Chapter 1 - Why Should I Incorporate?

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"I am starting a new business. Should I incorporate?" This is one of the most frequently asked questions by entrepreneurs. The answer usually is "It depends."

Factors to consider are the benefits of incorporating (rather than operating your business as a sole proprietorship or partnership) and the implications that incorporating may have on your business. Then you will have to choose between either federal or provincial/territorial incorporation.

Your choice really depends on the circumstances facing you at a particular time, and these may change over time. Therefore, even if you are not ready to incorporate now, you should bookmark this guide for later reference as your circumstances change.

The federal business law in Canada is the Canada Business Corporations Act (CBCA). When the CBCA was first made law in 1975, it introduced the notion of "incorporation as of right." In other words, when you properly complete the application form set out in the CBCA (known as the articles of incorporation), provide certain information (acceptable business name, directors and address of registered office) and pay the appropriate fee, you will be issued a certificate of incorporation. Federal incorporation services are available through the Internet under the Corporations Canada Online Filing Centre. This makes federal incorporation a very simple and less expensive process.

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Chapter 1.1

Benefits of Incorporating

Separate Legal Entity

The act of incorporation gives life to a legal entity known as the corporation, commonly referred to as a "company" (throughout this guide, the terms "corporation" and "company" are used interchangeably). A corporation has the same rights and obligations under Canadian law as a natural person. A corporation can acquire assets, go into debt, enter into contracts, sue or be sued, and even in some situations be found guilty of committing a crime. A company's money and other assets belong to the company and not to the shareholders.
(CBCAsection 15)

Once incorporated, the company's separate legal status, property, rights and liabilities continue to exist until the company is dissolved, even if one or more of its shareholders or directors sell their shares, die or leave the company.

Limited Liability

The act of incorporation limits the liability of a company's owners or shareholders. As a general rule, shareholders of a company are not liable for the company's debts. If the company goes bankrupt, then a shareholder will not lose more than his or her investment (unless the shareholder has provided personal guarantees for the company's debts). A creditor cannot sue shareholders for liabilities (debts) incurred by the corporation, even though shareholders are owners of the corporation.
(CBCAsection 45)

The CBCA, as well as many other federal and provincial/territorial statutes, imposes various duties on directors. In general, these duties or liabilities are imposed where the legislature has decided that a certain act or failure to act is of sufficient importance to warrant going beyond the general rule of limited liability (see Section 4.2, Duties and Liabilities of Management, of this guide).

Lower Corporate Tax Rates

A corporation is taxed separately from its owners and generally at a lower tax rate. For example, active private companies in Ontario pay a combined flat tax of less than half that of an individual in the highest tax bracket on the first $200 000 of taxable income.

Once dividends are paid out to the shareholders of a company, those dividends are taxable in the hands of the shareholders at the shareholders' personal tax rate. The corporate structure does permit some measure of tax deferral, since you decide when to pay out the company's earnings by way of dividend. Until you do so, this money is taxed only at the lower corporate rate, not at the personal rate.

Note that losses from the business cannot be written off against other personal income the owners or shareholders may have.

Greater Access to Capital

Raising capital is often easier for corporations than for other forms of business. For example, corporations are entitled to issue bonds or share certificates to those who invest money in the company. Other forms of business must rely solely on their own money and loans for capital. Reliance on these latter means of financing often limits a business's ability to expand.

Corporations often are able to borrow capital at a much lower rate than other forms of business. This is probably because financial institutions and other sources of financing perceive loans to corporations as being less risky investments.

While the reasons are not wholly clear, many financial institutions believe corporations (as opposed to partnerships or sole proprietorships) are better loan risks, and therefore feel more comfortable providing capital to corporations. They are supported in this view by studies showing that incorporated businesses are more successful than unincorporated ones.

Continuous Existence

Unlike a partnership or sole proprietorship, a corporation does not cease to exist upon the death of its owner(s). Even if every shareholder and director were to die, the corporation would still live on, and ownership would transfer to the shareholders' heirs. This assurance of continuous existence gives a business greater stability, allowing it to carry out planning over a longer term and to obtain more favourable financing terms.

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Chapter 1.2

Implications of Incorporating

Higher Start-Up Costs

Start-up costs are higher if you choose to incorporate rather than carry on business as a sole proprietorship or partnership. These start-up costs are directly related to the process of setting up the corporation, as well as any professional fees for legal and accounting services. While it is not necessary to obtain legal advice to incorporate, it would certainly be worthwhile to do so if you are considering setting up with a complex share structure.

On the other hand, the higher start-up costs may be offset by the lower financing and tax rates that corporations often enjoy. Moreover, obtaining financing may be easier because lenders are generally more accustomed to dealing with corporations than with other forms of business.

