Incorporating a Company in Canada
Immigrant business owners are a vibrant part of Canada’s economy, stimulating growth while creating jobs for others. In this article, we will discuss some of the issues involved in starting a new business and how to go about applying for incorporation of your company.
As in many other countries, there are essentially three ways you can structure a new business in Canada as a
- Sole proprietorship:
If you are the sole proprietor, Canada’s national tax authority, the Canada Revenue Agency, views the business and its owner as one entity. You are personally liable for your business, so a creditor who files a claim against your business can go after all of your assets, including personal ones such as your home. Income from the business is taxed at your personal rate. Sometimes this is an advantage: if you experience losses, you can deduct them from your personal income, which may put you into a lower tax bracket in Canada’s progressive tax system.
In a partnership, you and your partner(s) choose how to divide the profits, but you’re equally liable for debts or lawsuits. Your partnership should have an agreement that describes the structure of the business and the allocation of income, profits, expenses and debts to various partners. When it’s time to pay taxes, a written agreement helps ensure that each partner knows what percentage of income and expenses applies to them. Each partner is responsible for filing their own income tax return and claiming on it their agreed share of profits or losses from the partnership.
A corporation is the most robust form of business structure. For many businesses in Canada, incorporating is an excellent step. Incorporation makes the business its own legal entity, providing the owners with protections from liability. On one hand, there may be higher setup costs, more paperwork and the need to enlist professionals to handle more complicated tax filing. But on the other hand, the lower tax rates Canada offers to businesses can save a considerable amount of money.
There are several benefits of incorporating a company in Canada:
- Limits on liability: This is probably the №1 reason to incorporate. Incorporating helps to separate your business obligations from your personal ones, which can be crucial if your business fails. An Industry Canada study found that only half of small businesses last longer than five years. A corporation pays its own taxes, incurs its own debt and can be sued.
- Lower tax rates: Businesses are taxed much more lightly than individuals. If you are a sole proprietor, for example, and your business income reaches CAN $250,000, you might pay personal income taxes at a rate averaging 33% federally—and that doesn’t even count provincial taxes. The federal tax rate for incorporated businesses, in contrast, is only 15% and could be as low as 9%, depending on the nature of the business. An incorporated business can enjoy the benefit of the Small Business Deduction, which reduces the corporate income tax payable up to the business limit for the year, which is currently set at CAN $500,000 per year. You can also reduce the taxes that must be paid (income tax deferral) if you can leave some money in the corporation—to be invested in the business for doing things like hiring new staff, buying inventory, adding new equipment or spending it on marketing—rather than moving it into your personal account. Incorporation also gives you flexibility about how to pay yourself: in salary, dividends, or a combination, depending on what will result in the lowest tax burden.
- Lifetime Capital Gains Exemption: This comes into play when you decide to sell your business. If you sell an unincorporated business in Canada, you’re personally selling your personal property and assets, which, if you have made a profit, could mean paying capital gains tax on all or part of the profit. But when you sell a corporation, you are selling an independent entity, and the Lifetime Capital Gains Exemption (LCGE) could save you from having to pay taxes on all or part of the profits from the sale. The LCGE for qualified small business corporation shares is CAN $913,630 in 2022. (Certain rules apply to qualify.) This is a lifetime limit, so you can make repeated claims until you have reached that amount.
- Income splitting: An incorporated business can pay dividends to your spouse and children, which can vary from year to year. Splitting income in this way allows you to lower your tax bracket and pay lower tax overall. To gain this advantage, you must set up your incorporated business to include your husband or wife and/or children as shareholders. This can be done from right from the beginning, or you can amend the shareholders at any time. Shareholders don’t have to work for the company to receive dividends. But employees can also be shareholders, and receive both a salary and dividends through the business.
- Raising capital: If you want investors for your company, you must be incorporated so that you can have shares to sell to your investors. An outside investor will not invest in a sole proprietorship or a partnership.
- Succession planning: Corporations can be transferred between individuals simply by selling and buying shares, so it’s easier to plan for the time when you want to retire or leave the business. Also, corporations can last indefinitely; they don’t end when their owners die.
- Professional prestige: Your business image will benefit if it is incorporated and sends out invoices under an Inc., Ltd. or Corp. business name. Clients will know that you are planning for long-term viability of your business and take your obligations seriously.
However, there are some disadvantages in of setting up a business in Canada:
- There are costs to setting up an incorporated business, and there is more paperwork.
- You may lose out on some personal tax credits you would be eligible for under a sole proprietorship.
