INCORPORATION Is it right for you?

Transcription

1 INCORPORATION Is it right for you? Tax Issues to Consider Before Incorporating Submitted by: Theresa Francis, CPA, CA Paul Ianni, CPA, CA Rick Elliott, CPA, CA BDO Canada LLP Linda Campbell, CPA, CA 3630 Rhodes Drive, Building 100 BDO Canada LLP Windsor, Ontario 155 Thames Street Phone: Chatham, Ontario Phone: January 26, 2015

2 Topics Ideal Situations for Incorporation Disadvantages of Incorporating Advantages of Incorporating Advantages of a Small Business Corporation Page 2

3 If you carry on a business, there are many tax planning opportunities which become available to you by simply incorporating. By transferring your business to a corporation, you become the shareholder and employee of a separate taxable entity. If the corporation qualifies as a Small Business Corporation, or SBC, other possibilities arise. We will discuss some of the benefits of incorporating and the additional advantages that could apply if your company qualifies as an SBC. Whether you re thinking about incorporating or have already done so, you should consider making full use of these tax planning opportunities. Page 3

4 Do I incorporate my business? Incorporation is not for everyone. A cost-benefit analysis should be done. Do I meet any of the following criteria? 1. High levels of debt due to capital intensive nature of business 2. Growing business that requires increased working capital to fund growth 3. Personal cash needs significantly lower than income generated by the business 4. Am I able and willing to save and invest my surplus income? 5. Do I have significant assets that I can transfer to the corporation on incorporation? 6. Do I have a business related debt which the corporation can assume? 7. Are there income splitting opportunities 8. Is there potential in the future to sell business for significant gain to take advantage of $800,000 capital gains exemption per individual for Small Business Corporations? Page 4

5 Costs of Incorporation of Owner Operator* Legal & Accounting fees for incorporation: $2,000 - $8,000 (estimated) Certificate of Authorization: $750 (if needed) Legal Fees for annual minutes: $200 to $400 (estimated) Annual accounting fees for full set of financial statements and corporate tax returns - $1,500 $3,000 (estimated based on complete accounting records) *these fees will vary depending on size/scope of business, geography, g and quality of record-keeping. Page 5

6 Ideal situations for incorporation High levels of debt due to capital intensive nature of business Allows you to be able to pay debt with after tax dollars from within corporation (1 15.5% = 84.5%) compared to after tax dollars of high income proprietor ( % = 50.47%) Example Business purchases rig to operate for $150,000 and obtains mortgage financing for $112,500 (75% of $150,000) If proprietor operates their business in the unincorporated form they will have to earn $297,206 ($150,000/( %)) in pre-tax profits over the term of the debt to repay the principal amount of the mortgage If business purchases the rig in a corporate structure it will have to earn $177,515 ($150,000/(1-15.5%)) in pre-tax profits over the term of the debt to repay the principal amount of the mortgage; cash flow savings of $119,691 Page 6

7 Ideal situations for incorporation Growing business that requires increased working capital to fund growth - Internally financing growth with greater available after tax dollars (84.5% versus 50.47%) Personal cash needs significantly lower than income generated by the business - Allows greater cash to be left and grow before significant personal tax applied Page 7

8 Disadvantages of Incorporating Disadvantages: Increased recordkeeping Corporate tax returns & other government filings Unable to use business losses to offset your personal income Personal Services Business (PSB) rules Deductions claimed by the PSB will be restricted Is not eligible for the Small Business Deduction and not eligible for the general tax rate reduction resulting in a corporate tax rate of 39.5%. Notes: Advisable to defer incorporation until the business is profitable, unless there are potentially large business liabilities which h could deplete your personal assets If you provide services through your corporation and if not for the corporation you could be considered an employee of the entity to which you provide the services, the corporation may be considered a personal services business, or incorporated employee To benefit from incorporation, you must ensure that your business avoids the PSB rules. You have to be an independent contractor, not an incorporated employee. Page 8

9 Advantages of Incorporating Limited Liability Might protect your personal assets from creditor claims, lawsuits or other liabilities arising in the corporation Shareholder is generally not responsible for debts or other liabilities incurred by the corporation - Personal guarantees of corporate debts makes you liable up to the amount guaranteed - Can be held liable as a director for activities of the corporation in certain circumstances Page 9

