A common question I get from people in the process of starting a new business venture is “How do I set up a company?”. The process isn’t too difficult, but before you head down that road it’s important to consider why you wish to incorporate and whether incorporation is the right arrangement for you.
Before getting in to the benefits of incorporation, you need to understand what a corporation actually is. A corporation (or a company- the two terms are largely interchangeable) is a separate legal person that can do just about anything a “real” person can do, including owning property, entering in to contracts and, of course, being sued. It also has it’s own responsibilities, most notably filing taxes, maintaining records and filing annual corporate documents. As a company is a creation, it relies on its owners (shareholders) and managers (directors) to carry out activities on its behalf.
It is equally important to understand that you don’t need to set up a company to carry on business. You can hang out your shingle at any time and carry on business as a sole proprietor (or partnership). You can do so under your own name (Max Power’s Autogyros) or just about any other name you choose (Autogyros Be We). In Newfoundland & Labrador, there is no provincial trade name legislation requiring you to register your business or trade name. The main formalities to check are registration with CRA (for collecting GST/HST and payroll taxes) and any requirements from your municipality (zoning, etc).
The big reason most people want to incorporate is that doing so limits the liability of the people behind the company (the shareholders). If the company is involved in a dispute, it will generally be the company that gets sued, not the shareholders. Similarly, if the business runs in to rough times and can’t pay it’s bills, creditors can only look to the assets owned by the corporation and not the personal assets of the shareholders. Many people also like the idea of setting up a company because it gives the appearance of a more “professional” operation and lends some credibility to the operations.
Here’s a summary of what I see as the major benefits and disadvantages of incorporating:
Advantages of Incorporating
- Limited Liability- Your personal assets are generally protected (but see the exceptions below) from creditors of the corporation. If you start a business as a proprietor without corporate protection and default on loan obligations or are successfully sued, creditors can go after your house, car, investments, savings, etc. to satisfy the debt.
- Lower Corporate Tax Rates- The combined federal/provincial tax for most corporations in NL in 33.5%, but if you have income of less than $400k and meet a few other criteria, it drops to 16%. Compare that with personal income tax rates which range from 23.5% for the lowest income earners to 42.5% for those earning more than $76,000.
- Greater Ability to Raise Capital - Setting up a company can greatly facilitate your search for new capital, as you have the option of offering shares to potential investors. Many investors (and banks) simply will not provide capital to unincorporated individuals. A corporate entity gives investors certain assurances about the management of the company, their rights to your assets, and also appears much more professional and organized.
Disadvantages of Incorporating
- Additional Costs- The initial cost to set up a corporation in NL is $300 ($270 if you file online). If you retain a lawyer to help you draft the documents and get things in order, expect to pay an additional $400-$1000 in legal fees. In addition, every year you need to file an annual return at a cost of $75, and every time you change directors or registered office you’ll need to file a notice that costs $10. These costs aren’t huge, but for a new business with many other start-up costs, they can prove to be an obstacle.
- Additional Paperwork- In addition to the Annual Returns mentioned above, a company needs to maintain records of its activities, share transactions, meetings of directors, and other corporate minutiae in a corporate Minute Book. More concerning is the fact that a company must keep it’s own banking records and file its own tax returns. This process can be a little daunting if you’re not familiar with corporate taxes and may necessitate hiring an accountant.
- Limited Personal Tax Write-Offs- When you operate an unincorporated business, you can deduct any expenses or losses incurred against your personal income. If you’re starting your business on the side and still working at a day job, these deductions can be particularly valuable, as they allow you to reduce your higher personal tax rates. The reality is that many businesses will not turn a profit in the early years, meaning that it may be better to incur these losses personally and offset your higher personal tax rates than to incur them in a company and carry them forward against future profits (which will be taxed at a lower rate).
- Limited Liability DOES NOT Equal No Liability- We have already discussed that a company is a separate legal person and that shareholders are generally shielded from liability for the company’s debts and obligations. However, there are exceptions to this rule. First, directors of a company can still be held personally liable for unpaid employee wages, corporate taxes, and Workers’ Comp assessments, among others. Second, where the corporation is used as an “agent” or “alter ego” of the shareholders, or engaged in fraudulent conduct, courts may sometimes “pierce the corporate veil” to find liability against the shareholders. Finally, in practice very few banks or lenders will advance money to new corporations without personal guarantees from the shareholders, so liability will remain for these debts.
I’d love to hear any feedback you have on this post or any questions you may have about choosing to incorporate.
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This is helpful, thanks. Just one question- If I set up a company in one province, can I operate across Canada or do I need companies in each province?
Earthwaterfire, you can use one corporation to carry on business anywhere in Canada, but you need to registered that corporation in each province where you’re going to be operating. The cost for doing this varies, but expect to pay around $500 per province you want to register in.