How to Convert a Sole Proprietorship into a Corporation
So your business is growing and you’ve heard that it could be beneficial if you incorporate and continue your business on in this manner. Which it could be the case, but if you don’t do this correctly, there are some serious tax implications for you and your business. My name is Shayan Rashid and I’m a partner at SRJ Chartered Accountants. Well I don’t know who told you, maybe it was your Uncle Frank, your cousin Jimmy, or your Aunt Sue, but they said you’re going save tens of thousands of dollars a year if you incorporate in taxes. It might be the case, but there’s some other factors that we need to consider and look at before you move forward with this type of process.
1. Limited Liability Protection
The first item I want to discuss is limited liability protection. This is the case when you own a corporation and you get sued, only the assets within the corporation are exposed to that potential lawsuit. If you were to own that business personally and you got sued, all of your assets are exposed. Your house, your car, any investments you have could be taken away if the suit comes out negative against you. So, remember, by setting up a corporation, you could protect all of your personal assets.
2. Lower Corporate Tax Rate
The second item I want to discuss is a lower corporate tax rate. In Ontario, the corporate tax rate is 15% combined with federal taxes. That means that any profits up to $500,000 in a year are taxed at only 15%, whereas personally you could pay up to 53% on your profits. The variable is huge, I would rather pay 15% of corporate taxes than 53% personally, especially on funds that I’m going to be saving.
3. Income Splitting
The third item I want to discuss is income splitting. If you have a corporation, it gives you the ability to add family members on as shareholders and pay them a percentage of the profits each year. This makes sense if you are paying yourself, let’s say, $100,000 before, whereas now you can pay yourself 50,000 and your wife the same amount, which greatly reduces your taxes in any given year.
The Process of Converting
Now let’s talk about the actual process of moving from a sole proprietorship to a corporation. The first thing that we have to do is eliminate our sole proprietorship. This is done under two steps. One is eliminating your business registration or canceling it with the government, and second is calling the CRA and removing all tax accounts. This can be done easily over the phone. The next step is actually transferring our assets or selling our assets to the new corporation. Once the corporation is set up, we have to move all the assets into the new company. This can be done using something called a section 85 rollover. We won’t get into too many details, but if it’s not done correctly, then you could be subject to huge taxes and capital gains.
Types of Assets
There are two type of assets that we want to consider. The first are tangible or capital assets that have a long-term nature and life. If you’ve been operating your business for a long time, I’m sure you’ve built up quite a few assets. These can be transferred to the new business tax-free. The second type of asset is called intangible or goodwill. This is essentially the increase in value that someone would pay for your business over the other assets. Now this is the tricky part, and you have to make sure that you do this correctly. Under the rollover, if you don’t correctly transfer the assets, you could be subject to pay personal tax on the capital gain for the additional value or goodwill of your business.
Setting up a corporation and transferring your assets to the new company is a complex transaction. Make sure you give us a call so we can properly guide you through the process and ensure all the paperwork is correctly filed with the Canada Revenue Agency.