Running a business, regardless of its field, aims for one thing above all: profit optimization. To achieve this, the leaders in charge will develop customer acquisition strategies, expansion plans, and increasingly refined hiring methods. However, they will neglect the fundamental basis, which is tax optimization for the business.
What if we told you that incorporating your business as a corporation could help optimize your company's performance, save you taxes, and provide a complete company to your successors? In fact, too many entrepreneurs see incorporation as a mere formality with no real benefits, but JuriGo is here to set the record straight.
See all the tax benefits that incorporating your company with a lawyer can bring you and quickly find a professional through JuriGo!
Incorporation and the corporation: a preferred business structure!
Before extolling the tax benefits of the incorporated company, namely the corporation, it is important to understand the basics. Know from the outset that the corporation is a legal vehicle for operating a business among many others. In fact, Quebec law allows you to operate your commercial activities under any of the following forms.
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Individual enterprise
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General partnership (S.E.N.C.)
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Limited liability partnership (S.E.N.C.R.L.)
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Limited partnership (SEC)
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Joint venture
What makes the corporation (SPA) the ultimate legal structure? First, the fact that it has its own legal personality, which is distinct from its members. The SPA therefore contracts in its own name without engaging the responsibility of its directors. Other structures cannot boast of such a legal separation; entrepreneurs being one with the company.
This separate legal entity also results in a separate estate from that of the company! Thus, the debts of the company do not become those of the directors, and vice versa, which secures your personal interests as a director of the SPA.
Do other partnerships under the Civil Code benefit from the same advantages? Unfortunately not! The sole proprietorship and different partnerships do not have separate legal personality or estate; the entrepreneurs' liability is therefore unlimited! There is no need to draw you a picture, you understand that this is a risky business situation.
Now let's talk about the crux of incorporation, which is the tax advantages you can gain. Obviously, tax laws and rates are much more favorable to corporations than they are to unincorporated businesses.
See how incorporation could use tax laws to benefit your company and save you taxes!
The reduction of the tax rate, the first advantage of incorporating a business!
One of the primary advantages of incorporation is subjecting the corporation to a lower tax rate than individuals. Indeed, unlike individuals, incorporated companies are not subject to progressive tax tables, meaning that taxes do not increase for higher incomes.
In order to understand how corporate tax works in Quebec, it is important to understand that each level of government sets its own tax rate based on the current fiscal year, and that certain deductions can reduce the corporation's tax rate.
This is notably the case for the Québec Small Business Deduction (QSBD)* which allows a company to obtain a 7.5% (in 2021) reduction of its provincial tax rate if its paid-up capital in the previous fiscal year is less than 15 million.
To benefit from this deduction, the company must however be a Canadian-controlled private corporation (CCPC), meaning that it resides in Canada, is not controlled by non-residents, is not controlled by a foreign corporation or a public corporation.
As for the federal level, the net tax rate for corporations after the general reduction in tax is 15%. However, Canadian-controlled private corporations can apply for the Small Business Deduction (SBD)** to reduce their tax rate to 9%. It is therefore essential to verify your company's eligibility for this advantageous rate with a specialist.
Depending on the specific status of your company, here are the provincial and federal tax rates (including eligible deductions for small businesses that may apply):
| Tax rate applicable to DEP* (2021) | General tax rate (2021) | Tax rate without federal DAPE** | 26.5% |
|---|---|---|---|
| Provincial | 4% | 11.5% | 11.5% |
| Federal | 9% | 9% | 15% |
| Tax rate | 13% | 20.5% | 26.5% |
| 26.5% |
Why is it disadvantageous to operate a sole proprietorship from a tax perspective? Because any increase in profits will automatically translate into an increase in taxes to be paid. As a result, your hard work to grow the business will reward the government more than it should.
That's why incorporation becomes essential when the company's revenue grows.
Will incorporating your business allow you to income split?
Income splitting involves distributing dividends from the company to family members. This income splitting can only be done in favor of one's own family members and is generally done in the hope of saving on taxes. Is this really the case? It depends!
Since the tax reform in 2018, the benefits of income splitting have diminished. Indeed, it is now provided that dividends paid by a corporation during income splitting will be taxed at the highest tax rate. Obviously, the practice was discouraged at the time, but some exceptions remain interesting for owners of such corporations, namely:
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Dividend paid in exchange for reasonable work
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Dividend payment to spouse if owner is over 65 years old
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Family member works 20 hours or more per week for the company, all year long
However, it must be ensured that the splitting is done at an advantageous rate! The best way to ensure this is to speak to a competent tax specialist who will be able to analyze both your commercial and family affairs before proposing income splitting.
Capital gain exemption and incorporation: advantages in case of sale!
