the business to react quickly to changing circumstances or take advantage of new opportunities.

So, if you are used to making all of the decisions for your business and having complete control over its direction, you may need to be comfortable giving up a lot of business control.

Conclusion

You have various options for a good business structure as a business owner. You can choose to incorporate or not, and we have discussed the advantages and disadvantages of a corporation above to guide you. So, while incorporation offers limited liability, access to capital, and tax advantages, it also comes with drawbacks such as increased costs and complexity, double taxation, and limited control.

By weighing the advantages and disadvantages of incorporation, you can decide on the best structure for your business. You can work with the best business lawyers to guide you when forming a corporation. However, with many options available, deciding which is right for you can be difficult and confusing.

But we can help you choose & implement what is right for you and your business.

To learn more about whether you should incorporate, contact Winright Law today:

604-559-2529
[email protected]
http://www.winrightlaw.com

In this video, you’ll learn about the advantages and disadvantages of incorporating to help you understand the options you have for your business. Business owners are faced with an interesting dilemma when it comes to choosing between being a sole proprietor or incorporation. Hopefully, this video will give you a place to start learning and if you need some help or advice, let us know, and we’ll be happy to get you and your business on the path that’s right for you.