Have you ever wondered if you should take the leap and incorporate a business in Canada? Picture this: You’ve created a business name, but you’re at a crossroads. You’ve heard stories of small businesses thriving, while others struggle to stay afloat.
Well, here’s a startling fact to kickstart our discussion: 50% of small businesses in Canada do not survive past their fifth year.
Now, imagine if there was a way to not only increase your chances of success but also safeguard your personal assets in the process. That’s the power of incorporating a business in Canada. Now, let’s dissect the pros and cons and equip you with the knowledge to make an informed decision on whether you should incorporate a business in Canada.
Initially, as a sole proprietor, you run a small business name as an individual, with simple operations but high personal liability. A corporation, on the other hand, is a separate legal entity from you, even if you are the only one who owns and runs the small business.
Incorporating a business in Canada has many pros vs cons. It provides limited liability, business name protection, saves income tax, makes it easier to raise capital, gives a greater professional image, and better succession planning & ownership structuring. It is a superior business structure to a sole proprietorship.
However, incorporating a business in Canada has its cons, including initial setup and ongoing costs, business name costs, increased administration and legal requirements and, in some cases, higher taxes.
Generally, incorporating may be a good idea where: 1. there is a concern about liability in your business/industry; 2. your small business earns an excess of what you personally spend every year; or 3. You intend to build the small business name and sell it in the future by transferring shares for a profit.
Generally, incorporating a business in Canada may not be a good idea where: 1. the risk of you being sued is very low in your industry or profession; 2. you expect the business to lose money, at least in the short term; and 3. there is little surplus from business earnings after you deduct your personal living expenses;
If you own a rental property or portfolio of properties, incorporating a business in Canada may not provide tax advantages unless you hire more than 5 full time employees working for you.
A business lawyer can help you weigh the pros and cons of incorporating a business in Canada. You should always retain a lawyer to incorporate a business in Canada. No exceptions!
When you start a small business, you naturally fall into the category of a sole proprietorship.
A sole proprietorship is when one person operates a small business name without forming a separate legal entity. It’s the simplest way to run a small business, but the owner is personally responsible for all business debts and legal obligations. The owner reports business income and expenses on their personal income tax return.
A sole proprietorship is the simplest form of small business, but, in our experience, the most risky. If the business faces financial trouble or legal issues, the owner’s personal assets, like their home and savings, are at risk.
In contrast, a corporation is a separate legal entity. Your small business has its own identity, business name, assets and liabilities, apart from you.
Incorporating a business in Canada may sound complex, but it’s crucial to grasp. So, let’s break it down in simple terms.
When you incorporate a business in Canada, your business becomes a separate legal entity. It’s like giving your small business has its own legal personality and business name. Your business has its own business name, legal name, can own property, sign contracts, and engage in legal matters independently.
Because your business name is a separate legal entity, it provides a shield for your personal finances. If your small business encounters financial or legal troubles, your personal assets are generally protected.
However, it’s important to note that even with incorporation, there are situations where you, as a director, can still be personally liable. These include:
When you sign personal guarantees for your business
Unpaid employee wages and vacation pay
Employee deductions and remittances, such as income taxes, EI, and CPP contributions
Outstanding GST/HST collections that haven’t been remitted
Environmental contamination issues
Violating the articles of incorporation
Fraudulent activities
So, while there are many pros to incorporation, there are limits to being a separate legal entity.
As noted above, the most powerful benefit of incorporating a business in Canada is that it shields your personal assets. But what does that really mean? Let’s dive in with two real-world examples:
Example 1: The Restaurant Tragedy
Here is a situation we witnessed in at our law firm. Unfortunately, the client came to us too late and there was nothing we could do.
Maria used to be the proud owner of an Italian restaurant. She put her heart and soul into her eatery.
Then, one day, something went wrong. A customer got sick because an employee accidentally mixed up the ingredients in a dish. The customer was celiac and ordered a vegetarian dish, but there was gluten in the dish from utensils and in the base sauce.
