Could your business benefit from being structured as a corporation or using a holding corporation in the corporate structure? Entrepreneurs need to understand the business structure basics of operating in Canada. In this article, we examine the financial implications of structuring as a corporation, and some of the benefits of using a holding corporation.
For information on sole proprietorships and partnerships, please see Business structure basics and financial implications: Sole proprietorships and partnerships.
The corporation is the dominant business structure and is a separate legal entity.
With a corporation, there is legally a distinction between your personal assets and liabilities and those of the corporation. This means that, in most cases, you are personally protected from the liabilities of the corporation, but it is crucial to be aware of what you own and what the company owns. A corporation borrows funds in its own name, rather than yours personally, although you may still need to personally guarantee the bank that the loan will be repaid. With this structure, you are now able to sell ownership or shares in the business to others (including other businesses such as a holding corporation of which you own the shares).
A corporation needs to file a corporate income tax return and is taxed at the corporate rate. This is a set rate, unlike personal rates, which increase as your income increases. The corporate rate is lower than most personal rates and, in the case of Canadian-controlled private corporations, there is a further deduction of about 10%. As a result, the rate in effect for your business is considerably lower and you retain more after-tax dollars to reinvest in your business. However, if the business was to have a loss in one year, you would not be able to deduct that loss against your personal income. You would be able to carry the loss back to a prior year’s income, if there was taxable income within the past three years (taxes paid in that period would be refunded immediately) or the losses could be used against future income to decrease the taxes payable in those future years.
On the sale of your business, you may be eligible for the lifetime capital gains exemption. This exemption allows you to not pay taxes on the first $800,000* of capital gains from selling your business and can result in a savings of nearly $200,000 for each shareholder.
The use of a holding corporation presents significant options in terms of structuring, and tax planning.
In some cases, you may wish to have multiple corporations owning and running different portions of the business such as each location or each step (for example, manufacturing and retailing). Having a holding corporation own each of the subsidiaries can be useful in structuring the corporate group.
As a business grows and you no longer need to reinvest all of the profits into the business, owners often want to invest their surplus cash. If you do this within the corporation, the investments will become assets of the business (and will therefore be exposed to the risks of the business). If you take money out of the business, you will be personally taxed on it as income. If you are in the highest personal tax rate, this means paying as much as 30% extra in taxes at the time you take the cash out of the company. By transferring that cash to a holding corporation by way of corporate dividends, however, it transfers tax-free and you will be able to invest the entire amount and still take advantage of it being a separate entity.
Another major benefit of setting up a holding corporation is that you may be able to freeze the value of the shares that you own. By freezing the value, the future growth of the business then belongs to your children or designated successor. This can be structured in a way that gives you varying degrees of control in the business as you retire and lets others take a more active role in running the company. It also means that you can limit the amount of taxes your estate will have to pay on the capital gain on those shares when you die.
*Using the rates in effect for 2014