Should I Incorporate?: Companies And Tax Considerations in Nova Scotia

Should I Incorporate?

Sole proprietorship – Partnerships – Incorporation under Companies Act (Nova Scotia) - Income Tax Act (Canada)

Prepared for a presentation at DEMOhub, November 16, 2009

Christian Weisenburger Law, Inc.

OUTLINE

CostsTransferring existing business to a CompanyLiability ImplicationsIncome TaxationIncome Tax CreditsInvestment and Transferability

COSTS


start-up costsSole proprietor Partnership Company

Name Search and Reservation $58 Contact myself or Deb McLellan at [email protected] to make process easier

Fees to Registry $61.66 $406Corporate Minute Book $35 - $80Corporate Seal $50Legal Fees to Incorporate $500 - 800Start-up Costs (plus tax) $58 $120 $1050 - $1500

Shareholder/Partnership Agreement

$700 - $3000

mailto:[email protected]


ongoing and wind-up costsSole proprietor Partnership Company

Ongoing costs

Registry Annual Fees $61.66 $61.66 $106.49 + legal fees

Accounting fees $300+Cost of personal return

Cost of personal return and perhaps partnership filings

$1200+In addition to cost of personal returns ($150+)

Bookkeeping $25 - $100+ per hour

Wind-up costs

Registry $123.30

Advertisement Costs $200

Legal and Accounting Low Medium High e.g. $1500+

COSTS AND COMPLEXITY TO CONVERT TO A COMPANY FROM A PARTNERSHIP OR SOLE PROPRIETORSHIP


transfer of existing business to Newco

Newco

Business AssetsTangible assetsAccounts ReceivableWork-in-progressIntellectual PropertyGoodwill

Tax ConsequencesWithout tax-planning, capital gains tax, recapture, HST and other negative tax consequences can be triggered on the transfer as transferor is generally deemed to have disposed of such assets at their fair market value (i.e. and not their original cost amount)

Tax saved due to losses claimed in relation to the business in the past may be now payable

Sole proprietor orPartner

Transferred


assignment of contractual rights to Newco

Newco

RightsReal Property LeaseEquipment Leases - e.g. photocopierSupply ContractsPurchase ContractsWarranty RightsBusiness licensesFranchise or IP rights

Assigned(often requires consent of other party to be assigned)

Sole proprietor or Partner

» agreements often cannot be transferred without the other party’s consent» watch out for clause in some leases that allow lessors to walk away from

agreement in the event of transfer (and rent to someone else for more if they elect to do so)

» Newco may not be entitled to warranty rights (i.e. if transferred equipment later breaks)

» insurance policy, business licenses, tax accounts (e.g. HST) (often) cannot be assigned and have to be applied for by Newco


assumption of obligations by Newco

Newco

ObligationsDebtsObligations under contacts (e.g. pay amounts required under lease)

Assumed(requires consent of creditor for assumption to be binding)

Sole proprietor or Partner

» obligation to pay interest on debt must be assumed by Newco for the payment to be tax deductible to Newco

» failing to get consent for the loan assumption may put the loan in default, making it immediately payable in full

» likely creditor will not consent to assumption unless transferor agrees to personally liable as well (i.e. personal guarantee)

» tax considerations may come into play if amount of liability assumed by Newco is greater than the value of the business assets transferred to it


conversion costsSole proprietor Partnership Company

Accounting and legal fees to to review tax consequences and transfer business to Newco

from $1000 to substantially more

Transfer fees payable by terms of contracts to party to give consent to transfer

depends (e.g. some lessors require lessee to pay any legal costs they incur in the course of consenting to the assignment)


summary

1. companies are expensive to set up, maintain and wind-up– better to avoid if possible by not incorporating

2. if incorporation will be necessary in future:– present costs and tax implications have to be weighed against

conversion costs and complexities that otherwise wouldn’t have been triggered if business was initially set up in a company

LIABILITIES


examples of business liabilities• Breach of contract, e.g:

– failure to perform as required or on time– failure to repay loan as required

• Breach of Intellectual Property rights, e.g.:– using copyright without permission (e.g. source code)– using similar trademark to one registered by others

• Tort, e.g.:– slip and fall (occupier’s liability)– negligence– libel

• Environmental and Regulatory• Tax• Vicarious, e.g.:

– liability for acts of employees


liabilities – sole proprietor

AccountsReceivable

Sole Proprietor

BUSINESS LIABILITIES

personal assets business assets


liabilities – partnership

AccountsReceivable

Partnership


personal assets

business assets» partners are each personally liable for all of the obligations of the

partnership, even if the obligations were entered into by another partner without their approval

» merely investing in a friend’s business (other than as a loan) likely makes you their partner

