- Business Structure for Wealth Accumulation
“The Canadian Taxation System is setup to Benefit the Small Business Owner”
Structurally most businesses will incorporate as they grow, especially if they have an opportunity to defer tax versus the Partnership and/or Sole Proprietorship business models.
Corporation Setup and Overview
A Canadian Controlled Private Corporation (CCPC) is the term used to denote a business that incorporates. It is a Canadian owned entity that has its own ‘identity’ separate from the individuals or business shareholders. This ‘identity’ provides a CCPC with a legal status such that the shareholders are not liable for the CCPC’s actions (generally). Thus if the CCPC is sued, the shareholders assets are not at risk (generally). Incorporation can occur at either the Federal or Provincial level and the associated laws must be followed.
A general rule of thumb is that if your business grosses over $100,000 per year, or perhaps your business revenue surpasses the Maximum Pensionable Salary limit (MPS) of approximately $145,000 in 2016, then you should incorporate. Especially if you have a track record of profitability and don’t need all of the business income to provide for basic lifestyle expenses. The costs for incorporation, and the annual tax filings, are about $2000 each, this generally creates this minimum income boundary. Of course every business owner, and every business, is different so please consult your tax accountant to ensure the time is right for you to incorporate.
If you do incorporate, you don’t have more write-off’s per se, but you are allowed to deduct all bona fide and reasonable expenses and costs to operate your business. Car Allowances and Home Office expenses can be included in these deductions as well. From a tax standpoint, all monies taken out of the business, dividends or salary, will be subject to equalized taxes (the concept of ‘Integration’ in the Canadian Tax System), but the monies left in the incorporated business will be taxed at approximately 15% on the first $500,000 of income. Beyond the $500,000 threshold, income is taxed at 26.5% (variable per province).
Now that the business is a corporation, no longer a sole proprietorship or a partnership, the business owner(s) move from being self-employed to that of being shareholders and directors of the corporation. If they take a salary they are deemed to be an employee. Employment Insurance (EI) is not payable on salaries of majority shareholders or spouses. And the Health Tax (varies by province) has certain exclusions as well. Your Tax Accountant will be able to help you verify your status through the CRA regulations.
Incorporation involves administration and paperwork: choosing voting and non-voting shareholders (spouse, family members, and possibly family trusts), annual fees, appropriate permits, separate bank accounts, annual filings and choosing a year-end date (if allowed). The year-end date is key as the personal income tax return and ‘bonus’ dates may allow cash flow and tax deferral to a more favorable period (depending upon the bonus date). It is noteworthy to mention that ‘connected’ individuals, those that own 10% or more of any voting share calls of the corporation, are eligible for Individual Pension Plans (IPPs). See your Lawyer to setup your Corporation properly based on current and future family environments. Your Lawyer will also tell you to operate your business entirely through the OpCo so that you don’t run afoul of the CRA’s ‘Agency’ definition; an ‘Agent’ is taxed personally as opposed to through the OpCo.
Cash flow and Payment of tax is also a consideration for Corporations. The first year of tax for a Corporation can be deferred (unlike sole proprietorships and partnerships), but starting in the second year, the tax installments must be made monthly (vs. quarterly for sole proprietorships and partnerships).
The keys to setting up your business are to get it going, to a sustainable base level of revenue/income, ensure you are profitable and can leave cash in the business, and then incorporate. Incorporation allows:
- cash preservation through lower Small Business Deduction (SBD) tax rates,
- creditor protection,
- remuneration strategies that involve salary, dividends,
- income splitting, as well as
- Capital Gains exemptions at time of sale.
Ensure flexibility in the setup of the Operating Corporation (OpCo) so that you can account for 1. Can’t Fund, 2. Death, and 3. Family Dissolution. And this ranges from the ability to pay dividends whenever and to whomever, cancel shares and also setting up multiple share classes.
At setup, if applicable, transferring assets to the CCPC will require professional help.
Tax laws may change, but the economic stimulus derived from the entrepreneurial zeal of fellow Canadians has tremendous appeal to the Federal Government. In fact, there are still outstanding changes that may in fact lower the Small Business tax rate. Stay tuned.
Holding Company — HoldCo
Incorporated businesses also provide a form of financial creditor protection as the corporation is a legal entity and liability is transferred to the corporation. Your accountant will know if you should further protect yourself by creating a Holding Company (HoldCo) for your operating company (OpCo), but in general separate business practice insurance is required.
There are restrictions on who is allowed to setup HoldCo’s but they provide for a further level of protection and the opportunity to deploy different remuneration strategies. For example, you and your spouse could 50%/50% own the OpCo, or it could be 90%/10% ownership of the OpCo, or possibly you could own 100% of the OpCo, but pay dividends to the HoldCo (where remuneration takes place). Income splitting, allowable for Corporations, can occur via salary or dividends within the HoldCo or OpCo. And if, or when, the OpCo is sold it would also qualify for the Capital Gains Exemption (about $824,000 in 2016).
Investment Holding Companies
Investment Holding Companies (InvHoldCo’s) are not covered in this Condensed Overview. InvHoldCo’s are often used for real estate holdings and foreign business investments. The acquisition, associated income and disposition of the held assets involve the expertise of Wealth Professionals with jurisdictional specialization.
