Congratulations! You have just added another brick to the foundation of your own business. You have taken it from the ground up with the decision to give your business a corporate structure. Although your daily business operations have not changed much because of that, you have to realize how many things have changed for you from a tax perspective!
What is Incorporation?
Incorporation refers to the process of legally creating a new corporate entity or company. When a business is incorporated, it becomes a separate legal entity from its owners or shareholders. This means that the company has its own rights, liabilities, and legal obligations, can own assets, have a bank account, operate a business, and pay taxes– distinct from those of its owners.
Incorporating a business typically involves filing certain documents, such as articles of incorporation or a certificate of incorporation, with the appropriate government agency, usually at the state or provincial level. These documents outline key details about the company, such as its name, purpose, structure, and initial shareholders.
What is the process of incorporating a business in Canada?
You can incorporate either federally or provincially. This depends on whether or not you plan to do business in more than one province. For example, if you incorporate provincially, you have to register and file additional paperwork before you can operate your business in another province.
To set up a corporation, apply to the federal or provincial government, and submit the following:
- a unique name
- proposed by-laws
- the names of the first directors
You can save the cost of finding a unique name by asking the government to assign a unique number (to create a numbered corporation). The government will then issue a certificate of incorporation, making you the owner of a separate legal entity that pays taxes in its own right.
Tax Tips for Corporation Owners in Canada
Here is what you need to remember to get the full benefit from corporate structure:
1. Keep Good Records
Keep track of all your transactions and be sure to have the supporting documents. Good accounting shall maintain an up-to-date file of all transactions so that at any point in time you are aware of your Revenues, Expenses, and Net Income. Be sure to store all:
- invoices
- receipts
- bank statements
- deposit slips
- agreements
- letters from CRA, WSIB, and others
It’s important to recognize that good accounting records are extremely important for anybody who’s in business, as well as having a good filing system where you can find things easily.
When CRA comes in to take a look at something, the burden of proof is not on CRA; the burden of proof is on the taxpayer to prove their position. You need to be able to find all your receipts, logbooks, and documents.
2. Do Get an HST Number Registered
If what you sell or provide is HST taxable, or zero-rated, register for HST promptly! If you hear a reply from your accountant, that your sales have not just yet reached 30,000, by CRA rules you are not obliged to register, ask them how you will then return all HST that you paid at the business start-up. Keep in mind that you usually have more expenses than revenues in these first months of operation.
3. Phantom Deductions Do Not Exist
Think twice before leasing/buying/spending to reduce tax, there are other ways where you can save on taxes and keep your money! If you decide to go ahead with vehicle financing, remember that the maximum cost to be considered by the CRA for write-off is 30,000. Hence if the car is worth more, it will still be considered a 30,000-dollar car for tax purposes. You do not need to be reminded that extra funds are critical for keeping your business afloat, and if spending is meant to reduce taxes along the way, you may first want to make sure that you are looking at substantial net income and that tax is due.
4. Choose your Fiscal Year End Wisely
What year-end should you choose? Here you will have to realize that you will have two Income Tax Returns: the Personal - T1, and the Corporate -T2. The Personal Tax is filed for the calendar year, that is January 1 to December 31, and is due April 30. The Corporate Tax Return is filed for the set tax year as we described and is due six months after the year-end. Tax due is to be paid three months after the year-end for Small Private Canadian Corporations. The same tax year for you and your corporation makes it easy and transparent when determining your real income from the corporation.
5. Use Your Business Account Carefully
From the CRA's point of view, any deposit to the bank account shall be treated as income, unless it can be proven otherwise (e.g. loan, investment, refund, or transaction reversal). If you have a deposit that is not income, be sure to retain enough documentation to prove it. Otherwise, you may be liable for Income Tax and/or HST on that deposit.
6. Keep Shareholder Accounts Accurate
This is one of the areas that draw the special attention of tax collectors as most tax avoidance cases involve withdrawing funds without withholding tax, as it is in the case of regular payroll. From CRA's point of view, your net withdrawals from your corporation are your income subject to tax. This income needs to be declared in the T1 Personal Tax Return. An accurate calculation of what you withdrew less what you invested is key here. If you have paid some of the corporate expenses, you have invested funds into your company. If the company paid expenses for its owner, this is a withdrawal.
7. Separate Your Wealth from Your Tax and Legal Liabilities
A corporation may be a bounty for someone who has an intention to sue and get some of its assets. If you do a lot of business and accumulate funds and other assets over time, you might consider registering one more company, to be designated as a 'holding corporation', that will participate in less business, and therefore not be exposed to various claims. Limited liability offered by corporate structure has also its own limitations from a tax perspective. Paying HST and Payroll source deductions is a direct liability of the director since these funds were already received and are being held by the corporation. Before they are remitted to the CRA by the appropriate due date, (One month for monthly and quarterly HST, 15 days for payroll source deductions, refer to the due dates schedule at the end for more information) these funds are considered to be held in trust for the government.
8. Meet CRA Criteria for Self-Employed in Case You Are the One and Only Director and Shareholder in Your Corporation
To be considered a business from the Income Tax Act perspective, you must meet certain conditions. CRA has developed a range of criteria that distinguish business income from employment income. These criteria help the CRA to apply tax according to economic reality instead of legal structure. To be considered a business, you typically must have more than one client, bear responsibility for the completion of the whole work project, use your own tools, and hire workers in the process of performing the contract. These criteria do not need to be necessarily met all together, but you have to be ready to defend your position from that angle.
Also, for more information see: Tax Guide for Independent Contractors
9. Plan for Salary or Dividends in Advance
If your business generates net income, you as an owner would probably withdraw all or part of it. You may decide to do that in the form of salary or dividends. Salary is a tax-deductible expense for the corporation, whereas dividends are not. However, the recipient will pay less tax on dividends. This is especially true for the 50-60k annual income.
For more information on this subject see: Dividends Vs Salary
10. File on Time, Stay Good On CRA Record
Fulfilling hour obligations before the CRA is a good business practice, keeping you more organized and ready for possible audits or inquiries. Knowing that your books are in order and having no reason to be worried about tax issues will lift a great weight from your shoulders, so you can do your business.
Seek Professional Help
Despite the numerous CRA-approved tax-filing software available online, there is a reason tax accountants are still popular. There are lots of mistakes, especially if business owners do it on their own, which is becoming quite a trend. The average corporate return is more complex than filing a T1 return. As an average entrepreneur who will try and do taxes on their own, there’s a high chance that they will miss something, especially as the business gets more complicated and grows.
Another complication when using a corporation is determining how the owner-manager will receive funds from the corporation to pay for their personal expenses. Often, these funds will be paid as a salary or dividend, or perhaps even both. Hiring an accountant can help you determine the most efficient remuneration strategy based on your personal circumstances and ensure all the compliance steps are completed. A salary or dividend has to be reported on a T-slip and source deductions are required on a salary.
Every taxpayer's situation is unique and offers various opportunities for tax savings and the right tax strategy. Let our expert team of accountants in Toronto help you navigate through the process and avoid any unnecessary stress or penalties. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.