Disadvantages of Incorporating a Business in Canada

In a previous article, we explored the multiple advantages of incorporating your business in Canada. Incorporation can boost personal income through tax savings, provide powerful asset protection, attract investment opportunities and commercial prestige, skyrocket your company’s growth, and much more.

But incorporation isn’t for everyone. Incorporating a business in Canada has some disadvantages.

In our experience, the pros far outweigh the cons of incorporating. So, we highly recommend that you read our article “What Are the Advantages of Incorporating a Business in Canada?” and “Should I Incorporate A Business in Canada?” before reading this one.

However, we advise our clients of any potential cons of incorporating their business. So, let’s dive in!

Key Takeaways

• In our experience serving hundreds of businesses across Canada, incorporation is usually the right move for many reasons. But, there are disadvantages to incorporating a business in Canada.
• One of the biggest advantages of incorporation – limited liability protection – is not absolute, and you may be personally liable in certain situations. These include liability for unpaid taxes and fraudulent activities.
• The main disadvantages of incorporating a business in Canada include the initial incorporation costs and ongoing fees. Expect initial set up costs of about $1500-2500 plus ongoing yearly legal fees of $400 for corporate minute book maintenance. You should also budget accounting fees of $500-2000 per year.
• Another disadvantage of incorporating a business in Canada is the added complexity of accounting/bookkeeping. This can be managed by good planning and hiring the right professionals.
• When you incorporate a business in Canada, it may be more difficult to write off losses, since the losses in the corporation can only offset gains in the same corporation. You cannot offset losses in one corporation against income in another. However, you can offset losses in one sole proprietorship business against income in another, including employment income.
• If you are not careful, you may face higher taxes if you use a corporation. Seek appropriate tax advice.
• Incorporating a business in Canada may not be worth it if: 1) there is little income remaining after you pay yourself a salary for basic living expenses; 2) the business is in a low risk industry; and 3) you aren’t planning to sell the business in the future. However, if not all of these are true, incorporating could be beneficial.
• Incorporating a business in Canada may not be worth it if you expect losses in your business for the first several years.
• Incorporating in Canada to hold investments like rental property or stocks may be a bad idea from a tax point of view.
• Always speak to your accountant and business lawyer for your specific situation! No exceptions!

Key Disadvantages of Incorporating a Business in Canada

Based on our experience helping clients establish a Canadian controlled private corporation, incorporating is typically a smart choice. That being said, it’s crucial for all entrepreneurs to understand the disadvantages to incorporating a business in Canada. See our article, called “Should I Incorporate a Business in Canada?”

Nevertheless, it’s crucial for all entrepreneurs to understand the potential downsides.

Here are the most common disadvantages to incorporating a business in Canada:

Limited Liability is Not Absolute

Generally, when you incorporate as a separate legal entity, it reduces personal liability by shielding your personal assets. If your corporation faces financial or legal challenges, your personal assets are typically protected.

However, you should know that even with incorporation, there are scenarios where you, as a director, may still be personally liable. These situations include:

• When you sign personal guarantees for your business.
• Unsettled employee wages and vacation pay.
• Employee deductions and remittances, such as income taxes, EI, and CPP contributions.
• Unpaid GST/HST collections that haven’t been remitted.
• Issues related to environmental contamination.
• Involvement in criminal or quasi-criminal activities
• Involvement in fraudulent activities.

Understanding these exceptions is vital to maintaining the protection of your personal assets while operating as a director.

Initial Setup Costs

To properly secure limited liability and tax benefits, you’ll need help from an incorporation lawyer and an accountant. See our article “Do I Need a Lawyer to Incorporate a Business in Canada?”. Your lawyer will guide you through the incorporation process, ensuring limited liability, along with crucial advice and contracts related to the business.

Your incorporation lawyer will collaborate with your accountant to optimize tax benefits and structure, as incorporated businesses require specific share arrangements. For businesses with multiple partners, your lawyer can create a shareholder agreement, outlining each owner’s roles and conflict resolution procedures.

In addition to legal fees, incorporation involves government filing fees. This includes registration of the business and corporation. You should budget approximately $1500-2500 in setup costs.

Regarding timelines, a corporation can be set up properly in a few days to a week. The fees will vary slightly, depending on whether the new company is a Federal Incorporation or Provincial Incorporation and on whether it is a Named vs. Numbered Company.

To learn more, check out our article, “How Much Does It Cost to Incorporate in Canada?”

Ongoing Costs

Another of the disadvantages of incorporating a business in Canada are the ongoing legal and accounting expenses.

As your own legal entity, you’ll need to keep your corporate minute book updated and file annual returns, which costs about $300-500 each year.

On the accounting front, your accountant will handle annual corporate income tax returns (T2) and GST/HST returns. Costs vary based on business activity, ranging from $500 to $2000 annually.

Increased Complexity

When your business income increases, incorporating in Canada demands more meticulous record-keeping with double-entry accounting to meet Canada Revenue Agency standards. This can be more time-consuming than managing a sole proprietorship, which only involves an income statement on your personal tax return.

With incorporation, you expand beyond the income statement. You must also provide a balance sheet, outlining your corporation’s assets, liabilities, and equity.

Although it might seem complex, managing a corporation is simple with proper planning and the right help. At DiMinno Rizzi Lawyers, we connect our clients to the right bookkeeping professionals, so you don’t have to worry about it!

