Limited Liability. Since a corporation is a separate legal entity it can enter into contracts and own a business. Supposedly, your liability is the amount of your investment loan or share purchase price. Not so fast. Go to a bank and ask for a corporate loan. The banker will ask, “can the corporation guarantee repayment?” Usually, the corporation gets to borrow by using your personal assets as security.
While a corporation is liable for its own taxes, it is also tax collector for the government for HST/GST/PST, employee withholding taxes, or amounts paid to non-residents of Canada. Corporate directors are liable if the corporation defaults.
Lower Taxes. Some private corporations pay about 16% tax on their first $500k of income. If I made $500k, my tax rate would be 43.4% on income over $130K. When is someone going to get those corporate fat cats to pay their fair share of taxes? Why don’t I incorporate my business! One word: integration.
Integration means that if you need the income (to pay off debt, in my case a mortgage) using a corporation does not save taxes, personal tax rates apply. You can’t just use low taxed corporate income to pay personal bills. Well, actually you can, but when you get audited, the CRA will tax you personally on the payments and not allow them to as corporation expenses. The effective tax rate can reach 90% (taxes plus penalties).
Trapping Losses. A corporation is inefficient if a business is in the red. You may be financing the business to cover losses. If your business was not incorporated you could set-off the losses against other income. With a corporation, another taxpayer is losing money; you don’t get to use those losses personally.
Double Taxation: Your corporation (you own 100% of the shares) buys a building. The building value increases; your shares correspondingly increase in value. A share sale results in tax on the share’s increased value. The share buyer gets the corporation. If the building is then sold the corporation pays tax on its increased value. A share sale was taxed and a building sale was taxed – double taxation. If you owned the building and sold it only one gain is taxed.
Double taxation is a big problem if you die owning shares of a private corporation. The shares are deemed to be sold on your death and your estate gets a tax bill for a deemed capital gain. Often there is no cash on hand to pay the taxes due….because there was no real sale. If your estate has no other assets the CRA will ask your heirs to pay the estate’s taxes. Sometimes heirs are forced to sell the assets (more taxes on the gains) of an inherited corporation to pay the taxes of a deceased parent.
Corporations continue to be the choice du jour for most businesses. However a corporation is not a business plan. If an advisor is nattering at you about a “wasting estate freeze” or a “164 loss carryback” or an “88(1) bump” they are either loopy or trying to minimize double taxes. If they are talking about “dividend sprinkling” or “income deferral” they are planning using lower corporate tax rates. If they suggest separating share ownership from business management, they are attempting to limit liability. Planning doesn’t end with incorporation. That is when it starts.
- J. Andre Rachert
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
