If you are starting a new business venture or have an existing business that you personally operate, as a sole proprietor, it may be beneficial to consider incorporating a company. While there are a number of considerations, two of the major advantages of incorporating a company is the limited liability protection a company may provide and the potential ability to reinvest more of the profits back into the business.
The Business Corporations Act (the “Act”) is the legislation in the Province which governs corporations. The Act sets out the basis for the establishment of limited liability, by making it clear that a corporation is to be treated as a separate legal person from its owner. The Act gives corporations the ability to hold their own assets, enter into contracts and agreements and to operate and conduct business in its own name. As a result, if a liability arises in the course of conducting business, the corporation is the person to be held responsible, not the owner.
To illustrate this by way of an example, assume that a corporation is operating a renovation or construction business and undertakes a project. For this project, the corporation purchases materials from a supplier on credit. During the course of this project there was unintended damage to property, an accident resulting in personal injury and the client is refusing to pay, as they believe the project was not completed as agreed upon. In this scenario, the client and the injured party would look to hold the corporation accountable for the damage, personal injury and cost of completing the project correctly. If the corporation was unable to pay the supplier due to the client not paying, the supplier would also look to hold the corporation responsible for the value of the material sold on credit. What would be at risk for the corporation would be the corporation’s assets.
By way of contrast, if the same circumstances arose by a business that was being operated by the owner in their personal name, as a sole proprietorship, the owner would be the responsible person. The client, injured party and the supplier would all look to the owner’s personal assets to satisfy the amounts owed. If the client, injured party and the supplier were all successful with their respective legal claims, they could each take enforcement steps against the owner personally, which could include seizing and selling the owner’s personal assets, which may have no connection to the business.
By incorporating a company, with the appropriate legal documentation, the owner’s personal assets would be protected and only the assets which are left in the company would be at risk. There are of course, certain exceptions to this general rule, such as providing a personal guarantee to the supplier, allowing the supplier to collect against the owner personally.
Reinvesting Business Profits / The Small Business Deduction
Another major advantage of incorporating a company is gaining access to the income tax Small Business Deduction. There are a number of conditions which must be met in order to qualify for the Small Business Deduction, such as the company being owned / controlled by Canadian residents and the company being engaged in an active business venture, as oppose to a passive investment. If a company does qualify for the Small Business Deduction, this allows the company to pay a lower rate of tax on its earnings. Thus, the company is retaining more of its earnings, as it is paying less tax, leaving the company with more to reinvest back into its operations. A Saskatchewan company which qualifies for the full income tax Small Business Deduction, will only pay income tax at a rate of 9% (combined Provincial and Federal rate as of October 1, 2020).
By comparison, businesses which are personally operated, as a sole proprietorship, cannot access the Small Business Deduction. The rate of income tax which is to be applied to the business earnings, is the owner’s marginal tax rate, which is likely a much higher rate of tax as compared to the Small Business Deduction rate. The result, is the owner pays more tax on its earnings, as compared to a company which qualifies for the full Small Business Deduction, leaving less to be reinvested into the business.
If you have any questions or would like additional information with respect to your particular situation, please contact one of our Business Law Lawyers.
This article is for informational purposes only and does not constitute legal or accounting advice and does not create a solicitor-client relationship. W Law LLP does not make any guarantee about the accuracy or completeness of the information contained herein.