Benefits of Incorporation for Canadian Businesses: Everything You Need to Know

In this article, we’ll cover the following topics:

• Benefits of incorporation for small businesses in Canada:

  • Liability shield

  • Tax savings

  • Lifetime capital gains exemption

  • Selling Flexibility

What are the benefits of incorporation in Canada?

If you own a small business in Canada, here are four reasons why you may want to incorporate: liability shield, tax savings, lifetime capital gains exemption, and selling flexibility. 

Liability Shield

If your business is not incorporated, then you’re a sole proprietor, meaning that you and your business are one and the same. Anything that happens to the business also happens to you personally, and vice versa. Your personal assets - your home, car, savings - are on the line.

If someone gets hurt – that’s on you. If an employee files a complaint – that’s on you. If something goes wrong with your product – that’s on you. If anything goes wrong with your business and legal action is taken, it won’t be your business named in the lawsuit – it will be you. And if you have business partners, they’ll be held liable, too.

When you incorporate, you’re essentially separating yourself and your business into two legal entities. An incorporated business is, legally speaking, a person. This means that any legal action taken against your company is directed at your company, and no one else. You may own the company, but you’re not the company. You are a separate person entirely, and therefore you are protected from most litigation related to your business.

Tax Savings

In 2022, the marginal income tax rate in British Columbia, combined with federal-provincial taxes, is between 20.06% and 53.05%, depending on annual income. 

As we’ve discussed already, the owner of a non-incorporated business is the sole proprietor, and sole proprietors are, legally speaking, the exact same entity as the business they own. As such, the government will tax you accordingly.

As the sole proprietor of your business, every cent of your business’s income will need to be reported as your income, not your business’s. It’s easy to see how this could send your tax bill into the stratosphere.

Incorporated businesses domiciled in British Columbia, on the other hand, enjoy a flat marginal tax rate of 11 percent (2022 rates) on the first $500,000 of annual profit. Obviously, that’s a lot more attractive than being taxed as much as 53 percent, but keep in mind that to reap the most benefit from this lower tax rate, you’ll need to avoid pulling cash from your corporate account in order to pay yourself as much as possible. If you’re pulling out all of your corporate profits to your personal bank account then this tax benefit will be of little benefit.

Lifetime Capital Gains Exemption

Author Stephen Covey counsels “begin with the end in mind” and this applies to planning for the lifecycle and eventual sale of your business. The Lifetime Capital Gains Exemption (LCGE) may be the most important thing to consider when it comes to selling your business, and something that you should consider well in advance of the sale itself. 

The LCGE, allows Canadian taxpayers to sell certain qualified shares or property – up to $913,630 (2022 rates) – completely tax-free. It also permits sellers to sell qualified fishing or farming property (QFFP) of a value up to $1m tax-free.

To use an example, let’s say your sole proprietorship (remember that this indicates a non-incorporated business) is worth $100 today. Fast forward ten years – now it’s worth $1 million, and you’re ready to sell your company. But, since it’s just a sole proprietorship, every cent of that $1 million will be subject to capital gains tax. That means less hard-earned money in your pocket.

Another benefit of the LCGE as it relates to incorporation is that multiple shareholders can take advantage of it. For example, if you have four shareholders, then you have close to $3.5 million dollars of capital gains exemption on the sale of the company. There are also methods for multiplying your individual share of the LCGE via a family trust.

Selling Flexibility

Selling a business as a sole proprietor can be very awkward. In most cases, potential buyers will be a lot more reluctant to jump on sole proprietorships. They may want shares or some other creative means of ownership, but all you can offer them is a bill of sale.

Incorporated businesses present more options for how to structure their ownership. Companies can issue shares, stock options, employee incentives, bring on new partners, the list goes on and on. 

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