While virtually all home-based businesses start out small, many of these businesses grow to become large successful enterprises.
Maroney on Money for July 5, 1998
In their infancy, home-based businesses tend to be somewhat unstructured often operating in proprietorship form, more or less, by default. A proprietorship is an unincorporated commercial enterprise owned by a single individual. Although the owner may frequently refer to his or her proprietorship colloquially as “the company”, a proprietorship is not a company in a true legal sense.
Somewhere along the line, as these small businesses grow, the question of incorporating the business must inevitably arise. So what are some of the advantages of incorporating a business?
Limited liability is rarely mentioned as a reason to incorporate but it should be foremost on everyone’s list when making the decision to set up a company. In fact, if your business entails a high degree of legal risk you may want to incorporate right from the start. A company is a separate legal entity that can be sued on its own. The extent of legal protection provided by incorporating is a subject that should be addressed with a lawyer.
Notice though, that the operative word here is “limited”. Incorporating a business does afford certain legal protection to the company’s shareholder(s), however, this liability is not without bounds. When a business incorporates the owner(s) usually become the shareholder(s) and director(s) of the company. Directors of a company can still be held personally liable in certain cases. For example, under the Income Tax Act directors are jointly and severally liable to the Receiver General for employee withholdings such as income tax, EI and CPP. The Excise Tax Act contains a similar provision for GST.
Possibly the most frequently cited reason to incorporate is the perceived income tax advantage. And, yes, there are income tax benefits to be had but these advantages are often overstated. The truth is that, specialized industries aside, most so-called tax “write-offs” are available equally to both incorporated and unincorporated businesses.
Write-offs aren’t the key tax reason to incorporate but rather tax deferral. Upon incorporation the majority of small businesses will become what is known in the income tax world as Canadian-controlled Private Corporations or CCPC for short. CCPC’s are taxed a rate of approximately 22% on the first $200,000 of income they earn from an active business. In other words, $0.78 of every dollar earned by the company can be retained for use in future growth and expansion.
Contrast this with person earning the same amount of money as a proprietor and not a corporation. At the top tax bracket of approximately 52%, this person will be left with only $0.48 on the dollar to finance future growth. Clearly, when the proprietor is paying tax at the top rate there is an advantage to incorporating.
Another reason to incorporate a business is protection of the business name. You can register your business name as a proprietor but you cannot protect it. If your business is a roaring success, incorporation will provide you with exclusive use to the name.
In general, unincorporated businesses must have a December 31st fiscal year-end. It is possible for an unincorporated business to have a non-calendar year-end but additional complexity is involved. As an incorporated business you are free to choose a year-end on whatever date you wish. Often a fiscal year-end is chosen at a slower point in the business cycle.
Accessing the enhanced $500,000 lifetime capital gain exemption is also a good reason to consider incorporating. This exemption is available to individuals on the disposition of shares of certain qualifying corporations. This is a complicated area where professional advice is definitely required.
Are there disadvantages to incorporating? Absolutely. One of the more significant disadvantages is the fact that, if the business loses money, the losses belong to the company and cannot be claimed by the shareholder. If an unincorporated business loses money, the losses are deductible against the taxpayer’s income from all other sources.
Honourable mention also goes to increased cost for accounting and legal work relating to filing tax returns, annual reports and preparation of various resolutions. Complexity, regulation and red tape are also negative factors to be considered.
Jim Maroney is a chartered accountant with Andrews Brown Maroney in Maple Ridge.
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