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Should I Incorporate?: Companies And Tax Considerations in Nova Scotia
1. 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.
2. outline Costs Transferring existing business to a Company Liability Implications Income Taxation Income Tax Credits Investment and Transferability
6. Costs and complexity to convert to a company from a partnership or sole proprietorship
7. transfer of existing business to Newco Business Assets Tangible assets Accounts Receivable Work-in-progress Intellectual Property Goodwill Newco Transferred Tax Consequences Without tax-planning, capital gains tax, recapture, HSTand 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 or Partner
8. assignment of contractual rights to Newco Rights Real Property Lease Equipment Leases - e.g. photocopier Supply Contracts Purchase Contracts Warranty Rights Business licenses Franchise or IP rights Assigned (often requires consent of other party to be assigned) Newco 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
9. assumption of obligations by Newco Obligations Debts Obligations under contacts (e.g. pay amounts required under lease) Assumed (requires consent of creditor for assumption to be binding) Newco 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
11. summary companies are expensive to set up, maintain and wind-up better to avoid if possible by not incorporating 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
13. 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
14. liabilities – sole proprietor BUSINESS LIABILITIES Sole Proprietor Accounts Receivable personal assets business assets
15.
16. merelyinvesting in a friend’s business (other than as a loan) likely makes you their partner
17. you can be deemed to be a partner even if the partnership is not registered at the RJSC
18. for these reasons, most investors require incorporationAccounts Receivable
23. Lenders and lessors often require personal guarantees, which circumvent the protection of the corporate modelbusiness assets Newco personal assets are shielded from corporate liabilities Shareholder Accounts Receivable personal assets
25. tax rate comparison: earn business income personally vs. in a company 16% (corporate tax) Newco dividend Shareholder between 3% and 28% (personal tax on dividend as % of original profit) 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) between 19% and 44% (total personal and corporate tax on business income) between 24% and 48% (total personal tax on business income) Sole proprietor or Partner
26. tax rate comparison: income splittingearn business income personally vs. in a company 16% $10,400 Tax (corporate tax on $65,000 of corporate business income) Newco $27,300 dividend $27,300 dividend Shareholder Shareholder (spouse) Income splitting by utilizing the low marginal tax rates available to family members allows for significant tax savings 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 32% $20,100 Tax (approx. effective personal tax rate, including CPP, on $65,000 of business income) Sole proprietor or Partner
27. 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
28. 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
30. 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
31. 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)
32. lender contacts Clients looking for (small) loans have received strong service from the following contacts: BDC, Danny Connors, danny.connors@bdc.ca BMO, Lisa M. Miller, lisam.miller@bmo.com CIBC, Ian Lewer, ian.lewer@cibc.com INOVA Credit Union, Gerry Latta, glatta@inovacreditunion.coop RBC, Derek Stone, derek.stone@rbc.com TD Canada Trust, Tracy Kempton, tracy.kempton@td.com Available financing and other considerations when starting-up are described here: http://www.canadabusiness.ca/eng/125/
34. contact Christian Weisenburger Christian Weisenburger Law, Inc. (902) 412-1461 christian@beyondtheboxlaw.com beyondtheboxlaw.com Download presentation at business blog: colouredcomplexity.com
