Incorporate Sole Proprietorship (In-Depth Guide For 2021)

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Businesses in Canada can take three legal structures: Sole proprietorship, Partnership and, Corporation. Each structure has different and important implications for liability, taxation, and succession. In this article, we will discuss the incorporation of sole proprietorship which means converting a sole proprietorship into a corporation.

What is Incorporation?

First thing is first– What does it mean to incorporate your business?

In simple words, it means separating your business from yourself. As a sole proprietor, there is no separation between you, the owner, and your business. Incorporation is the legal process of setting up your business as a separate entity recognized by the state as a corporation. The corporation is a legal entity separate from the owners of the business. It can bring lawsuits, buy and sell property, sign contracts, be subject to tax. In this way, a corporate protects its owners from personal liability against corporate debts and obligations – with defined limits.

Why is there a need for the Incorporation of Sole Proprietorship?

Incorporation is not just for big guys because the decision to incorporate your business is less about the size and scale of your business and more about what you do and your long-term objectives. The need to incorporate your business depends on several factors. You should consider four questions to determine  the incorporation of your business.

  1. How much legal protection do you need?  As an unincorporated business, there is no separation between your business and personal assets. Whereas, an incorporated business provides a protection shield for personal assets. This means only the business assets can be used to pay back debts. The level of legal protection you require depends on your industry and what products and services you offer. Consider how at-risk you are for the potential legal issues in your business. If you are operating in a high-risk industry, that is with a high probability of being sued, you may want to incorporate it for legal protection.
  2. The income of your business. Generally, the higher the net income of your business, the more advantageous it is to incorporate instead of remaining as a sole proprietorship. For this reason, incorporation makes sense from a financial perspective. The tax differences for both the business structures can have a huge financial benefit for business owners. If your taxable profits are following an increasing trend, incorporation could save you big bucks on your taxes. Professionals at Filing taxes can assess if incorporation makes sense for your business.
  3. Does your business need its own credits? Incorporation allows a business to have its own credit, credit reports, and scores. Just like an individual, a business can build its credit overtime. If you plan the expansion of your business in the coming few years for which you might need a business loan, consider incorporating your business now.
  4. Planning a capital funding. Investors are more likely to invest in an incorporated business as it has the capacity to issue stock.
  5. Preserving the brand name. When you incorporate, you register your business name with the state, then no one else in the state can use the name of your business. If you are building brand recognition, then incorporation is the best solution to safeguard your brand.

The right time to Incorporate

Below are some important considerations to bear in mind, to incorporate, at the ideal time.

  1. Early incorporation. Regardless of the type of business early incorporation is generally beneficial rather than later. At the establishing stage of a business, incorporation helps in presenting a professional image to stakeholders. Credibility and status are enhanced giving you an edge to compete for business. Lenders generally prefer an incorporated business; hence it brings greater ease in obtaining financing and funding, much required at the initial stage of business development.
  2. To reap the benefits of limited liability, incorporate before you sign contracts. Incorporation guards your personal wealth against business liabilities. There is a risk of legal obligation associated with every contract hence it is better to play safe and incorporate before signing contracts, leases, franchises, and other agreements.
  3. Incorporation establishes business interests among founders. For the business to grow harmoniously and effectively it is essential to have a clear understanding of ownership interests. Any future ownership conflict can be avoided through incorporation as each owner will have financial and management rights in the governing documents.   

Note: Incorporate only when you have concrete business plans covering important matters such as contract relationships, hiring employees, taking on partners. 

 How to Incorporate a Sole Proprietorship?

Let’s zoom in a little more to get a closer look at how to incorporate your business.

  • Choose a legal status. There are mainly four types of corporations in Canada: S corporations, C corporations, Non-profit Corporations, and Limited liability companies (LLC’s). Consider your short- and long-term objectives to determine which type of corporation best suits your goals.
  • Choose a jurisdiction. In Canada, a corporation can be incorporated either under the federal Canada Business Corporations Act (CBCA), or the equivalent provincial or territorial corporate statute.
  • Select and register a name. Every incorporated business must have a name that legally identifies it, called “Corporate Name”. Your corporation can adopt either a corporate word name (made up of letters and symbols) or numbered name.
  • Prepare documents required for incorporation.
  1. Business name reservation form.  It allows you to reserve a unique name.
  2. Articles of incorporation. Foundational document for C corps and S corps. A document used to form a corporation that sets forth basic information (corporation name, address, purpose, directors, stock, share structure, business regulations). You can tailor your articles of incorporation to align them with your specific business needs. 
  3. Corporate Bylaws. This document outlines how the shareholders, officers, and directors will split control within the organization and manage the business operations.
  4. Stock certificate. This document records the details of stock structure and related regulations.
  • Establish the initial registered office address and the first board of directors. The registered office is where you must keep your corporate records. Finalize the address where you can practically receive any documents. As any documents delivered to the mentioned address will be presumed to be received by the corporation. 

The directors appointed must meet the eligibility criteria established by CRA.

  • Submit the documents and pay the fee. The fastest and simplest way to submit your incorporation application and pay fee, is through the Canadian government’s Online Filing Centre. You can also apply by email or mail using a PDF form available on the government’s official website.

The Advantages of Incorporating your Business

  • Limited Liability: The corporation holds a status of a legal entity separate from its owners hence the company is itself responsible for its debts and obligations. Incorporation limits the responsibility of shareholders to the money they have invested in the business. It is one of the best ways to guard your personal assets.
  • Have Easier access to capital. Raising capital is generally easier for a corporation. In most cases, banks would rather lend money to corporations than to unincorporated business ventures. Corporations generally have access to more alternative sources of capital.
  • Business credibility is enhanced. The benefits of incorporation go beyond finances. Corporations are perceived to be more stable than incorporations by the stakeholders.
  • Perpetual Existence. Incorporating your business may help you avoid the business legal entanglements that could result in a sole proprietorship. A corporation can continue indefinitely, regardless of what happens to its individual directors, officers, managers, or shareholders.
  • A lower tax rate. An incorporated company pays fewer taxes on net income generated from commercial activity. These rates may vary on different bases but are often more advantageous than those that apply for individual employment income.
  • Tax Deferral. Shareholders investment is not subject to tax as long as it remains in the company’s bank account as company’s funds.

Considerations and Risks of an incorporation

  • Setting up incorporation is expensive.
  • Less Tax Flexibility than a sole proprietorship.
  • Increased paperwork, including yearly documentation that must be filed with the government.
  • With strict regulations, you will need to ensure all your paperwork is well organized.

There are several factors to consider when deciding to incorporate your business. If you are still uncertain about incorporating your small business, our experienced and professional team at Filing taxes is here to set you on the right path considering your personal business situation. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.

Salman Rundhawa
Salman Rundhawa
Salman Rundhawa is the founder of Filing Taxes. Salman provides valuable tax planning, accounting, and income tax preparation services in Toronto, Mississauga, Oakville, and Hamilton.

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