Incorporation Basics

What is Incorporation and Why do Businesses Incorporate?

What is Incorporation?

Incorporating a business means to form a separate legal entity, called a corporation, that can borrow money, enter into agreements, hire employees, pay taxes, be subject to lawsuits, and own assets that are distinct from its owners or shareholders. To incorporate a business, you must register the proper paperwork with your provincial or federal government.

Why do Businesses Incorporate?

Businesses incorporate to protect their shareholders. When a corporation is formed, the shareholders no longer become individually accountable for the corporation’s debt and obligations. In other words, creditors cannot seize a shareholder’s property if the corporation goes bankrupt. However, there is one exception. When a business does not have the assets to secure a loan and the shareholders provide a personal guarantee, they can become personally accountable for the corporation’s financial obligations.
The directors can also be liable for the corporation’s debts if they breach a fiduciary duty, such as not paying GST owed.

Types of Business Structures

Sole Proprietorship vs. Corporation
A sole proprietorship is a business run by one individual. The sole proprietor is the business owner. It differs from a corporation in that a sole proprietor is liable for his or her business debt. If the business encounters financial issues, creditors can turn to the business owner and the owner’s assets for restitution.
Simply put, the business is the individual. He or she may enter into legal agreements, manage finances under their name, as well as be personally liable for lawsuits.
Unlike a corporation, a sole proprietorship has no long-term existence and dissolves upon the death of its owner. Taxes for the business are recorded on the sole proprietor’s tax return and they may have difficulty securing funding because there is no equity to impart in exchange for capital.
Partnership vs. Corporation
A partnership is a business owned by two or more partners. There are three different types of partnerships:
In general partnerships, all partners are liable for the business’s debt and obligations unless a Partnership Agreement states otherwise. Furthermore, partners share equally in profit or according to their share of equity. They also make decisions, sign agreements, and conduct business as a team.
Limited partnerships are made up of general partners who have unlimited liability in the business and make all of the company’s day-to-day decisions, and one or more passive investors who fund the business but do not take an active role in running the business nor incur any liability for the company’s debt.
Limited liability partnerships are similar to general partnerships, but protect all of the partners from the negligence of their partners. This type of partnership prevents an individual from being sued as a result of their partner’s actions. However, they are still responsible for their own actions or negligence in the business.
Partnerships are not taxed on the company’s income, but each partner is taxed on their individual share of business profits. The losses are divided amongst the partners and applied to each partner’s individual income.
Unlike a corporation, a partnership may be dissolved if one or more partners decides to withdraw.
Most businesses begin as sole-proprietorships or partnerships, and eventually incorporate to protect the owners.

How Will Incorporation Affect My Taxes?

Corporations are taxed at two levels’initially on the corporation’s annual income, and at a subsequent level on the profits (dividends) shareholders receive from the corporation.
If you are the business owner, you would file both a corporate tax return, as well as a personal one.
Generally, corporate tax rates are lower than individual tax rates. Corporations may also be eligible for tax savings (deductions).
At the end of each fiscal tax year, a corporation files a T2 tax return, complete with all financial statements, regardless if there is no tax payable.
Corporations should always consult with their tax professional before filing their annual return to ensure they are following the proper federal income tax procedures.
Visit the Canada Revenue Agency for more information about corporate taxation.

Named and Numbered Corporations

Named Corporation: A named corporation is one where the company’s chosen business name is provided by the incorporator. It should consist of three parts: a distinctive part, a descriptive part, and a corporate suffix (e.g. Layder Bookkeeping Inc.).
Before a named business can incorporate, the proposed name must be searched using a NUANS or provincial corporate name search (depending on the province) to confirm the name is unique and no other business is currently registered under that title.
Numbered Corporation: A numbered corporation is a business that is assigned a number as a corporate name (e.g. 232323 Canada Inc.).
It is quicker and easier to incorporate as a numbered corporation. One can always later switch to a named corporation for a small fee by amending its articles. Depending on the nature of your business and where physical assets are located, you may need to register extra-provincially.

Public and Private Corporations

Public Corporation: A publicly held company has shares which can be bought and sold on a stock exchange. Typically, a public company is run by a board of directors who are expected to be transparent in their operations by disclosing financial information, such as annual reports, to their public shareholders.
Private Corporation: A privately held company is owned by a small number of shareholders. Shares in a privately held company are not available for public purchase. There must be a minimum of one shareholder in a private corporation, but should be no more than 50 shareholders total.
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