- If certain “personal guarantees” are made, you may not be able to avoid liability entirely.
- Closing a business may be more difficult.
In Canada, you can choose to incorporate
- Federally, or
- In a single province if you don’t plan to expand your business beyond that province.
There are advantages and disadvantages to both.
If you incorporate federally, you will be able to carry on business in all provinces and territories, using one protected, unique name. You will be able to change your headquarters to any other province. Your company will also be recognized internationally. However, there are stricter requirements about the name you choose, and more annual paperwork, as you have to keep up with both federal filings and those required by each province where you carry on business. Note: you still have to register your business in each province where you carry on activities.
If you incorporate provincially, you can carry on business only in that province, although you can easily incorporate in another province (called extra-provincial incorporation) as your business expands. The requirements are less onerous than with a federal incorporation. To find a list of links for provincial incorporation authorities, visit this webpage.
One important difference — federal corporations require at least 25% of the directors of a corporation to be Canadian residents. In contrast, there are no Canadian residency requirements for directors in several provinces and territories, including Alberta, British Columbia and Ontario.
When you incorporate your business in Canada, you do so under the regulations of the Canada Business Corporations Act. Business corporations issue shares, and the owners are shareholders. Once you have worked out the name, structure and share classes that will apply to your company, applying for incorporation is a fairly simple process that can be completed online.
But before you start, you will need to make several decisions.
- Choose a unique name for your business in Canada: This can be trickier than it seems. Your business name can be a number name that is simply assigned to your business, such as 12345678 Canada Inc., or, as most companies prefer, you can choose your own word name, made up of letters and symbols. There must be three elements to a corporate name:
- A distinctive part that identifies your particular company
- A descriptive part that identifies the activities or products of the company
- A legal element that identifies the company as a corporation, such as Limited, Incorporated, or Corporation.
For example: Sugarman Bakery Ltd.
A corporate name is the legal name used on contracts and invoices. It must properly represent your business. It can’t imply that your company is a government agency, or that it sells something different than what it sells. It can’t contain obscene words or suggest that it carries on illegal activities. In Canada, corporate names can be in English or French, or a combination. (In Quebec, you can be required to choose a French name.)
But your corporate name in Canada can’t be identical to or substantially similar to an existing company’s name. To be sure your name doesn’t duplicate that of another company, it’s important to carry out a name search. Federally, and in five provinces, you are required to do a search through NUANS (New Upgraded Automated Name Search, Canada’s database of registered business names) and submit the report along with your articles of incorporation. In some provinces, you need to do the name search after you’ve submitted a name approval request, and if the results are acceptable, your chosen name is reserved for a certain number of days, during which you need to complete the incorporation process.
- Choose your company directors: The company must have at least 1 director, who must be 18 or older. Directors must be individuals, and you must provide details of each director’s residential address and Canadian residency status. You can elect to have more than one director for your company’s board.
Note that, if you are incorporating federally, and also in some provinces, at least 25% of the directors must be legal Canadian residents. If there are fewer than 4 directors, at least one must be a Canadian resident.
- Determine your Registered Office: The company must designate a residential or commercial address as the Registered Office. It can’t be a Post Office Box number. If your mailing address is different from that of the Registered Office, this must also be recorded in the incorporation process.
- Determine your share structure: When you first incorporate your company, you can create multiple share classes to create different groups of shareholders, who will have differing rights and privileges. But you don’t need to issue shares in all of those classes right at the beginning. The Corporations Canada website provides more details on share classes, shareholders, and shareholder meetings.
- Prepare your Articles of Incorporation: If you are choosing the Basic Incorporation option (see below), you will be provided with a standard Articles of Incorporation document. If you choose the Custom Incorporation option, you can prepare your own Articles of Incorporation Your Articles of Incorporation may be written in English or French, or a combination. Once you have the required documents and decisions in hand, you can file your application and pay the fees online.
- File Your Application for Incorporation: You can start the process of incorporating federally at the Corporations Canada Online Filing Centre, which will take you through the process of providing basic information, settling on a name, paying fees, etc., step by step.
At the beginning, you may choose from:
- Basic Incorporation: This is the easiest way to do it, if you are content to have a numbered name and basic shareholder classes. This pre-packaged option removes guesswork from the process. You will be provided with pre-determined Articles of Incorporation (these can be amended later if needed), your choice of one or two classes of shares, and an assigned numbered name. You may have a maximum of 10 directors.
- Custom Incorporation: Choose this option if you want to give your company a unique word name and/or want to have a share structure with multiple classes of shares.