The customer sued Maria and her restaurant. It turned out Maria was at fault, and things took a terrible turn. Her restaurant didn’t have much money, but she had something precious – her house. She had worked hard for 25 years to pay it off back when she was just an employee before starting her own small business name.
But here’s the sad part: Maria had to sell her house to pay all of her legal fees and the court-ordered award, which together almost equaled the market value of the house. It was a place filled with memories, and she had planned to retire there. Now, she had to rent a place to live during her retirement. She fell into depression and was never the same.
Had Maria’s restaurant been incorporated, things would have been totally different. The restaurant only had about $5000.00 in assets. These assets were the kitchen appliances, equipment, furniture, and décor. Her house would have been protected and she would have been able to start again.
Example 2: The Machinist
Here is another real-life example we observed in our law practice.
John owned a machinist factory. He ran the show all by himself, proud of his small business, with 4 apprentice machinists. One day, he thought about incorporating his factory to protect his personal assets, but he hesitated. He was a frugal man, and the idea of paying $1500 to a lawyer didn’t sit well with him. “What am I paying insurance for?” he wondered. So, he put it off.
Then, a fateful day arrived. A supplier came to his factory and was seriously hurt on the premises by a piece of shrapnel from an unmanned machine. John promptly turned to his insurance company, believing they’d cover the costs.
However, trouble brewed when the insurance company denied his claim. Why? John had accidentally left out a crucial detail in his policy application.
The injured supplier, faced with mounting medical bills and lost wages, sued John. Legal battles drained John’s savings. In the end, they settled on a payment of $400,000 for bodily injury and loss of wages. To cover this staggering sum, John had no choice but to place a second mortgage on his house. His wife had always been annoyed by his frugality, but this was the last straw for her. The couple divorced and John took 15 years to recover his losses.
Had John incorporated a business in Canada, his losses would have been limited. His personal assets would have been protected.
Lesson: Spend a Little Now, Save a Lot Later
In our experience, situations like these are not uncommon. Even where the entrepreneur is not at fault, lawsuits can be extremely expensive. These massive legal debts can destroy an entrepreneur’s financial future and, in turn, harm every other aspect of an entrepreneur’s life, including their mental health, family, and relationships.
Incorporation is a small price for peace of mind. We’re here to help.
After limited liability, in our opinion, the next largest benefit of incorporating a business in Canada are the tax advantages. These advantages include:
A Lower Income Tax Rate
We often compare the pros and cons of filing articles of incorporation. As a sole proprietorship, you pay personal income tax on your small business income. This small business income is taxed directly in the sole proprietorship’s hands, and can be as high as 54.80% for income over $220,000. In contrast, if you incorporate a business in Canada, it pays 9-13% on the first $500,000 depending on the province and about 26.5% on earnings above $500,000. This massive tax savings gives you more money to reinvest into growing your small business. It also allows you to save big on income taxes by running all your business ventures through corporations.
Tax Deferral
After filing your articles of incorporation, you only pay personal income tax on small business income that is drawn out of the corporation as a salary. This means that you can defer paying income taxes at a higher marginal rate by leaving most of your earnings in the corporation.
To demonstrate the tax deferral benefits of incorporating a business in Canada, let’s look at an example from one of our clients who recently incorporated.
Would Giulia benefit from incorporating?
Giulia is a long-time client who runs a digital marketing business in Ontario. She recently decided to incorporate a business in Canada using our firm.
As a sole proprietorship, she made about $200,000 a year of revenue. She had about $25,000 in yearly business expenses. Giulia is single and has no other sources of income besides her income earned as a salesperson. Her yearly personal living expenses (e.g. rent, food, travel, etc.) are about $50,000 per year.