Transferring a business comes with a lot of considerations! The first one is to determine whether to sell the assets or shares of the company. Obviously, such a question arises only when the business is incorporated and, therefore, issues shares!
Through the mechanism of the capital gain exemption during the sale of shares, you will see that it is much more profitable for a seller to transfer an incorporated business than a sole proprietorship or partnership. You will definitely be tempted by incorporation, believe us!
In 2021, the cumulative capital gain exemption threshold (ECGC) is set at $892,218. What does this mean? That when transferring a business in the form of a share sale, you will not be taxed on the capital gain resulting from the sale up to this amount. This is therefore a way to keep a substantial portion of the capital gain out of the hands of the taxman.
In addition, the capital gain exemption is also cumulative! So you can reuse it. Indeed, as long as you have not used up your exemption limits, you will be able to reuse them in a future sale.
Which companies are eligible for the capital gain exemption? First, only corporations are eligible for the CGE, as mentioned earlier. However, the law provides other eligibility conditions, including the fact that the company is considered a small business and that more than 50% of the assets are used for the operation of a business located in Canada during the 2 years prior to the sale.
Is it possible to optimize or improve the operation of the capital gain exemption? Absolutely! It is possible to combine the mechanisms of the CGE, estate freezing and family trust in order to multiply the exemption rights among the members of your family during the transfer of the business. However, this is a complex tax process that requires the establishment of a trust, which is best left to a tax lawyer.
The eligibility of companies for capital gains exemption is a intricate and complex issue. It would therefore be appropriate to seek the expertise of a tax lawyer or a tax accountant to shed light on the subject!
Dividend tax credit vs. salary: which pays more tax?
Incorporating a company has the effect of creating shares, and where there are shares, there is also the generation of dividends. Thus, the shareholders of such a company face a dilemma, namely; should they pay themselves a salary or rather opt for remuneration in the form of dividends? The question arises, since the choice has a certain impact on the tax to be paid.
The payment of a salary has the main advantage of being deductible for the company, giving the shareholder/employee the opportunity to contribute to the QPP, QPIP and RRSP in order to deduct a certain amount from their taxable income. In addition, tax is withheld directly at source for the employee.
On the other hand, the payment of dividends involves a tax credit for the shareholder who receives them. This type of compensation has the advantage of simplicity compared to setting up a more complex payroll system, but the shareholder will have to manage their own taxes at the end of the fiscal year, since no withholding tax is applied. In the end, who pays more taxes between income in the form of salary or dividends? Except in specific and exceptional situations, the answer is that the tax bill will be the same! Indeed, under the tax integration principle, the government has ensured that the shareholder who works for the company does not escape taxes. Obviously, each company is a unique case, so consult a specialized lawyer who can evaluate in detail the advantages and disadvantages of each of these two options! Succession freezing and tax planning for a solid business succession!
For many entrepreneurs, the eventual transfer of their business to a successor is an integral part of their business plan. Succession freezing is an excellent way to plan for the transfer of the business while saving on taxes.
In concrete terms, succession freezing is a tax process that involves transferring the future capital gain of a company's shares to other individuals (often the children who inherit the business) so that this value accumulates in their hands, while the owner retains the current value of the company's shares.
The owner thus retains the value of their shares and control of their business, while deferring taxation on the capital gain until the actual transfer of the shares. In practice, the capital gain on the shares in question is usually transferred to a family trust holding the shares for the benefit of family members.
What are the advantages of estate freezing from a tax perspective? Tax savings! Since the owner transfers the future capital gain of their business in exchange for retaining only its current value, it stops appreciating in value.
As a result, if this same owner dies 10 years after the freeze and the shares were worth 1 million at the time of the freeze, they will still be worth the same amount, and it is on that value that taxes will be levied.
On the other hand, any capital gain accumulated between the freeze and the actual sale, in the hands of the family trust or direct beneficiaries, is not subject to taxation because the freeze transferred that same capital gain to new shareholders.
You now understand that estate freezing is an essential tax planning tool to take advantage of optimal business succession. However, its operation requires the exploitation of a corporation because the capital gain is transferred in the form of shares.
Interested in saving taxes to pass on a complete business to your loved ones? Consult a business lawyer who will incorporate your company to take advantage of all its tax benefits, including estate freezing!
Consult a JuriGo partner lawyer to benefit from the tax advantages of incorporation!
Are you tired of leaving a substantial portion of your profits to taxes when a simple solution could allow you to reinvest them in the business? In that case, you know what to do, find a business lawyer who will incorporate your company to take advantage of all the tax benefits that come with it.
It's much easier than you think to find a capable legal professional to incorporate you; simply fill out the form at the bottom of the page and JuriGo will quickly find a lawyer in your area.
This contact is not only free and without obligation, but it also allows you to find qualified lawyers! What are you waiting for to take the leap towards incorporation, contact us!