The tax efficiency of investing in Canada has been made all the more important since tax barriers formerly placed on nonresident investors were removed. Previously, U. These barriers meant that most foreign investment i was done either through tax-favorable jurisdictions or countries that had entered into tax treaties with Canada to facilitate obtaining tax clearance certificates; or ii required the Canadian target to implement a share exchange structure discussed below or reorganize as a U.
The removal of these barriers, which was brought about largely through advocacy efforts by U. This has permitted founders to focus on CCPC eligibility as the key determining factor on where to incorporate. Practice has evolved over the past 10 years such that emerging companies in Canada are now commonly implementing National Venture Capital Association NVCA -style documents with which U.
This change has effectively eliminated a legal distinction that had given some U. Nevertheless, there are certain differences, such as the scope of fiduciary duties of the board, changes triggering class votes, shareholder consent requirements, and the availability of the oppression remedy that continue to distinguish the jurisdictions.
The Canadian NVCA-styled documents are designed to harmonize the differences between Canadian corporate law and Delaware corporate law through contractual agreement. For example, many Canadian technology companies will provide for unanimous shareholder consent on written instruments and enumerate certain changes triggering class votes.
They also address U. Given the compelling CCPC benefits, what might make a forward-thinking or risk-averse founder consider incorporating in the United States? First and foremost, any cross-border investment is inherently complex and comes with certain risks. Will a non-U. Are the entities able to share intellectual property and other facilities across the border? This risk is amplified by the fact that most potential tax impediments apply when the foreign party is exiting from the investment e.
This means that both the company and the investors must have confidence in the future tax regime between the applicable jurisdictions. Canada and the United States are no exception to this. As mentioned above, prior to , certain barriers were imposed on foreign investors of Canadian companies that resulted in many investors investing through other jurisdictions or not at all. Although these barriers have since been removed, there is no guarantee that the more tax-efficient regime will be permanent or that similarly efficient rules will stay in place.
For example, U. Thus, although current tax regimes support foreign investment in Canadian corporations, these recent tax considerations demonstrate that it is possible this may not be the case in the future. For forward-thinking founders, another consideration is the tax issues that can arise when a Canadian company is acquired by a foreign corporation. This is predominantly relevant where an acquirer wants to satisfy part or in some cases, all of the purchase price with its own shares—a common acquisition structure for technology companies.
In Canada, shareholders of a target company are entitled to defer the taxes owing on consideration shares in a stock-for-stock deal until those shares are sold. This rollover treatment is not available, however, where the shares of a Canadian target are exchanged for shares of a foreign company. This means that in cross-border, stock-for-stock deals, Canadian shareholders can be left with a tax bill without having received any cash to pay it.
This concept can be a little bit misleading. When she eventually decides to withdraw that money from the corporation, she will have to pay personal tax on the income. If Heidi instead decided to use the money within the corporation to buy income-producing assets power tools to rent out or a vehicle to deliver things, for example , then she would not ever have to pay personal tax on those funds.
The real benefits come from the ability to use deferred tax dollars to grow your business. You also gain the ability to plan out personal income to take advantage of lower marginal tax rates. Before , income splitting was one of the more common reasons people incorporated their businesses.
Dividends could be used to distribute business income to a lower-income spouse, who would then be taxed at a lower rate. As of January 1, , regulatory changes called a tax on split income or TOSI have significantly limited the ability to use this technique. The rules are designed to limit the benefit of income splitting through private corporations. TOSI rules apply when the income recipient is an adult family member and has not made a sufficient contribution to the business.
The main thing to keep in mind is dividends to adult family members who are not active in the business are taxed at a high rate. You can read our in-depth TOSI article for more details on this. For example , Paul operates an accounting practice he started from scratch. Paul is considering retiring and would like to sell his accounting practice. There are a few specific requirements that must be met before the LCGE can be claimed on the sale of an incorporated business.
