It’s the age-old question for small business owners: to incorporate or not to incorporate? Incorporation may have seemed like a distant dream when you started your business, but as your business grows and evolves, you may find yourself considering this option more seriously. It can be tempting to put off this decision, but the truth is that incorporating your small business can open up new doors. In this blog, we’ll examine the pros and cons, provide real-world scenarios, and outline steps you’ll need to take to incorporate your small business in Canada.
Incorporating Your SMB: What Does it Mean?
‘’The incorporation process establishes a legal entity separate from its owners. As a result, the business becomes a legal “person,” with its own rights and obligations, including the ability to own assets, enter into contracts, and sue or be sued.’’
Advantages of Incorporating
1. Limited Liability Protection
If the business incurs any debts or liabilities, your assets, such as personal savings, house, or car, are not at risk of being seized to pay off those debts. Think of it as a safety net that protects you and your personal assets from financial or legal trouble in your business.
2. Tax Benefits
As a separate legal entity, corporations pay taxes. This allows you to defer personal income taxes by leaving profits in your business, rather than withdrawing them as salary or dividends. Corporations are also subject to lower tax rates, helping you save on taxes.
Incorporated businesses can also take advantage of various tax deductions like the small business deduction (reduced tax rate on the first $500,000 of income earned), capital cost allowance (recoup costs from depreciating assets), and general business expenses like furniture and equipment, supplies, utilities, etc. Tax deductions can translate into significant savings over time.
3. Perpetual Existence
A corporation exists even if the owner or shareholders leave or sell the business. This can provide greater stability and continuity for the business and simplifies transferring ownership.
Perpetual existence can also provide more credibility to the business. Corporations are often viewed as more legitimate and professional business structures than sole proprietorships or partnerships. This can help build trust with customers, suppliers, and investors, creating more opportunities for growth and expansion.
Disadvantages of Incorporating
1. Associated Cost & Complexity
Depending on the size, complexity, and location of the business, the price of incorporating a small business in Canada can quickly add up.
a) Incorporation Fees ($300 – $600): Choose a unique name for your corporation and prepare articles of incorporation with the government.
b) Legal Fees ($1000 – $2,000): Lawyers and accountants guide the legal and financial aspects of incorporating, making the process much easier and personalized for your business.
c) Shareholder Agreement ($500 – $1,000): If other owners are involved in a corporation, drafting a shareholder agreement is usually necessary. A shareholder agreement helps define the roles and responsibilities of shareholders, outlines how decisions will be made, and provide guidelines for dispute resolution.
d) Annual Fees ($300+): Once a business is incorporated, there are several annual fees and expenses (report fees, corporate income tax, business license fees, etc.) that it must pay to maintain its legal status and comply with government regulations.
2. Time Commitment
Incorporating a small business in Canada involves various administrative tasks and requirements, which can be a challenge for time-strapped business owners.
Things like annual reporting and maintaining detailed financial records are time-consuming. You’ll also need to stay on top of relevant laws and regulations governing your business, including employment standards, taxation, and licensing.
3. Higher Tax Rates
It’s possible that corporations end up paying more taxes. For example, if a corporation experiences losses in a given year, it may not be able to deduct those losses from the owner’s personal income. Instead, the losses can only be carried forward and applied against future profits.
The tax implications of incorporating a small business vary depending on several factors, including the type of business, the level of profits earned, and the owner’s tax situation. A qualified accountant or tax professional can help you fully understand the tax implications of incorporation.
Small Business Incorporation Scenarios
Now that we’ve covered the pros and cons of incorporating a small business, let’s look at two scenarios:
Mike owns a small mechanic shop that provides automotive repair services. Over the years, his company has grown, and he has several employees. Money is starting to flow into his business, more than enough to cover yearly expenses. Eventually, Mike wants his son to take over the shop.
Factors to Consider
a) Liability: Mechanic shops are high-risk and can attract lawsuits or other legal claims that can arise from accidents or injuries caused by faulty repairs or defective parts.
b) Taxation: Mike earns more than he needs and is most likely paying more taxes than he should.
c) Exit Strategy: Mike needs to think about the future of his business. A corporation would certainly simplify a transfer of ownership.
Due to the nature of his business and the number of employees, Mike’s business could be exposed to significant liability risks. By forming a corporation, he can separate his assets from those of the shop and limit his personal liability for any legal or financial issues that may arise. Incorporating can also help Mike save money come tax season, allowing him to defer taxes on his personal income by leaving profits in the corporation. A corporation would solidify his business’s continuity, allowing him to transfer ownership to his son.