10 Advantages of Incorporating Small Business Deduction Active business earnings of a Canadian-controlled private corporation (CCPC) are eligible for special reduced rates of tax at both the federal and provincial levels; currently 15.5% tax rate on first $500,000 of active business income annually in Ontario A CCPC is a Canadian corporation that is not controlled by: - Public corporations; - Non-residents; - Corporations with a class of shares listed on a designated stock exchange; or - Any combination of the above The small business limit must be shared by associated corporations Page 10

11 Advantages of Incorporating Small Business Deduction Benefits Tax Savings can be achieved where after-tax tax small business income is paid to a family member taxed at a low marginal tax rate as an ineligible dividend Tax Deferral: If the after-tax corporate earnings are not paid out as dividends and left in the corporation, the additional personal tax is deferred. An example is shown later in the presentation - Greater after-tax dollars in the corporation to pay expenses and reinvest in assets Notes: As a rule, earning small business income through a corporation and paying it out as a dividend to an individual who is taxed at the top marginal rate will generally not produce a substantial benefit or cost in most provinces. Eligible dividends are basically dividends that are paid out of after-tax business income that was taxed at the general corporate rate without t the benefit of a Small Business Deduction. Where a corporation earns income eligible for the small business rate, the after-tax income is generally paid out as an ineligible dividend. Ineligible dividends are subject to a lower gross-up and tax credit to reflect the fact that small business income is subject to a lower corporate tax rate. What does this mean? Ineligible dividends are taxed at a higher tax rate when compared with eligible dividends. Page 11

12 Advantages of Incorporating Tax Deferral on Bonuses By choosing an appropriate year-end, a bonus declared by the corporation can be deducted in its current fiscal year, but not taxed to you until the following calendar year. Six month deferral in remitting tax from when bonus accrued at a corporation s year end to when it must be paid (179 days) Notes: Even if there is no need to bonus out general rate income with the eligible dividend taxation rules, having the corporation pay a bonus or a regular salary to you will provide you with earned income for an RRSP contribution in the following year A bonus is deductible to the corporation in the year it is accrued, if it is paid within 179 days of the corporation s year-end. If the corporation s year-end falls within the last half of the calendar year (July 6 th or later), the bonus could be paid to you in the following year Page 12

13 Advantages of Incorporating Employee Benefits As an employee of your corporation, you can receive employment benefits that are deductible to the corporation and eligible for special tax treatment in your hands. - A company car potentially beneficial if leased and high business use proportion - Health care premiums paid to a private group health insurance plan on behalf of employees up to certain restrictions - Car allowance for business use of personal vehicle (54 cents/km first 5,000 km, and 48 cents/km over 5,000 km) - Individual id pension plan Page 13

14 Advantages of Incorporating Estate Planning The goals of estate planning include: - Maximize the value of your assets, including the preservation and protection of property during your lifetime; - Minimize and defer tax and other costs arising on your death; - Allow for an orderly transition of assets to your beneficiaries; and - Provide for your dependents, which can include decreasing their taxes where possible. If your assets are held through a corporation, you can do an estate freeze which caps the value of your assets, while allowing future growth to accrue to other family members Page 14

15 Advantages of Incorporating Probate Tax Transferring your business assets to a corporation can significantly reduce probate tax payable on your death If you own an unincorporated business, all the business assets could be subject to probate tax, while unsecured liabilities would not be allowed as a deduction If your business is held by a corporation, the value of your shares would be subject to probate tax rather than the underlying business assets and because all liabilities would be considered in determining the value of your shares, probate tax could be substantially less if you have a large amount of unsecured debt Tax planning opportunity through the use of dual wills (one for the corporation and one for all other property) Page 15

16 Advantages of Incorporating Income Splitting Your spouse and adult children may be able to subscribe for shares of the corporation and receive dividends from the profits of the business. - Ensure that family members pay fair market value for any shares issued to them - Family members must acquire the shares with their own funds. If you provide the funds to them, any dividends they receive would be taxed in your hands. - If you ve transferred property or made low-interest loans to the corporation, watch the corporate attribution rules - Income splitting i is simpler if the corporation qualifies as a Small Business Corporation (SBC) Note: The advantage to your spouse and adult children subscribing for shares and receiving dividends is the ability to have the dividends taxed in the hands of more than one person, which generally means the overall tax on the dividends is lower. Page 16

17 What is a Small Business Corporation? A corporation qualifies as a Small Business Corporation if: It s a Canadian-controlled Private Corporation (CCPC): - A Canadian corporation that is not controlled by public corporations, non- residents, corporations with a class of shares listed on a designated stock exchange, or any combination of these, and All or substantially all of its assets are used in an active business carried on primarily in Canada. Page 17