May Be More Difficult to Use Losses

Incorporating a business in Canada provides limited liability protection, but it may not be the best tax move if the business is not turning a profit beyond your basic living needs. Unlike sole proprietorships where personal tax credits and losses can be claimed, corporate losses can’t be written off against personal income outside the corporation.

However, there’s a twist: A corporation facing losses this year can still benefit. It can use the ‘carry-back’ option to offset current losses against business profits from the past three years. Alternatively, it can carry these losses forward for up to twenty years, reducing future taxes until profitability returns.

Understanding these options is key to making the right financial choice for your business.

May Pay More Tax

In some cases, operating your business as a corporation can lead to higher tax payments compared to being a sole proprietorship. That’s why it’s crucial to seek advice from an accountant and incorporation lawyer. Their expertise can help you navigate complex tax situations effectively.

Examples of the Disadvantages of Incorporating a Business in Canada

Now that we’ve explored some key disadvantages of incorporating a business in Canada, let’s delve deeper by examining real-world examples we’ve encountered at DiMinno Rizzi Lawyers.

1. No Extra Income, Low-Risk Industry, and No Plans for Sale

Many entrepreneurs are the heart of their businesses, or they run what’s known as a “lifestyle business” that serves basic needs without generating substantial income.

Example

Let’s consider an example. Victoria contacted our office about incorporation. She is a retired seamstress who works from her living room. A few hours a week, she mends clothing for her neighbors, earning around $400 monthly to supplement her $2500 monthly pension income.

Incorporation does not make sense in Victoria’s situation. Why? First off, she is in a low-risk business. If she makes a mistake in her mending, the worst case situation is that her customer never uses her services again. No one is going to sue her for making a mistake!  She doesn’t have a brick and mortar location either, so there is no chance she’ll have to deal with a “slip and fall” lawsuit.

However, incorporation could still make sense if she is making surplus income above her living expenses. In that case, she would get taxed at the corporate rate of about 12% and then only pay income tax on any money she takes out of the company as a salary. But, this doesn’t work in Victoria’s case. She is only making $400 per month and most of it goes to her living expenses.

Finally, she is not building a business to eventually sell it. making the lifetime capital gains exemption irrelevant for her situation.

Victoria wouldn’t benefit from having the prestige that a corporation brings to the commercial marketplace. Her “market” is her neighbors, who could care less if she was incorporated.

Victoria doesn’t plan to “pass on” the business to her beneficiaries in her will, so succession planning or share transferring is not a concern.

In short, Victoria would not benefit whatsoever from incorporating her business. In fact, the yearly legal and accounting costs would eat up much of her yearly profit!

To learn more, check out our article, “At What Income Should I Incorporate in Canada?”

2. You Expect Losses for the First Years of the Business

Many businesses take time to succeed, often not turning a profit for several years.

In a sole proprietorship, these losses can be used to lower the owner’s personal taxes, offsetting them against other income. In contrast, with an incorporated business, losses can only offset income in that corporation only.

Example

Consider Greg, one of our long-time clients. He is an ambitious entrepreneur who worked on his tech start-up on evenings and weekends while working a demanding day job. For four years, he dedicated himself to building the intricate code necessary for his phone app, “WeRoach”. During this time, the business barely made any money. It had losses of 10k per year, which he offset against his software developer job income, to decrease his total personal income tax paid every year.

However, once the code was perfected, Greg secured his first client, bringing in $30,000 annually. Over time, his client base expanded, he quit his full-time job, and WeRoach’s income grew to $150,000 per year. It was at this point that Greg decided to incorporate his business.

To transition smoothly, we executed a “rollover” transaction, transferring the assets of his sole proprietorship to the corporation. While legal fees were involved, the income tax savings over the next decade were well worth the investment. Greg saved a substantial $175,000 in income taxes over the next five years.

As his corporation continued to thrive, a larger company noticed his success and expressed interest in acquiring his business. When the time came to sell the shares of his corporation, Greg reaped significant tax benefits. He saved a remarkable $400,000 in capital gains taxes. In total, his investment to incorporate ($2000) saved him $575,000 in taxes.

In Greg’s situation, it did not make sense to incorporate right from the beginning. He wasn’t making any money, so there were no tax advantages. Also, he was only coding, so not much legal liability either. When his business income increased to the point where incorporating made sense, he did so, saving income tax and capital gains tax when he finally exited the business.

3. Incorporating to Hold Real Estate

Our core clientele consists of real estate investors who frequently inquire about incorporating for rental property ownership. In many scenarios, our experience is that incorporating doesn’t yield tax advantages for rental income. This is usually because rental income within a corporation employing fewer than five full-time workers is categorized as specified investment income—a category taxed at a rate exceeding 50%.

You should speak to your accountant regarding this as every situation is different.

Nevertheless, there might be compelling reasons to consider incorporating your rental property. To learn more about incorporating to hold real estate, check out our article, “Should I Incorporate my Rental Property in Canada?”.

How an Incorporation Lawyer Can Help

When considering whether you should incorporate a business in Canada, a crucial first step is to speak to an incorporation lawyer.

At DiMinno Rizzi, our incorporation lawyers will work closely with you to ensure that your company is sailing in the right direction!

Frequently Asked Questions

Disclaimer: All number figures are approximate only and may be subject to change. Like all material on this website, this is not financial, legal, or tax advice. Contact a professional for your specific situation.