More details are found here. A corporation is a separate entity to the business owner. The corporation has the same rights and obligations under Canadian law as a natural person. This means it can acquire assets, obtain a loan, and enter into contracts. So, the corporation continues to exist even if the business owner passes away. This is not the case for partnerships or sole proprietorships, which cease to exist on the death of their owners.
This stability allows you and the corporation to plan over a longer-term. It provides more flexibility when transferring assets to others. Looking to incorporate? Check out Ownr for a straightforward DIY incorporation process.
As you can see with the lists of additional costs, you may end up dealing with expensive professionals more often if you operate your business through a corporation.
The corporation is a separate entity, which means you have to keep its filings up-to-date on top of your own. When you operate a proprietorship and incur a loss, you can deduct that loss against your other personal income. If you were operating that same business through a corporation, the loss could not be applied to your personal income.
The company could carry the loss backward up to three years to receive a refund of some previously-paid taxes. Or the company can carry the loss forward up to twenty years to reduce taxable income on a future return. The benefit is losses can reduce corporate income in other years. This is less helpful than it would be to have the loss directly reduce personal income taxes in the current year. In some situations, you may end up paying more tax when operating a business through a corporation.
This most often occurs when the small business deduction is not available to corporations. In addition, personal tax credits available to unincorporated business owners can mean a proprietorship pays less tax than a corporation. It is less common for a corporation to pay higher taxes overall, but the situation can exist.
We recommend discussing your scenario with your accountant to see if this will be the case or not. Sometimes, people may just assume incorporation is the best way to go because it seems like the gold standard for running a business. Business Name Protection When you incorporate your business in a state or province, the business name you choose is reserved for your use in that state or province, or if you incorporate your business federally , you have the right to use your business name throughout the country.
Sole proprietorships and partnerships have absolutely no business name protection. If your business is not incorporated, anyone can start a business with the same or a similar name. Incorporating your small business sounds like a great idea, doesn't it? But there are also disadvantages that you need to consider.
Another Tax Return When you incorporate your small business, you'll have to file two tax returns each year, one for your personal income and one for the corporation. This, of course, will mean increased accounting fees. Increased Paperwork There is a lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership.
Corporations, for example, must maintain a minute book containing the corporate bylaws and minutes from corporate meetings. Other corporate documents that must be kept up to date at all times include the register of directors, the share register, and the transfer register. No Personal Tax Credits It's possible that being incorporated may actually be a tax disadvantage for your business. Corporations are not eligible for personal tax credits. Every dollar a corporation earned is taxed.
As a sole proprietor, you may be able to claim tax credits a corporation could not. Less Tax Flexibility A corporation doesn't have the same flexibility in handling business losses that a sole proprietorship or a partnership does.
As a sole proprietor, if your business experiences operating losses, you could use the loss to reduce other types of personal income in the year the losses occur.
In a corporation, however, these losses can only be carried forward or back to reduce the corporation's income from other years. Liability May Not Be as Limited as You Think The prime advantage of incorporating—limited liability—may be undercut by personal guarantees or credit agreements. A corporation's much-vaunted limited liability is irrelevant if no one will give the corporation credit. When a corporation has what lending institutions consider to be insufficient assets to secure debt financing, they often insist on personal guarantees from the business owner s.
So, although technically the corporation has limited liability, the owner still ends up being personally liable if the corporation can't meet its repayment obligations. Registering a Corporation Is Expensive Corporations are more expensive to set up than other business structures.
A corporation is a more complex legal structure than a sole proprietorship or partnership, so it naturally carries more costs to set up. Fees for incorporating a small business federally or within a province range in the hundreds of dollars. Closing a Corporation Is More Difficult Closing a corporation requires passing a corporate resolution to dissolve the corporation, winding up payroll accounts, and sending a copy of the certificate of dissolution to your provincial authorities or the Canada Revenue Agency.
You will also need to file your final tax returns for the corporation.
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