Here is the breakdown comparing her two options:
SELF-EMPLOYED REALTOR (SOLE PROPRIETOR)
PREC
PERSONAL INCOME
CORPORATE INCOME
Annual Income from Self Employment
$200,000
Annual PREC Income
$200,000
Operating Expenses
-$25,000
Operating Expenses
-$25,000
Taxable Personal Income
$175,000
Taxable PREC Income
$175,000
Personal Tax Payable on Taxable Income (Marginal Rate 49.29%)
-$57,166
Corporate Tax Payable on Gross Income (Marginal Rate 12.5%)
-$21,875
Net Income
$117,834
Net PREC Income
$153,125
Living Expenses
-$50,000
Living Expenses
-$50,000
Personal Income Tax Paid to Withdraw from PREC
-$11,000
After-Tax Cash Available for Investment
$67,834
After-Tax Corporate Cash Available for Investment
$92,125
+$24,291.00
The examples provided above are generic in nature and tax rates are approximate as of the writing of this guide. Tax results will vary widely based on individual circumstances. Obtain professional tax and legal advice prior to incorporating a business in Canada.
If Giulia files articles of incorporation for her business, she will have $24,291.00 more cash available in her small business to reinvest, or withdraw in a lower income tax year. The savings of $24,291.00 in the first year of having a corporation pays for the initial incorporation fee ten times over! Even better, Giulia will be able to enjoy these savings each and every year afterwards!
A lower corporate income tax rate allows you to grow your small business far quicker than you could otherwise.
Since you only pay personal income tax on small business income that is drawn out of the corporation as a salary, you can defer paying income taxes at a higher marginal rate by leaving a portion of your small business income in the corporation. This will leave you with a greater amount of after-tax dollars to invest in your business, pay for expenses, and expand.
For example, as a sole proprietorship, every $100 earned would leave you with only $47 left to invest – in fact, it would be even less than $47 after deducting CPP and EI contributions. The other $53 goes to the government immediately with no ability to defer tax.
On the other hand, for every $100 earned by your corporation, you will have about $88 remaining to invest in your business. This $88 can then be deployed to invest in the small business to further increase your income! You could:
hire employees or contractors to free up your time to get new customers
invest the funds into new marketing strategies or into education and training
hire another salesperson, who could generate passive income for you through his/her commissions
The list goes on and on.
The best part: having all that capital to reinvest in your small business means that you will likely make even more income each successive year. That income will be taxed at a lower rate too, before being invested again, and so on.
The savings you get by being incorporated can quickly snowball into a money-making machine!
Lifetime Capital Gains Exemption
If you build a small business name with tangible value, you can sell that business with a significant tax break. Corporations have access to a lifetime capital gains exemption which allows them to shelter over $883,384 from capital gains tax on the sale of the corporation’s shares. You don’t get this tax break if you’re a sole proprietorship. This tax protection is also available to your estate when transferring shares at death.
Income Splitting
Another tremendous benefit of incorporating a business in Canada is the ability for you to, under certain circumstances, split your income with family members in lower income tax brackets. Paying dividends to family members provides you with the flexibility to lower your combined tax burden with your family and the corporation.
In recent years, the CRA has restricted income splitting, so it is important that you get legal advice before implementing this strategy.
A sole proprietorship is required to remit Canada Pension Plan (CPP) contributions. You will not receive these amounts until you retire many years from now. However, when you incorporate a business in Canada, you can choose to avoid the delay. With a corporation, you may pay yourself in salary or dividends. If you pay yourself a salary, you will have to remit CPP. But, if you pay yourself a dividend, CPP contributions are not required, allowing you to have that excess cash to invest back into your small business or other investments.
Another advantage of incorporating a business in Canada is that you can compensate employees through your business structure, in the form of employee share ownership plans or employee stock options. As an entrepreneur, you can choose to incentivize your team by granting them ownership in your business, without losing control of the decision-making process. This method ties their rewards to your business’s success. When your business prospers and earnings rise, so does the financial gain of your staff. In our observations, our clients who provide ownership options to their employees see a noticeable increase in their employees’ productivity and loyalty.
Tax Deductions
When you incorporate a business in Canada, you gain access to additional tax deductions than you would have otherwise.
One such deduction is the Health Spending Account (HSA). HSAs allow a corporation to be reimbursed medical expenses that are personally incurred without the withdrawals being treated as taxable income.
Another deduction is for corporate paid retirement counselling. Normally, when an employer provides services such as financial planning or income tax preparation to its employees, this is considered a taxable benefit to the employee. Thus, the employee must pay tax on the service or “perk” as if it was regular income. However, after you file articles of incorporation, you may receive retirement & financial counselling without having to pay tax on the service.