Maria’s restaurant has a few employees and a loyal customer base, but her income is relatively modest. Maria has no plans of growing or expanding her business and enjoys her free time. She has no intention of selling her restaurant or transferring it to her family.
Factors to Consider
a) Increased Costs: Incorporating can be expensive, and Maria most likely doesn’t have extra money to set aside.
b) Added Complexity: Corporations are subject to complex regulations and requirements, which can be time-consuming and challenging to navigate. The time commitment might not be worth it for Maria.
c) Limited Tax Benefits: While incorporating can provide some tax benefits, Maria doesn’t earn enough to take advantage of these tax savings.
In this scenario, Maria shouldn’t incorporate her restaurant. The company she operates is small and low-risk, so incorporating would probably involve additional paperwork and fees without providing any significant tax savings or liability protection. In this case, a sole proprietorship or partnership is more appropriate for Maria’s business structure.
Steps to Incorporate Your Small Business
If after reading this blog you’ve concluded that incorporating your small business is worth it, we’ve outlined the steps to help you kickstart the process. It’s recommended to get professional legal advice to ensure all necessary steps are completed. Online platforms, like Ownr, make incorporating your business an easy and pleasant experience for a reasonable price.
Step 1 – Choosing a Name
You will need to choose a name for your corporation that complies with the naming rules set out by the Canadian government. Your name must be unique and distinguishable from other registered corporations, and it should include the word “Limited” or “Ltd.” at the end. Remember, this is your legal name, your brand name (DBA) doesn’t have to be the same.
In Canada, name availability searches are conducted through the NUANS (New Upgraded Automated Name Search) system. The NUANS system compares your proposed business name with existing names in the registry to ensure its uniqueness.
Step 2 – Federal Vs. Provincial
Small businesses in Canada are required to choose whether to incorporate at the federal or provincial level.
Federal Corporations: If you plan on doing business outside your home province, incorporating at a federal level is a good choice. Your business name will be protected nationally, and your head office can be anywhere in Canada.
Provincial Corporations: As a provincial corporation, you’re protected under provincial laws and can ‘’only operate’’ within that province or territory. However, you can still operate nationally if you abide by the applicable legislation and obtain the necessary licenses. Applying provincially is often a cheaper and quicker option. Here’s a list of all provinces and their application links.
Step 3 – Articles of Incorporation
Articles of Incorporation are legal documents that set out the basic structure and rules of your business.
a) Purpose of Your Business: A statement of the purpose of your corporation, which outlines the general nature of the business you will be conducting. This can be a brief statement describing the type of business you’re starting, such as “to operate a retail clothing store” or “to provide consulting services to small businesses.”
b) Share Structure: Details about the ownership and structure of your corporation, including the number and type of shares that will be issued, the rights and privileges associated with each class of shares, and any restrictions on the transfer of shares. You’ll also need to decide whether your corporation will be publicly or privately held and whether it will issue common or preferred shares.
c) Number of Directors & Names: Number of directors responsible for managing your corporation, as well as their names and addresses. You’ll need at least one director, but some provinces require more.
d) Define Your Bylaws: Your articles of incorporation may also include provisions for your corporation’s bylaws, which are the rules and regulations that govern how your corporation will be run. Bylaws typically cover issues like the roles and responsibilities of directors and officers, the procedures for holding meetings and making decisions, and the handling of shares and other corporate matters.
If your articles of incorporation are approved, you will receive a certificate of incorporation from the government. This certificate confirms that your corporation has been legally created and is authorized to conduct business.
Step 4 – Licenses & Permits
As a new corporation, you may need additional licenses and permits to operate your business legally. The specific licenses and permits that your business will require will depend on various factors, including your location, industry, and nature of your business activities. Research the requirements in your province or territory to determine what licenses and permits you need.
Does Incorporating Make Sense for Your Business?
Deciding whether to incorporate your small business in Canada is not a one-size-fits-all approach. It depends on a multitude of factors like size, longevity, lifestyle, and business goals. If you intend to establish a long-term business, then it might be a prudent decision to incorporate. However, if your business is short-lived or limited in scope, then it may not be justifiable to bear the expenses and complexities associated with the process. So, to incorporate or not to incorporate? Only you can answer that question.