It is important to distinguish between the business and the corporation that operates the business. A business may exist before it is incorporated, for example, if it is operated as a sole proprietorship or partnership. Thebusiness can be incorporated at different times, depending on a number of factors that can make incorporation advantageous at certain times. In this article, we propose different moments when you, as an entrepreneur, can decide to incorporate your business.
Many entrepreneurs will decide that the business will, from the outset, be operated through a corporation. One of the advantages of doing so is that the entrepreneur will not have to incur the additional costs of professional fees often required to incorporate the business at a later date, such as tax planning and preparation of legal documentation to transfer the assets of the sole proprietorship to corporation. However, one must also consider the additional accounting and legal costs of incorporation, including the costs of incorporation, financial statements and tax preparation.
From a tax point of view, the corporation will be useful and advantageous when the company generates more profits annually than the entrepreneur needs to cover his living expenses. In other words, if the business is able to generate a surplus after paying for the business owner's current expenses, the corporation will become a choice to be strongly considered. This is due to the corporate tax rate, which is generally lower than the personal tax rate. Surplus earnings can be left in the corporation, either to be reinvested in the business, or to be invested in passive income generating investments. When the surplus is distributed to the shareholder in the form of a dividend, another portion of the tax will be payable; in the meantime there will be a tax deferral.
If all of the profits of the corporation are returned to the shareholder, either as salary or dividends, corporation will not allow for any tax deferral, and therefore the choice to incorporate may not be tax efficient.
A relatively recent Quebec specificity regarding business taxation is that the provincial small business deduction (SBD) will not be available to companies with less than 5500 hours of paid time per year. A partial SBD is available between 5000 and 5500 hours. This represents a difference of approximately 8% on corporate taxes payable in 2022, which is not insignificant at all. Tax deferral is still available, but the benefit of incorporation is greatly reduced.
To determine when to incorporate the business, the entrepreneur should first consult an accountant and a legal advisor. If the business involves a significant risk of civil liability, incorporation may be a wise choice in order to benefit from the limited liability of the shareholders, regardless of whether or not incorporation is advantageous from a tax standpoint. If the field of activity is not risky, it will then be essential to verify with a professional the tax aspect to ensure that the incorporation would be advantageous or useful.
It is also important to consider whether the business will be operated by a single person or by several partners. The corporation is often preferred to a partnership to operate a business with several partners, as the formalities of corporate law allow for the efficient regulation of the legal relationship between the shareholders and the company.