Insurance Plans
When you incorporate a business sin Canada, you have more access to tax saving opportunities through insurance policies. Speak to your accountant and insurance broker about this for more details.
When you incorporate a business in Canada, it is much easier to raise capital and obtain grants. Your small business appears more credible with lending institutions and the whole process of arranging business financing is much smoother.
If you are planning raise capital for your small business, venture capital firms and investors prefer business names they can buy shares in, so they often avoid sole proprietorships.
Furthermore, the Canadian government provides exclusive loan and grant programs that only incorporated businesses have access to. “The Canadian government offers a number of loan and grant programs that are open only to incorporated businesses,” says Yasmine Chaouni, a manager with Corporations Canada, Canada’s federal corporate registry.
Filing articles of incorporation sends a clear message to your potential investors, lenders, suppliers, customers and employees: that your small business means business! Incorporating a business in Canada greatly improves your professional image. You will have a unique business name. Based on our experience, this is very important when you’re trying to raise capital, land a potential big client, or sell your business to someone else down the road.
Succession planning is crucial, and here’s where this business structure shines. Because a corporation is a separate legal entity under Canadian law, it exists even if its owner passes away. Sole proprietorships and partnerships vanish with their owners. Incorporation makes transferring shares transfers easy, whether they are common shares or preferred shares. Incorporating a business in Canada allows for a future that extends beyond your lifetime – perhaps one that you will want to pass on to your children.
When you incorporate a business in Canada, you don’t directly own the business’s assets. Instead, you own shares in the corporation, and the corporation owns the assets.
Where there are multiple parties that contribute to building a business (i.e. business partners), a sole proprietorship doesn’t work well. How do you know who owns what?
In contrast, when you file articles of incorporation and issue shares, all the parties will know exactly what their ownership interest are. They may also delineate their rights/responsibilities related to the company via a Unanimous Shareholders Agreement. The parties may own common shares or preferred shares, or a combination of both, in a federal corporation or provincial corporation.
In our experience, incorporating a business in Canada is usually the right move for a business. However, there are always pros and cons to any legal structure. There are some disadvantages of filing articles of incorporation that all entrepreneurs should be aware of. Let’s examine the disadvantages of incorporating a business in Canada in more detail.
You should obtain legal advice from an incorporation lawyer and an accountant when filing articles of incorporation. Your incorporation lawyer will guide you through the decision making process and will help you properly incorporate, ensuring you have a properly formed legal entity. This means deciding between whether to incorporate federally or incorporate provincially, filing articles of incorporation, obtaining a legal name, business name, issuing shares, and drafting the initial corporate resolutions.
Your business lawyer will also work with your accountant to maximize your income tax advantages by setting up the right business structure and share classes. If there are multiple partners in your small business, a business lawyer will help you set up a shareholders agreement, which will detail each owner’s rights and responsibilities and what happens if there is ever a disagreement. Your lawyer will also discuss preferred shares and commons shares options (see below).
There are also government filing fees when incorporating, which depend on whether you incorporate federally or incorporate provincially.
So, in total, expect to spend about $1500-3000 in fees to incorporate a business in Canada, depending on complexity.
You also need to consider ongoing legal and accounting costs for legal requirements.
On the legal side, one must maintain legal requirements by keeping the company’s Minute Book up to date and filing an annual return with Corporations Canada. Expect to spend $300-500 on this per year, depending on whether you incorporate provincially or incorporate federally. This involves drafting corporate resolutions and keeping them up to date.
On the accounting side, your accountant must file an annual corporate income tax return (T2) and GST/HST returns with the Canada Revenue Agency (CRA). These fees can range from $500-2500 per year depending on how active the business is and whether you incorporate provincially or incorporate federally. They are legal requirements and must be kept up to date.
Incorporating a business in Canada involves thorough accounting and record-keeping of important information to meet the CRA’s standards. This can be more time-consuming compared to running a sole proprietorship, which only requires an income tax statement on your personal tax return.
