In this article, we’ll explore in plain terms the benefits of incorporating a business in Alberta. We’ll look at how it differs from other structures, what incorporation means, and most importantly, how it can benefit you as a small business owner.
This article aims to provide an overview of the subject in an easy-to-understand way. It is not intended as legal or financial advice. Let’s get started!
What Does It Mean to Incorporate a Business?
In simple terms, incorporating a business means forming a new legal entity called a “corporation” to legally operate your business. This corporation is separate and distinct from its owners.
Here are two examples to help explain the difference:
- Julia the Sole Proprietor: Julia starts a sole proprietorship business called “Julia’s Bike Rentals”. Julia and the business are one and the same. There is no legal separation between Julia as the owner and the business itself.
- James the Incroporator: James starts a business called “Craft Beer Emporium”. Instead of operating as a sole proprietorship, James incorporates the business to form a corporation. This establishes “Craft Beer Emporium Inc.” as a distinct legal entity separate from James personally.
In scenario #1, Julia as a sole proprietor would personally enter into contracts, open bank accounts, obtain loans, and hire employees. All of the risk and liability related to the business would be taken on by Julia herself. Meaning all of her personal assets are at risk if problems arise.
In scenario #2, it is the corporation (Craft Beer Emporium Inc.), rather than James himself, that would enter into contracts, open bank accounts, obtain loans and hire employees. In other words, the corporation as a separate entity would be the one taking on the primary risk of the business. The corporation can be sued and even go bankrupt, without James automatically being responsible personally as the shareholder/owner.
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What are the Benefits of Incorporating a Business in Alberta?
As business incorporation lawyers, we’ve helped thousands of business owners decide whether incorporation is the right choice for their business. Part of this process involves asking why the business owner is considering incorporation in the first place.
What follows is a review of the seven most common reasons that entrepreneurs tell us they are thinking about incorporating a business.
Potential Tax Savings
Incorporating a business can offer tax advantages compared to alternative structures. That’s because corporations are taxed separately from their owners, and pay taxes in two separate parts:
- Corporate Income Tax: A corporation is required to pay corporate income tax on profits it earns in the year. This tax may be offset by things like salaries, insurance fees, loan interest, and other business-related expenses.
- Owner Distributions: When the corporation distributes money to its owners, the owners themselves pay personal tax on the money they receive.
So, how does this benefit you?
Although the overall goal of the government is to achieve what’s called tax “integration”, which essentially means that sole proprietors and incorporated businesses are taxed at roughly the same rate overall, there are at least three potential ways for incorporated business owners to save on tax:
By incorporating, you get the option of paying owners through dividends, wages, or a combination of the two.
This flexibility allows corporations to adjust payment methods based on what is most tax-efficient in any given year and for each owner’s unique tax circumstances.
This can lead to a lower administrative burden, as well as potential tax savings.
By holding profits within the corporation instead of paying them out immediately, business owners can delay payment of personal tax. You can think of this like an RRSP. You don’t pay the tax until you eventually pull the money out of the corporation. The longer you wait to pull the money out, the longer you avoid paying the personal tax.
Delaying distributions to shareholders can also help level out income fluctuations over good and bad years. This can prevent you from entering higher tax brackets (with higher tax rates) when business is booming.
Lifetime Capital Gains Exemption
When it comes time to sell your business, operating as a corporation gives you the ability to sell the shares of the business, rather than the business assets themselves. This helps maintain the continuity of your business (discussed in more detail below), but may also allow you to access the lifetime capital gains exemption on the sale of your shares.
This can result in significant tax savings if various conditions and rules are met.
The best business and payment structure will depend on your personal and business circumstances.
Certain tax benefits or payment types may not be available to all businesses and owners. It’s critical to consult an accountant or tax advisor to ensure that you are selecting the best business structure based on your specific tax situation.
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Operating as a corporation can send a strong signal of credibility and stability to your client base.
To clients, vendors, and lenders, a corporate structure often suggests a more established, larger-scale operation. In contrast, sole proprietors enter contracts and agreements in a personal capacity. This doesn’t always carry the same level of perceived professionalism.
In some cases, companies will only agree to deal with incorporated businesses. We see this frequently with contractors who provide services in the areas of oil and gas, construction, and IT. This can be due to both credibility issues and potential liability concerns on the part of the company paying for services.
Limited Liability Protection
Another significant reason that entrepreneurs contact us to incorporate their business is for liability protection.
As mentioned previously, operating as a sole proprietor or partnership exposes the owners’ personal assets to the debts and liabilities of the business. This means if the business is sued or goes bankrupt, the owner’s personal bank account, house, car, and other assets could potentially be seized to pay off the business debts.
With a corporation, there is a separation between the owner’s personal liability and the business’s liability. Unless an owner has provided a personal guarantee, business debts remain with the corporation, helping to protect the owner’s personal property.
