Incorporation is maintaining or increasing its tax edge over other business structures. The benefits go beyond simple differences in tax rates.
Both federal and provincial governments (depending on the province) have announced reductions in corporate income tax rates over the next couple years to improve productivity of Canadian businesses.
Although personal income tax rates declined in the early 2000s, there remains a real tax advantage to operating a business as an incorporated enterprise.
This is particularly true if your business qualifies for the small business tax rate, which is substantially lower than the personal income tax rate that applies to income from sole proprietorships or partnerships.
But clearly, incorporation isn’t for everyone. The acid test relates to how much of your annual farm or business income is required to meet your basic needs compared with the portion that can be left in the company.
Once funds are paid out as salaries by a corporation, the benefit of low corporate income tax rates disappears.
If virtually all profits of the business are needed to meet your basic living expenses, incorporation is generally not a good idea from a tax perspective. If only a portion of those profits are required to fund personal cash flow, however, a corporate structure provides a useful vehicle for reinvesting surplus profits in the business.
Taxes on such reinvested profits are effectively deferred (in some cases almost indefinitely) while you use the funds to expand or increase the value of your operation. You might, for example, add land and buildings to raise your business’s efficiency and productivity.
Other potential advantages of incorporation include:
- Limited liability
By separating corporate assets, you help to creditor-proof your personal assets. If the business fails, creditors generally cannot attach personal assets. Increasingly, however, financial institutions are seeking some additional security in the form of personal assets to secure business loans. In such cases, these personal assets can be attached by creditors.
- Fiscal year flexibility
Incorporated businesses can choose a true non-calendar fiscal year for income tax reporting while unincorporated businesses cannot. This is particularly useful if you want a fiscal year more closely matched to your farm’s business cycles.
- Group insurance and retirement benefits
Corporations are entitled to create a registered pension plan and obtain tax-deductible group health and life insurance plans for their employees and family members. (Under certain conditions, non-corporate businesses may also deduct group health insurance premiums.)
- Income splitting flexibility
If your spouse or children are involved in the farming operation as employees, shareholders and/or directors, funds can be distributed to them in a number of ways including:- Salaries, which are considered a corporate expense and therefore deductible by the corporation. A company issuing salaries must also collect, at source, income tax, Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums for the government.
- Consulting fees, which are also considered a corporate expense that serves to reduce taxable income. Such fees do not require withholding of income tax, CPP or EI, but they are taxable for GST.
- Dividends, which the corporation cannot deduct, but which are treated more favorably in the hands of shareholders since they qualify for dividend tax credits.
- Directors’ fees, which are treated much like salaries. If your spouse or children aren’t physically active in the operation of the farm, reasonable fees may be paid to them as directors of the farm corporation.
- Additional means of compensation
Business may also take money out of the corporation in the form of:- Rent for assets like land or equipment owned personally rather than by the corporation.
- Repayment of loans for assets such as cash, equipment, land or buildings that a shareholder originally transferred to the corporation.
- Retiring allowances, in the form of one-time payments made to employees (including shareholder employees) leaving the corporation. A portion of a retiring allowance may be rolled over pre-tax to an RRSP based on the number of years the individual was employed by the corporation prior to 1996.
- Capital dividends when corporations realize a capital gain from sale of assets. In this situation 50% of the total capital gain may be distributed to shareholders tax-free.
Most small business corporations in Canada, including farm operations, get a tax break on at least the first $200,000 of active business net income.
| Highest | Corporate | Rates | |||
|---|---|---|---|---|---|
| Highest Personal Tax Rates 2012 % | General % | Manufacturing & Processing % | Small Business (under $500,000 net income) % | ||
| British Columbia | 43.70 | 25.00 | 25.00 | 13.50 | |
| Alberta | 39.00 | 25.00 | 25.00 | 14.00 | |
| Saskatchewan | 44.00 | 27.00 | 27.00 | 13.00 | |
| Manitoba | 46.40 | 27.00 | 27.00 | 11.00 | |
| Ontario | 47.97 | 26.50 | 25.00 | 15.50 | |
| Quebec | 48.22 | 26.90 | 26.90 | 19.00 | |
| New Brunswick | 43.30 | 25.00 | 25.00 | 15.50 | |
| Nova Scotia | 50.00 | 31.00 |
|
15.00 | |
| Prince Edward Island | 47.37 | 31.00 | 31.00 | 12.00 | |
| Newfoundland | 42.30 | 29.00 | 20.00 | 15.00 | |
| Yukon | 42.40 | 30.00 | 17.50 | 15.00 | |
| Nunavut | 40.50 | 27.00 | 27.00 | 15.00 | |
| NWT | 43.05 | 26.50 | 26.50 | 15.00 |
As you can see from the chart, the owners of small businesses can shave from about 20 to 30% off their tax bills if they incorporate. A farm that generates $500,000 of net income a year could save as much as $150,000 by incorporating.
The advantage varies from province to province. The difference is smallest in Alberta, but in making tax comparisons you have to look at the whole picture.
Alberta is an extremely attractive province for operating a small business because of its relatively low personal and corporate tax rates, zero corporate capital tax and zero sales tax.
Incorporation looks pretty attractive but there is a downside. The accounting and legal work is more detailed and therefore more costly. Regular tax filings must be made for the corporation, as well as the individual owners, and the level of government scrutiny and regulatory compliance increases substantially.
This said, however, the ability to build future net worth by reinvesting before-tax dollars in your own corporation is very appealing indeed.