18 Advantages of a Small Business Corporation Capital Gains Exemption If you sell the business in the future or pass it on to your children at death, you can make use of the $800,000 capital gains exemption. - The corporation must be a SBC at the time of the sale; - More than 50% of the corporation s assets must have been used in an active business carried on primarily in Canada throughout a 24 month period immediately before the sale; and - The shares must not have been owned by anyone other than you or someone related to you during the 24 month period immediately before the sale. Lock in this benefit by stepping up your shares tax cost when the shares qualify for the enhanced exemption. - Transfer your shares back to your corporation or to a holding company and elect to realize a gain on the transfer Note the enhanced exemption ONLY applies to shares of a SBC and not to the sale of assets of an active, unincorporated business. Page 18

19 Advantages of a Small Business Corporation Income Splitting Splitting income with your spouse is made easier if your corporation is an SBC - The corporate attribution penalty does not apply for any period throughout which the corporation qualifies as an SBC. Your spouse does not have to work in the corporation to receive dividends No benefit to splitting income with your minor children there are negative tax consequences Page 19

20 Advantages of a Small Business Corporation Allowable Business Investment Loss (ABIL) If your corporation qualifies as an SBC and the business should fail, you may be allowed to deduct an ABIL rather than a capital loss for the loss of your investment in shares or debt of the SBC CAPITAL LOSS ABIL ½ of the loss is allowed as ½ of the loss is allowed as a deduction a deduction Can only be applied against capital gains Can be claimed as a deduction against other types of income If you have previously claimed a portion of your capital gains exemption, the ABIL may be converted into an ordinary capital loss to the extent you claimed the exemption. Page 20

21 Small Business Rate Comparison Large Tax Deferral is Available... Small Business Rate Federal Rate 11.00% Ontario Rate 4.50% Combined 15.50% Top personal rate is 49.53% for an individual Deferral of almost 34% is available, if small business income is left at corporate level l rather than earned personally based on 2014 personal and corporate rates Page 21

22 Tax deferral using the Small Business Deduction (SBD) SBD benefit is a tax deferral, personal tax will be paid when after-tax corporate cash is distributed Actual saving is generally small when after-tax corporate cash paid out immediately as a dividend id d to a shareholder h who is at a high h marginal tax rate Therefore, generally, need to be able to leave profits behind at corporate level over the long-term Page 22

23 Small Business Rate Comparison Earned Inside the Corporation Business income $ Corporate tax Corporate cash Personal tax on dividend Cash personally Savings using 2014 rates 0.12 Earn Personally Business income $ Personal tax Cash Add l benefit arises where personal tax is deferred and reinvested Savings will be higher for individuals who are not top-rate taxpayers when dividends d d paid out; in retirement you will not be receiving a salary so marginal tax rate likely to be lower No federal tax payable on $35,546 ineligible dividend in 2014 when no other income Page 23

24 Benefits of Incorporation Tax deferral using the Small Business Deduction Tax deferral on incorporation: - Can transfer assets to corporation at their tax cost, in exchange for combination of a note receivable up to tax cost and shares for balance - You cannot take back cash or other non-share consideration when triggering a gain this could produce bad tax consequences. - Note receivable can be repaid using after-tax corporate income that was taxed at small business rate - An election must be filed with Canada Revenue Agency when transferring business assets into the corporation (Section 85 Election) Page 24

25 Examples The following examples assume that only the basic federal and provincial personal credit is available for personal tax purposes and the small business deduction is available for the proposed corporation. The rates used are the substantially enacted rates and should only be used for discussion purposes only for years after the 2014 taxation year. The following basic example shows the net cash to an individual operating a transport business in a proprietorship p p at varying levels of taxable income. Each subsequent example will compare the net after-tax cash received as if you operated the business through a corporation rather than operating as a proprietorship. Page 25

26 Base Example Income earned as individual Taxable income 75, , , , Personal taxes 20,845 30,433 43,456 57,236 Net 54,155 69,567 86, ,764 Page 26

27 Example 1 Income earned in corporation and distributed as dividends Annual Earnings 75, , , ,000 Corporation Taxes 11,625 15,500 20,150 24,800 Available for distribution 63,375 84, , ,200 Dividends 63,375 84, , ,200 Deferral Personal Grossed up Dividends 74, , , , Personal taxes 5,636 11,592 19,936 29,126 Net Cash 57,739 72,908 89, ,074 Deferral and Cash 57, ,908 89, , Savings (Cost) 3,584 3,341 3,370 3,310 Page 27