Increased Paperburden

Carrying on business as a corporation may increase the number of filings you are required to make. For instance, the CBCA requires that you file each year an annual return (Form 22 — see Appendix H of this guide) and also inform Corporations Canada of any changes in your board of directors and/or location of your registered office (Forms 3 and 6 — see Appendixes C and D of this guide). You will also be required to file separate income tax returns for yourself and your company, which may lead to an increase in your ongoing professional costs. Your company is also required to maintain certain corporate records (see Section 4.1, Corporate Records, of this guide).

Further, you will likely be required to register your company in any province or territory where you carry on business. Registration is different from incorporation. While a company may be incorporated only once, it may be registered in any number of jurisdictions to carry on business. You should contact the local corporate law administration office in each province or territory in which you plan to carry on business to determine what filing requirements you will have to fulfil.

Required: Directors, Officers and Shareholders

Although a corporation is a distinct legal entity, it does not have a physical presence. It must act through people. There are three main types of persons who may have an interest in a particular corporation and through whom it acts:

• directors
• officers
• shareholders.

Individuals may hold more than one position in a company. For example, the same person may be a shareholder, a director and an officer, or even the sole shareholder, director and officer.

The directors are responsible for supervising the management of the company's business. Your company's articles of incorporation will specify the number or minimum and maximum numbers of directors. You must have at least one director.
(CBCA sections 6, 102, 105)

Officers may hold positions in the company such as president, chief executive officer, secretary and chief financial officer. They are appointed by the board of directors. The duties of the company's officers are normally found in its by-laws. In general, the directors assign the officers the responsibility to manage and execute the day-to-day business of the corporation.
(CBCA section 121)

Shareholders, who own the company, make decisions by passing resolutions, usually at meetings (see Section 5.3, Shareholders' Meetings, of this guide). One of the most important decisions that shareholders make is the election of directors.

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Chapter 1.3

Benefits of Incorporating Federally

In Canada, you have the choice of 13 provincial and territorial jurisdictions and one federal jurisdiction of incorporation. While company law statutes in Canada are quite similar, incorporation under the CBCA does offer certain distinct advantages.

Heightened Name Protection

One of the reasons most often given by our clients for choosing federal incorporation is the heightened name protection provided to federal corporations, seen as an important element of the right to carry on business throughout Canada. While every incorporating jurisdiction in Canada screens potential corporate names (see Section 2.1, Choose a Name, of this guide), the level of scrutiny varies from province to province and from territory to territory. At Corporations Canada, we apply the most stringent of tests before granting the right to use a particular name. What does this stringency mean to you, the client? It is a guarantee that once your corporation obtains its name, that name has a protected status second only to trade-mark protection.

A related benefit is the constitutional right of a CBCA company to carry on business anywhere in Canada. "Carrying on business" includes the right to do so under your own name. All corporations, including CBCA corporations, may be required by a province or territory to register to carry on business within its borders, and to register its name for exclusive use within that province or territory. If you are incorporated under one province's or territory's legislation and later wish to expand your business to another, a company name similar to yours may already be in use in that other province or territory. Only with CBCA incorporation can you be assured of being able to operate under your corporation's own name throughout Canada, both now and later.

Location Flexibility

Incorporation under the CBCA offers flexibility not available under other jurisdictions. For instance, the CBCA does not set restrictions regarding the province or territory where your head office is located, your corporate records are maintained and your annual general meetings are held. You can even hold your meetings electronically or outside of Canada if you wish.

High-Quality Service

Corporations Canada takes great pride in its customer service standards. Turnaround times for various services such as incorporation are a matter of public record, as are Corporations Canada's results in reaching such standards.

As a service provider in a competitive market, Corporations Canada is always pursuing ways to make itself more accessible and convenient to clients. For example, it now offers clients an online service that allows you to send documents, pay fees, and receive documents and acknowledgments back from the Director under the CBCA, via the Internet.

Resource for Small Businesses

Industry Canada views SMEs as the key to jobs and economic growth in our country.

Dealing with a complex piece of legislation, like the CBCA or any of the provincial/territorial incorporation statutes, can be daunting to many individuals. Incurring professional fees to help deal with them can often be beyond the reach of people starting out in a business venture.

Corporations Canada therefore has invested much time and effort in developing materials, such as this guide, designed to help the small businessperson through the steps involved in starting and operating a corporation. (See the Contacts section for a list of these materials.) Do-it-yourself information kits on most aspects of the CBCA, as well as policy statements and guidelines clarifying the position of the Director under the CBCA on various matters, are also available.

New materials are continually being prepared in consultation with clients. In addition, a great deal of research and analysis is being done with respect to developing new services, policies and legislative or regulatory amendments.

Regardless of your location in Canada, incorporation under the CBCA is available to you. With federal incorporation comes excellence in customer service, a focus on accessibility and, of course, the status of being a federal corporation. We are your jurisdiction of choice.

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