Tax Advice

Small Business Incorporation in Canada: Is It for You?

Whether you’re starting a business or have been self-employed for a while, it’s natural to wonder if you should incorporate. Having an “Inc.” at the end of your business name may seem more professional, and it is a potentially more advantageous structure than the simple sole proprietorship. However, small business incorporation in Canada does come with its drawbacks.

In this article, we’ll define the difference between incorporation and a sole proprietorship, and explore the advantages and disadvantages of small business incorporation in Canada.

The Difference Between Sole Proprietorship and an Incorporated Business

When you’re a sole proprietor, you are your business, and your business is you. Income and losses are taxed on your personal income tax return, so there are no corporate tax benefits or complexities. It’s the simplest way to start a business and is usually the choice of solopreneurs who don’t expect to build a huge company.

By contrast, when you incorporate your business, you’re creating a legal entity that is separate from you as an individual. This means you’ll be absolved of any personal liability associated with your business. It also shields potential investors from liability and provides tax savings in the long run. Most small business owners who choose to incorporate have set their sights on growing a larger business with multiple employees that can be sold someday.

Advantages of Small Business Incorporation in Canada

For many entrepreneurs, incorporating is the logical first step when setting up a business. Here’s why:

You Have a Separate Legal Entity

When you incorporate your business, it automatically becomes a company that has the same rights and obligations under the law as a person. This means your small business can own assets, get a loan, be an official party in contracts, and sue or be sued by people and other companies. And all of it is separate from you.

You Have Limited Liability

Since your corporation is its own entity, you can’t be held personally responsible for any debts or lawsuits associated with the business—unless you’ve given a personal guarantee. If you haven’t, your personal assets, such as your house or vehicle, can’t be taken to pay the debts of your business or answer to a lawsuit.

Incorporation also limits the liability of a company’s shareholders, meaning they won’t be held responsible for any debts (unless they’ve signed a personal guarantee). Creditors can’t sue your shareholders for any liabilities.

You Can Sell Your Business

If a sole proprietor retires or dies, their business goes with them. There are no company assets or income to pass on or sell to others. An incorporated business, however, continues to exist even if the ownership changes. This makes the “selling of a business” much easier.

You Have Global Recognition

A business incorporated under the Canada Business Corporation Act is recognized around the world as a Canadian corporation. This is important if you’re considering doing business with international customers who want to feel assured that you’re a legitimate company endorsed by its government.

You Have Better Access to Financing

Financial institutions and private investors are much more likely to take a chance on an incorporated business than a sole proprietorship. Even lenders often give corporations lower rates for loans because they deem them less risky.

Plus, a corporation has the option to issue bonds or share certificates to investors. Non-incorporated businesses have to use their own money and personal loans for capital, which limits their ability to grow.

You Can Optimize Your Income by Deferring Taxes

When you’re a sole proprietor, every dollar you make is your personal income. You can choose to keep it or invest it back into the business, but you will be taxed on it the same way. If you incorporate your business, you can play around with how and when you receive income from the business. This is a tax advantage.

Another way to get income from your business is through dividends (usually paid out every year or quarter) instead of a salary. This is another way to lower your tax bill. For example, instead of taking a salary when your business receives income, you can choose to leave it in the business and take it out when your personal tax rate is lower.

You Have Lower Corporate Tax Rates

Incorporating a business is often seen as a way to save money because the corporate tax rate is typically lower than an individual’s tax rate. This is due to the small business deduction (SBD) available to qualifying corporations on the first $500,000 of taxable income. In fact, corporations are taxed separately from owners, so remember you still have to pay personal tax on any money the corporation pays you. Generally, the higher your revenues, the more likely it is that you’ll see a tax advantage by incorporating. It’s best to talk to a lawyer or accountant to help you decide whether incorporating would help you pay less in taxes.

You Can Split Your Income

As the owner of an incorporated company, you can hire your spouse and children, which can be a significant tax advantage to your family overall. The company can deduct the amount it pays them as an expense, while family members pay tax at their own personal income tax rates, which are often lower than your own.

With the new rules around tax on split income (TOSI), you need to determine whether your family members will have to pay tax at the highest rate on income the corporation pays them before you start.

You May Get More Business and Bigger Clients

Large corporations want to ensure they’re working with professional, legitimate businesses that are stable and can absorb some risk. As a result, they typically overlook small, sole proprietorships in favour of incorporated businesses.

Your Business Name Is Protected

According to Corporations Canada, when you incorporate your business in a province, the business name you choose is reserved for you—and only you. If you incorporate your business federally, you have the right to use your business name throughout the country. Sole proprietorships don’t have the same business name protection. If your business is not incorporated, anyone can start a business with the same or similar name.

Disadvantages of Small Business Incorporation in Canada

The many long-term benefits of incorporating a business do come with some drawbacks, including:

It’s More Expensive to Set Up and Maintain a Corporation

The business structure of a corporation is more complex than a sole proprietorship. It requires legal paperwork and costs money to set up, which could add up to thousands of dollars. And then there are other, ongoing costs to consider, including professional fees for legal and accounting services. Corporations require professional advice that you’ll need to pay for, particularly if you’re including a complex share structure.

You Have 2 Tax Returns and More Administrative Requirements

Sole proprietors file 1 tax return every year; owners of corporations must file 1 for their personal income and an additional 1 for their company. The increased complexity means that it’s advisable to enlist an accountant to ensure everything is right.

All incorporated businesses must file certain documents with Corporations Canada, or their provincial corporate registry if incorporated provincially. These include articles of incorporation, annual returns, notices of any changes, and articles of amendment if the structure of your corporation changes.

There’s More Paperwork

The owner of an incorporated business has an additional task beyond running their business: Making sure they keep up-to-date records of business activities. These include maintaining corporate documents like a register of directors, the share register, and a transfer register. You also need to maintain a minute book comprised of the corporate bylaws and minutes from corporate meetings.

There’s More Complexity

Even small business owners must manage the additional intricacies of an incorporated business. A company that has its own legal entity must have individuals who act on its behalf. These are typically shareholders (owners of the corporation), directors (supervisors of the management of the corporation’s business), and officers (e.g., president, CEO, secretary, CFO).

As a small business owner, you may hold all of these positions or you may enlist others to act in these capacities. No matter how you do it, you will need to have a paper trail of all of the activities and ensure you are following all bylaws.

There’s Less Tax Flexibility

There are plenty of tax advantages to owning a corporation—when revenues are high. When you experience losses, however, this business structure could be considered a disadvantage. That’s because a corporation doesn’t have the same flexibility when managing business losses.

Sole proprietors can use losses to reduce other types of personal income in the tax year the losses are incurred. For corporations, losses can only be carried forward or back to reduce the corporation’s income from other years.

When it comes to small business incorporation in Canada, it’s wise to consider every angle before making your decision. Some accountants advise picking a path early on in your business to avoid the tumult of transferring from one structure to another. This also means you’ll maintain a consistent, professional image to clients and prospects.

Whatever you decide, it pays to take the time to research and reflect on the best path for you.

This post was updated in January 2024.