Medical Corporations and Professional Corporations –MedCo’s and ProfCo’s
Certain Professionals in Canada have the ability to incorporate; creating a Professional Corporation (ProfCo) or a Medical Corporation (MedCo); a partial subset (in alphabetical order) is outlined below:
- Land Surveyors,
- Social Workers,
etc …, . These professionals are allowed to operate their business as a CCPC subject to Provincial regulations, Again, subject to Provincial Regulations, Real Estate Professionals and certain Investment Professionals may be on this list in the near future.
These CCPC’s are subject to additional rules of the governing bodies of each profession. The governing rules of the ProfCo or MedCo can extend to:
- The business operation of the CCPC must be solely focused on the profession
- Naming Conventions apply; for example in Ontario the CPSO requires ‘Medicine Professional Corporation’ or ‘Medecine Societe Professionnelle’ to follow the exact spelling of the Doctors’ surname as it appears in the CPSO registry
- Shareholders must be of the same profession (a notable deviation from this rule permits family members of Doctors in Ontario to be shareholders of the MedCo)
- Officers and Directors of the ProfCo/MedCo must be shareholders
- Limitation of ownership by HoldCo’s and/or Family Trusts (that affect income splitting tax strategies). For example, in Ontario, Doctors and Dentists cannot have HoldCo’s that own shares in their DrCo or DentCo (respectively).
A legal professional can help setup your ProfCo and/or MedCo and include the appropriate filings with the provincial professional regulators. Your legal professional will also structure your ProfCo or MedCo to address to ‘Loss of Status’ situations when death of the professional occurs and the possibility that the ProfCo/MedCo will not be owned by a regulated professional.
Recent Federal Budget Changes
The recent Federal budget, March 22 2016, also removed the eligibility of the ‘multiplication’ of the Small Business tax rate for ‘related’ or ‘associated’ businesses. A business operation that provided ‘contracted services’ to a ‘related’ business no longer qualifies for the lower 15% tax rate. Your tax accountant will know the exact details of how to setup an arm’s length transaction (if at all possible). And to counsel you with respect to having multiple professionals as part of one CCPC or setting up multiple CCPC’s (the generally preferred strategy).
There were also several other Education related items within the 2016 Federal Budget. Again, tuition, student debt and certain credits have changed and your tax accountant will know how these affect your MedCo/ProfCo.
Please Note: professional negligence is a personal liability, not available through the Professionals’ operation of the OpCo (or possibly HoldCo).
Of note, Personal Services Businesses (PSB), businesses with essentially one client where you act akin to a ‘contracted employee’, and Specified Investment Businesses (SIB), where income is generally derived from physical property (rent, interest, dividends, etc …), have certain limitations including the denial of the Small Business tax rate. Your Tax Account will know the details including the SIB regulations that include the test of ‘more than 5 full time employees’.
A trust is not a legal entity, it is a relationship between 3 parties; a ‘settlor’ who transfers assets to the ‘trustee(s)’ for the purpose of the ‘beneficiaries’.
Family Trusts, and Trusts in general, are a way to maintain control of assets. And Family Trusts can own shares of an incorporated business, a CCPC, and thus are eligible to receive dividends from either an OpCo (or a HoldCo). Plus if the CCPC is sold, the Capital Gains Exemption can be ‘multiplied’ across the beneficiaries of the Trust.
Family Trusts setup costs range from approximately $500 to $15,000 and may require a valuation and Estate Freeze if the CCPC is quite successful. And the Business Structure could be 1. Opco, 2. HoldCo and then 3. Family Trust or perhaps 1. OpCo, 2. Family Trust, and then 3. HoldCo. And you may have multiple Trusts, OpCo’s and HoldCo’s. The OpCo and HoldCo are known as ‘connected’ companies and can tax-free dividend from the OpCo to the HoldCo. Plus the Family Trust can dividend to the family members (a form of Income Splitting). It is also possible to transfer assets to your trust (possible tax consequences but creditor protection is the underlying initial rationale).
If you do have over $824,000 of cash within a HoldCo, and an established Family (spouse, children), then Family Trusts should be considered as part of the Business Structure to maximize your Tax Deferral Strategies and provide Creditor Protection.
There are other concerns around Family Trusts including the handling of business losses and income attribution rules; your Tax Accountant can guide you in regard to these situations. If the beneficiaries of the Family Trust have no other income, it is possible to use the Family Trust as a conduit for income and if any, associated tax, because of the personal tax credit system (varies by province). Beneficiaries of the Family Trust can receive a ‘flow through’ of tax-free income in the following approximate amounts; $10,000 of interest income, $20,000 of capital gains or $50,000 of eligible dividends per year.
The Bottom Line is that business liability protection can be enhanced through an OpCo, HoldCo and/or Family Trust structure, and that Tax Deferral plus Tax Strategies are maximized when you are incorporated.
As mentioned above, there are also tax-free dividend transfers that can occur from OpCo’s to HoldCo’s.
And the incorporated business structure, OpCo/HoldCo, tremendously aids the Tax Strategies if you don’t need to withdraw all your cash from the business for living expenses.
Please Note: The designation of Management Companies exists as a structure such that the relationship between OpCo’s, HoldCo’s and Family Trusts can be maximized. Also profitable and non-profitable companies (ProfitCo and LossCo) can be envisioned such that tax minimization occurs. Your Tax Accountant will know all the appropriate details and nuances.