After you file articles of incorporation, you go beyond the income tax statement. You also need to submit a balance sheet detailing your corporation’s assets, liabilities, and equity.
While it sounds complex, managing a corporation is simple with proper legal advice and help from professionals. Seek legal advice to understand the process fully. This ensures you’re well-prepared for success and keeps your small business running smoothly.
When a small business isn’t turning a profit, filing articles of incorporation might not be the best tax move. Unlike sole proprietorships, losses incurred in a corporation can’t be used to lower the owner’s personal income. These losses stay within the small business, “trapped” until profitability returns.
But here’s the twist: A corporation facing losses in the current fiscal year can still benefit. It can use the ‘carry-back’ option to offset present losses against profits from the past three years. Alternatively, it can carry forward these losses for up to twenty years, reducing taxes on future earnings until profitability is restored. Understanding these options is key to making the right financial choice for your business.
In certain situations, running your small business as a corporation may result in higher income tax payments compared to operating as a proprietorship or other legal entity. This is why it is important to consult an accountant and obtain legal advice before filing articles of incorporation.
After carefully weighing the pros and cons of formalizing your business structure, you may still find yourself pondering the question of whether or not to proceed with filing articles of incorporation.
To shed light on this matter, let’s look at a few examples from our observations at DiMinno Rizzi Lawyers.
Note: All examples and figures are a general guide only. Always obtain legal advice for your specific circumstances.
“If you are in a type of business where there is a reasonable chance, even a possible chance, of getting sued, you should incorporate.”
– Antonio DiMinno, Business Lawyer
One of the main reasons our clients incorporate their small businesses in Canada is for liability protection. If creditors pursue your small business, incorporation can protect your personal assets. Essentially, this means that only the assets owned by the business are at risk. This applies whether you have a federal corporation or provincial corporation.
If you are in a type of small business where there is a reasonable chance, even a possible chance, of getting sued, you should file articles of incorporation. This is where speaking with a business lawyer is beneficial.
For example, if you run an online arts and crafts store, your risk of being sued is probably pretty low. However, if you run a construction business, where people are physically active and operating in dangerous environments, filing articles of incorporation is recommended.
However, even if you are in a low liability business, it could be that you should incorporate a business in Canada to save on income taxes.
If you are starting a small business name with the intention of growing it to the point where you can sell it, then you should probably incorporate a business in Canada. Filing articles of incorporation now will mean you save a ton of taxes later because your shares will be shielded by the lifetime capital gains tax exemption.
As we discussed, when your small business generates more income than what you require for personal expenses, you have the option to retain the surplus funds within the company. This approach allows you to be subject to the lower corporate tax rate rather than higher personal income tax rates.
The additional tax liability is postponed until such time as it is distributed to shareholders, typically in the form of salaries or dividends. You can defer taxes this way whether you incorporate provincially or incorporate federally.
For many entrepreneurs, their small business is a “lifestyle business” that supports some basic needs and/or is not a considerable source of income. They don’t intend to sell it; there isn’t a lot of legal liability; and the small business does not make a surplus income that they can afford to leave in the company.
For example, a client of ours named Victoria asked us whether it was a good idea to file articles of incorporation. She is a retired seamstress who works in her living room. A few hours a week, she repairs and mends articles of clothing from various people in the neighborhood. She does this to stay busy and supplement her pension plan income of $3000 per month, and makes about $400 per month.
In this example, after learning about Victoria’s personal finances and speaking to her accountant, we discouraged Victoria from filing articles of incorporation because:
She is in a very low risk industry – no one is going to sue her for doing a bad job!
She is NOT building a business to sell.
She is NOT making enough money to obtain any tax advantages from incorporating.
Many small businesses require some time to become successful. It’s quite normal for some types of small businesses to break even or have losses for their first few years.
If these losses happen in a sole proprietorship, you could offset those losses against your personal income, reducing your total income tax. On the other hand, if the business is incorporated, these losses can only be applied against future corporate income from that business, and not income from other businesses.
