The way corporations work is as follows: A corporation is owned by shareholders. Each of these shareholders own shares, and most shares allow their owners to vote at shareholder meetings. One of the things that shareholders do at the meetings is decide upon important business and this is also where they elect the directors of the corporation. The directors of the corporation are not involved in the day-to-day operation of the corporation. Instead the board of directors meets regularly to make important decisions about the corporation and its direction, including the hiring of officers of the corporation such as the President, the Vice-President, the Treasurer, etc. who are the day-to-day managers of the corporation.
So to recap: the shareholders own the corporation and elect the board of directors who in turn appoint / hire officers of the corporation like the president and vice-president who in turn manage the company for the shareholders.
As far as I am concerned, ninety-nine times out a hundred I would recommend a corporation as the vehicle of choice for a business. There are just so many clear advantages over say a sole proprietorship or a partnership.
What makes a corporation great is that it is its own entity. And generally (with some exceptions), what happens in the corporation stays in the corporation (or was that Vegas?).
So, being its own separate identity in the eyes of the law means that it is separate from its owners or shareholders or directors. This creates a liability shield for the shareholders, and there are very few items which can penetrate this liability shield, among them certain taxes like unpaid GST/HST and payroll remittances. Otherwise shareholders and their assets are immune from creditors action and lawsuits against the corporation.
And while a shareholder is generally immune from actions against the corporation, if a shareholder receives payment of dividends when the corporation has not paid its taxes, this payment is considered a non-arm’s length transfer of assets. And in this case the CRA may claw-back the dividend payment made to the shareholder.
If you are planning on opening a corporation and you will not be the sole shareholder, it is important to draw up a unanimous shareholders agreement (a “USA”) to keep everybody in check. There are many reasons why a USA is an essential part of a corporation, and it is important to negotiate and sign the USA while everything is new and fresh and while all shareholders are still friends.
The USA governs what the shareholders can and can’t do. It provides dispute resolution mechanisms to help end problems between shareholders. It provides minimum numbers of votes which are required in order to do certain things. It provides very clear rules and mechanisms for the transfer of shares and can prevent shareholders from disposing of or offering their shares as collateral. The USA also may provide mechanisms to force minority shareholders to sell their shares along with the majority when there is a takeover bid, or to allow shareholders to “piggyback” on a deal where another shareholder is selling their shares to a third party.
There are so many clauses in a USA which protect shareholders from each other, and which make the operation of the corporation that much clearer. I think that it is a mistake for any corporation with more than one shareholder to overlook the USA.
Taxation of Corporations
Corporations are taxed on their net taxable income each year. Like sole proprietorships, expenses are deducted to arrive at the taxable income. Unlike a sole proprietorship, for larger amounts of active income, the corporation is typically taxed at a far lower rate.
And for qualified corporations, active income up to $500,000 per year is subject to the small business deduction, which effectively reduces the rate to 12.2% for Corporations in Ontario this year. The difference can be considerable. Consider for example, the example provided above. If the individual had incorporated and the business had earned the $128K in income and had paid $28K of expenses, the corporation would have earned the $100K. It would have in turn paid the shareholder $66K, leaving the $34K in the corporation.
The difference between having the money in the corporation versus in the taxpayer’s pocket is as follows:
Assume the taxpayer earns a total of $150,000 per year in total between this business and everything else.
The tax rate above $150,000 is 48.19% in Ontario in 2020.
So on the $34K, the taxpayer would be left with almost $18K, while the corporation would hold onto almost $30K.
The difference is that the extra $12K, which isn’t immediately payable to the CRA may be used within the corporation to build the corporation.
If or when the $34K and whatever it grows to gets paid out to the taxpayer, it will be taxed in the taxpayer’s hands. But for now this $12K of found money sits in the corporation’s bank account for the corporation’s benefit.
So as you can see, among other benefits, a corporation offers an opportunity to defer taxes and use what would have otherwise gone to the CRA to the corporation’s advantage. And besides the tax advantages and the liability shield, there are so many advantages to adopting a corporate structure.
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