» you can be deemed to be a partner even if the partnership is not registered at the RJSC

» for these reasons, most investors require incorporation


liabilities - company

AccountsReceivable


personal assets

business assets

Newco

Shareholder

» However, corporate shield does not protect against:

Fraud Director liability (e.g. HST, unpaid

source deductions, environmental, workplace)

Certain torts like inducing breach of contract

» Lenders and lessors often require personal guarantees, which circumvent the protection of the corporate model

personal assets are shielded from corporate liabilities

INCOME TAXATION


tax rate comparison: earn business income personally vs. in a company

Newco

Shareholder


between 24% and 48%(total personal tax on business income)

between 3% and 28%(personal tax on dividend as % of original profit)

16%(corporate tax)

between 19% and 44%(total personal and corporate tax on business income)

It is now slightly more tax efficient to earn business income in a company and pay dividends vs. earning it personally (as a sole proprietor or partner)

dividend


tax rate comparison: income splittingearn business income personally vs. in a company

Newco

Shareholder


16% $10,400 Tax(corporate tax on $65,000 of corporate business income)

Income splitting by utilizing the low marginal tax rates available to family members allows for significant tax savings

$27,300 dividend

NO TAX* NO TAX** Due to combined benefit of dividend tax credit and personal exemption (approx $10,000); Assumes that the Shareholder and spouse have NO PERSONAL INCOME FROM OTHER SOURCES

Shareholder (spouse)$27,300 dividend

32% $20,100 Tax(approx. effective personal tax rate, including CPP, on $65,000 of business income)


• corporate tax can be higher than shown if the company does not qualify as a “Canadian Controlled Private Corporation” or earns income $400,000+ in a year

• Unlike a partnership or sole proprietorship, corporate losses cannot be set off against other personal income of the owner (and instead are useless unless the company makes a profit in the future)

• if the shareholder does not immediately want to personally spend the profits earned in the company, delay the dividend so that only 16% tax is paid; however – leaving cash in company makes it available to creditors and could have the effect of

inadvertently loosing the availability of the capital gains exemption (i.e. $750,000) on the sale of shares in the company;

– tax planning should be considered to reduce these concerns

tax rate comparison: earning business income in a company


tax incentives to use a company

The following tax incentives are only available if the business is incorporated:

• $750,000 capital gains exemption– growing the business in a company can save each owner tax they would have paid

on up to $750,000 of capital gains as the business grows and is subsequently sold – also would apply to save capital gains taxes that might otherwise be applicable on

the death of shareholder • 3 year tax holiday – NS small business tax credit

– requires 2 employees, 1 being full time and at arms length• NS equity tax credit

– tax credit equal to 30% (35% after January 1, 2010) of equity investment into qualifying companies, deductible against NS personal tax of shareholder

INVESTMENT AND TRANSFERABILITY


investment and use a company• Usually companies are financed by a nominal payment from shareholders

(e.g. $10) as equity, and the remainder is debt financing, however– certain banks and institutions (e.g. BDC) require a minimum equity investment– NS Equity Tax credit is available only for equity investments

• Investors often require incorporation:– so that they are not at risk of being deemed to be a partner (i.e. making all of

their assets available to creditors of and claimants against the business)– corporate legislation and constating documents are long and relatively worked

out (i.e. allowing for proper corporate governance)• in contrast, the Partnership Act (Nova Scotia) is short and not as many protections to

investors apply by default

– rules applying to the transferability of ownership interests in companies is more settled than those of other business structures

– partnerships technically terminate with each change in partnership; whereas companies are stable and shareholders death or change in ownership has no effect on existence of entity


investment and use a company

• Securities law restrictions:– you cannot sell or issue shares in a private company to persons who are

not:• Employees• Close personal friends• Accredited Investors (e.g. $200,000+ income per year or $1 million+ in net assets)• Buying enough shares to take over control• Other prescribed persons

– i.e. once you buy shares of a private company, you are generally stuck with them if you can’t find someone in these categories to sell to

– (Same prohibitions apply with respect to purchasing partnership interests)


lender contacts

Clients looking for (small) loans have received strong service from the following contacts:

BDC, Danny Connors, [email protected], Lisa M. Miller, [email protected] CIBC, Ian Lewer, [email protected] INOVA Credit Union, Gerry Latta, [email protected] RBC, Derek Stone, [email protected] TD Canada Trust, Tracy Kempton, [email protected]

Available financing and other considerations when starting-up are described here:http://www.canadabusiness.ca/eng/125/







http://www.canadabusiness.ca/eng/125/


summary

CONTACT

Christian WeisenburgerChristian Weisenburger Law, Inc.(902) 412-1461

[email protected]

Download presentation at business blog: colouredcomplexity.com