28 Example 2 Income earned in corporation and 50,000 distributed as dividends Annual Earnings 75, , , ,000 Corporation Taxes 11,625 15,500 20,150 24,800 Available for distribution 63,375 84, , ,200 Dividends 50,000 50,000 50,000 50,000 Deferral 13,375 34,500 59,850 85,200 Personal Grossed up Dividends 59,000 59,000 59,000 59,000 Personal taxes 2,943 2,943 2,943 2,943 Net Cash 47,057 47,057 47,057 47,057 Deferral and Cash 60,432 81, , ,257 Savings (Cost) 6,277 11,990 20,363 29,493 Page 28

29 Example 3 Income earned in corporation and 50,000 distributed as wages Annual Earnings 75, , , ,000 Corporation Wages 50, , , , CPP 2,302 2,302 2,302 2,302 Net Income 22,698 47,698 77, ,698 Taxes 3,518 7,393 12,043 16, Available for distribution 19,180 40,305 65,655 91,005 Dividends Deferral 19, ,305 65, ,005 Personal Grossed up Dividends Personal taxes 8,664 8,664 8,664 8,664 Net Cash 41,336 41,336 41,336 41,336 Deferral and Cash 60,516 81, , ,341 Savings (Cost) 6,361 12,074 20,447 29,577 Page 29

30 Example 4 Income earned in corporation and 50,000 distributed as wages and remainder distributed as dividends Annual Earnings 75, , , ,000 Corporation Wages 50,000 50,000 50,000 50,000 CPP 2,302 2,302 2,302 2,302 Net Income 22,698 47,698 77, ,698 Taxes 3,518 7,393 12,043 16,693 Available for distribution 19,180 40,305 65,655 91,005 Dividends 19,180 40,305 65,655 91,005 Deferral Personal Grossed up Dividends 22,632 47,560 77, ,386 Personal taxes 12,365 18,055 26,399 35,491 Net Cash 56,815 72,250 89, ,514 Deferral and Cash 56,815 72,250 89, ,514 Savings (Cost) 2,660 2,683 2,712 2,750 Page 30

31 Summary As seen from the summary and preceding examples, at each level of taxable income shown in these examples there is a slight savings of operating a business through the corporation rather than personally if all the income is distributed to the shareholder. The savings are attributable to not contributing to CPP. Otherwise there would be a slight cost associated with the introduction of the corporation at the various levels of income shown above. Ignoring CPP, the cost of the introduction of the corporation disappears once taxable income is subject to the top marginal tax rate at the personal level. However, if the income is retained in the corporation and not distributed as either wages or dividends, then there is a savings due to the deferral of the amount not being subject to tax at the personal level. Page 31

32 Summary cost of incorporation Taxable income 75, , , , Net cash to proprietor 54,155 69,567 86, ,764 Savings 50,000 dividend, retain 6,277 11,990 20,363 29,493 Distribute all 3,584 3,341 3,370 3,310 50,000 salary, retain 6,361 12,074 20,447 29,577 50,000 salary, distribute 2,660 2,683 2,712 2,750 Page 32

33 Other things to consider If your proprietorship is registered for any business accounts (payroll, HST) with the CRA, you should close those accounts unless they can be transferred to your corporation. Source deduction and withholdings - If the corporation remunerates your employees or you in the form of wages - A new payroll account should be set up; - Source deductions should be reported to the CRA by a certain time; - Withholdings should be remitted to the Receiver General by a certain time otherwise penalties and interest may be assessed HST/GST - The corporation should register for HST, collect, remit and file as appropriate otherwise interest and penalties may be assessed. Page 33

34 Other things to consider Most businesses in Ontario are required to register with Workplace Safety and insurance Board (WSIB). See for more information Remuneration in the form of dividends: Does not require deductions at source, however, instalment payments may be necessary; Is not considered earned income for RRSP purposes. p Unless other earned income is received your unused RRSP deduction room will not increase ; Does not contribute towards any future Canada Pension Plan retirement benefit Is not considered earned income for child care expenses. Unless other earned income is received, no deduction in respect of child care expenses can be claimed. Page 34

35 INCORPORATION: Is It Right For You? Any Questions? Call a BDO advisor for more information Page 35

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