In Canada, there are two types of corporations. The first type is the corporation created under federal law, and the second type is the corporation formed under the provincial laws of the provinces and territories. Typically the federal form is preferred because it allows business operations across the country and the statutes controlling the corporation are consistent. The province and territory statutes vary quite a bit concerning issues like the rights of minority shareholders, internal governance, financial recourses and soon.
When you start a business, there are basically three business structures to choose from: sole proprietorship, partnership or incorporation. There is a fourth form called a cooperative, but it’s a very specialized and uncommon business form. The choice of business form influences the types of deductions you are allowed to take. Incorporation is often chosen because it can allow you to maximize the benefits of expense deductions while limiting personal liability.
There are several corporation types in Canada as summarized below:
• Canadian-Controlled Private Corporation (CCPC) – resident in Canada and is not controlled by corporation(s) or person(s) outside of Canada.
• Private Corporation – resident in Canada, not a public corporation, and not controlled by one or more public corporations
• Public Corporation – resident in Canada and meets requirements for listing of shares on the stock exchange or elects to be designated as public under Regulation 4800(1)
• Other Corporation – corporation form that doesn’t fall within the other 3 types of corporations
The advantages of incorporating include limited liability, ongoing operations with transferable ownership, easier to raise capital, possible tax deferral and lower tax rates. For any of these reasons, sole proprietors may choose to incorporate. For example, the Canadian-Controlled Private Corporation eligible for a small business deduction will currently pay a net federal tax rate of 11 percent which may be much lower than a personal income rate.
Corporations are also able to deduct all operating expenses while sole proprietorships face limitations. This gives you much leeway in terms of controlling the tax you will owe. For example, corporations can pay out profits to its management and staff turning what would be taxable profit into a deductible expense. A sole proprietor would have to pay all the tax due on business profit and personal income. In addition, any legitimate and legal expense incurred to operate the corporation is deductible, while it may be more difficult to separate personal from business expenses in a sole proprietorship.
It’s important to make sure you are getting all possible tax deductions on a business. The business structure you choose makes the difference on the type and amount of those deductions in addition to the tax rate paid.