If we assume that these losses can be used to reduce the owner’s personal income taxes, then the advantage lies with the sole proprietorship. The business could later be turned into a federal corporation or provincial corporation once it begins to make a profit, especially if there are other compelling reasons for doing so.
Real estate investors are the core of our client base, and they often ask us whether they should incorporate a business in Canada to hold rental properties.
In many cases, corporations do not provide a tax advantage for rental income. This is because, if the corporation employs less than five full time employees, the rental income is taxed as investment income. Investment income is taxed at a rate of over 50%! So you would need to hire employees to make this work!
To ensure full rights under Canadian corporate law, use a lawyer to incorporate a business in Canada. Despite their claims, online incorporation companies cover only about 10% of the process, putting your legal protection and tax benefits at risk.
It is technically possible to incorporate a business in Canada on your own, but we strongly recommend against it. In our experience, “DIY” corporations are usually incomplete or full of errors that threaten legal liability protection and tax advantages.
How much does a lawyer charge to incorporate a business in Canada?
Depending on the jurisdiction and complexity, incorporating in Canada costs $1500-2500 CAD +HST, covering government and legal fees. Not hiring a lawyer initially can lead to higher costs later to fix errors.
What is needed to incorporate a business in Canada?
To incorporate in Canada, you need a unique business name, at least one Canadian resident director, a registered office address, articles of incorporation, and a minute book with bylaws, resolutions, and issued shares. A NUANS report is required for business name registration. Learn more about incorporation requirements.
When should I incorporate a business in Canada?
The decision to incorporate depends on factors like business age, earnings, and personal finances. Incorporation is often beneficial if there’s liability concern, excess earnings, or future sale plans. It may not be ideal if the risk of being sued is low, you expect losses, or if earnings are minimal after expenses.
Is incorporating worth it in Canada?
Incorporating in Canada offers tax savings, limited liability, income splitting, capital gains exemptions, estate planning, and professional stature. However, it depends on your business’s size and goals. Weigh the pros and cons, as setup and management costs can be high. Consult a business lawyer for advice.
Is it better to incorporate or sole proprietor in Canada?
In Canada, choose a sole proprietorship for simplicity, direct control, and lower costs, ideal for small businesses with low risk. Opt for incorporation for limited liability, tax advantages, and enhanced credibility, suitable for higher income, higher risk, and growth-oriented businesses.
What are the steps to incorporate a business in Canada?
1. Hire a lawyer 2. Choose federal or provincial 3. Check business name availability 4. Determine share structure 5. Decide on shareholders, directors, officers, and address 6. File articles of incorporation and get a certificate of incorporation 7. Create a minute book 8. Sign documents and issue shares 9. File initial return
Should I incorporate my business provincially or federally?
Choose federal incorporation for Canada-wide business name protection, flexible office location, and international prestige. It requires 25% Canadian directors and takes longer. Provincial incorporation is faster, cheaper, and suits local operations but needs extra-provincial licenses for wider business.
Should I incorporate a named corporation or a numbered corporation?
Opt for a named corporation if brand identity is vital for your business, as it allows a unique business name. Choose a numbered corporation for a quicker, often cheaper process, if the business name is not a priority.
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.
About the Author Email: antonio@drlawyers.ca Phone: (647)-205-9128
Antonio DiMinno isa business & real estate lawyer, entrepreneur, and founder of the law firm, DiMinno Rizzi Lawyers. Antonio takes pride in working differently than most law firms. He doesn’t see himself as just a lawyer, but rather a trusted business and legal advisor in your corner. His focus is helping entrepreneurs and real estate investors through practical, business-savvy, and cost-effective solutions delivered in plain English.
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.
About the Author Email: antonio@drlawyers.ca Phone: (647)-205-9128
Antonio DiMinno isa business & real estate lawyer, entrepreneur, and founder of the law firm, DiMinno Rizzi Lawyers. Antonio takes pride in working differently than most law firms. He doesn’t see himself as just a lawyer, but rather a trusted business and legal advisor in your corner. His focus is helping entrepreneurs and real estate investors through practical, business-savvy, and cost-effective solutions delivered in plain English.