For example, let’s say Julia slips and falls in James’ store. If James operated as a sole proprietor, Julia could potentially sue him personally and he could lose his personal assets. However, since James incorporated his business, Julia would likely have to sue the corporation (Craft Beer Emporium Inc.), helping to shield James’ personal bank account and property.
If you’re interested in learning more ways to protect yourself as a business owner from personal liability, consider reading our Guide to Limiting Liability for Business Owners.
Additional Financing Options
The financing opportunities for a corporation are very different from those available to sole proprietors and other business structures. Let’s review how corporations are different.
Equity Financing through Shares
Corporations can issue and sell shares (subject to securities rules and the Articles of Incorporation), providing a funding source that is not available to sole proprietors or alternative business structures. Unlike traditional loans, this capital doesn’t require repayment, freeing up cash flow. The downside is obviously the partial transfer of business ownership.
Debt Financing and Credibility with Lenders
Corporations, given their perceived stability and longevity, often appear as more reliable borrowers. This perception can translate into better loan conditions, such as favourable terms or increased loan approvals. Just watch out for personal guarantees, which can increase your risk of personal liability as a business owner.
Exclusive Grants and Incentives
There are specific grants and incentives that are available exclusively for incorporated entities. If you want access to these grants and incentives, you will be required to incorporate your business.
Corporations clearly offer more flexibility than the alternatives when it comes to potential financing opportunities.
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Registering a corporation provides protection for the name of the business and prevents others from using it. No other business can register in the same jurisdiction with the exact same name.
If you incorporate an Alberta corporation, this means that no other Alberta business (no matter where in Alberta they are located) can operate under the same business name.
If you incorporate a federal corporation, this means that no other business can register the exact same name as a corporation anywhere in Canada. This expanded name protection is the primary difference between federal and provincial corporations in Canada.
Sole proprietors on the the other hand will not receive the same protection. If a sole proprietor carries on business using a name that is not their own, such as Julia’s Bike Rentals, they are required by law to register what is known as a trade name. This registration merely provides notice to the public that an individual is using a name in business.
Unlike the registration of a corporate name, a trade name registration does not provide exclusivity for that name.
If your business name is important to you, consider incorporating your business to protect it.
Separating Business and Personal Expenses
As previously mentioned, a corporation is a separate legal entity from its owners. This means that
a corporation will be required to set up its own separate bank account, credit cards, and accounting records.
Any money made by the business must be deposited into the corporation’s account (rather than the accounts of the owners).
Although this can lead to more administrative work and expense, it also means that you will have a clear separation between business and personal expenses. This makes it easier to track your profitability and to prove the value of the corporation when it comes time to sell. It can also make it easier to prove compliance if your business is ever audited by the Canada Revenue Agency.
Transferable Ownership and Continuous Existence
Choosing between a sole proprietorship, partnership, or corporation can be a defining decision for entrepreneurs in Alberta. While the former may appear simpler, incorporating a business comes with distinct advantages, especially when it comes to ownership transition and longevity.
Ownership Transfer Options
When a sole proprietor goes to sell their business, their only option is to sell the business assets. This means that the new purchaser will need to set up their own bank accounts, hire employees, etc. In other words, they are starting a new business from scratch with the assets purchased from the old business.
When the owners of a corporation want to sell their business, they have two options.
- First, they can cause the corporation to sell its assets like a sole proprietor would. There are benefits to this approach, but it’s not always the best option.
- Second, the owners could sell their shares of the corporation itself. This means that the corporation remains exactly the same. Only the owners of the business change. In other words, the business continues on, without the need to set up a whole new entity. Not only can this be better for the new owners, it can also result in tax savings for the sellers.
Ongoing Corporate Life
A distinct characteristic of corporations is their resilience and longevity. Regardless of changes in ownership, or even if a shareholder passes away, the corporation continues to exist. It remains active unless it’s dissolved, merged, or unfortunately succumbs to events like bankruptcy. This continuous existence safeguards the business’s value and legacy.
It’s essential for business owners to be aware of these issues when considering their long-term plans and strategy. Incorporating in Alberta provides both security and versatility in ownership, ensuring a firm foundation for your business’s future.
Other Considerations When Incorporating a Business
Does this mean that incorporating a business is the right choice for everyone? Of course not. There are several reasons why incorporation may not be the right choice for you and your business. The main reason people choose to operate as a sole proprietor is the cost of incorporating a business. This is certainly a factor, but in our experience, most serious entrepreneurs who have weighed the pros and cons of incorporation decide that the benefits of incorporating a business outweigh the costs.
If you’re still on the fence, we recommend taking our Incorporation Quiz, or booking an incorporation consultation to speak with a lawyer about your specific circumstances. If your main concern is limiting tax, we also recommend speaking with an accountant or tax advisor to determine which potential tax savings may be available to your business.
At the end of the day, our goal is to help you make an informed decision. We want to help you get your business started on the right path, whether that’s as a corporation or a sole proprietor.