Is It Time to Incorporate?

Article by the tax lawyers at Ritchie, Kwo & Wright LLP.

Phone: 604.600.7704

E-mail: admin@rkwlaw.ca

Most businesses reach a point where this becomes an important question: whether or not it’s time to incorporate. There are costs involved but the tax and legal benefits can be significant for business owners and professionals.

A number of years ago I wrote a note similar to this one, but tax law has changed significantly in the interim. This note will address some of the benefits of incorporation, as well as some of these changes. Finally, it closes with some specialized planning that could offer you significant tax savings.

Defer tax

At the time of writing, the small business rate for corporations in British Columbia is 11%. The top tax rate for individuals in BC is currently 53.5%: a spread of 42.5%.

The tax deferred by incorporating is ultimately largely made up by the government when the shareholder takes out a dividend from the corporation. In the meantime however, your corporation may reinvest $89 of every $100 earned, losing only $11 to tax. Conversely, only $46.50 may be reinvested for income earned personally at the top marginal rate.

Limited liability

A corporation is a separate entity—i.e. a separate legal “person”. This means that if the corporation is carrying on a business and is sued for a mistake or a faulty product, the liability stops at the corporate level. The creditor might sue for the corporation’s assets but it won’t have access to those of the shareholder, such as your home or savings.

Lifetime capital gains exemption (“LCGE”)

I covered this area in more detail in an older article I wrote a number of years ago for Business in Vancouver, but in brief, every Canadian has a LCGE on the sale of shares of a corporation which is indexed to inflation ($1,250,000 at the time of writing). There are requirements that need to be met but, if satisfied, the result is that on the sale of your corporation, $1,250,000 in gains is exempt (subject to alternative minimum tax).

Bring in other shareholders, whether directly or by way of trust (see below), and this exemption can be multiplied. For example, a corporation owned solely by a trust with four beneficiaries could claim exemptions upwards of $5 million in respect of its beneficiaries.

Income splitting and the tax on split income (“TOSI”) rules

Income splitting was at one time the most significant benefit of incorporation. The new TOSI rules have limited this somewhat. However there are a number of exemptions, and the tax lawyers at Ritchie, Kwo & Wright can help you navigate these very complex rules, potentially resulting in significant tax benefits.

Advanced planning: family trust and “holdco” structure

One structure we’ve been implementing more frequently has a family trust owning the shares of an operating company and a holding company. The beneficiaries of the trust would include the individual running the business, and her spouse and children—but importantly, it would also include the holding company as a beneficiary.

This structure provides two main benefits. First, it permits tax-free dividends from the operating company through the trust to the holding company, allowing you to invest proceeds from the operating company’s business in a separate entity not subject to liability from the operating company. Second, it allows for the multiplication of the LCGE among the beneficiaries of the trust on the sale of shares of the operating company.

You can read more about these structures here.

Time to incorporate?

If you are considering whether incorporation makes sense for you or are looking for tax advice on whether setting up a trust or holding company will be beneficial for your business, please don’t hesitate to set up an appointment with one of our tax lawyers by e-mailing admin@rkwlaw.ca or calling 604.600.7704. Our fixed fees for a simple incorporation of a new business start at $1,320, plus tax and $430 in disbursements.

This note is only a summary and does not constitute legal advice. If you require advice on the topics considered here, we would be pleased to assist you.