TAX RATES: Advantages of Incorporation
Contact Neufeld Legal for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Corporations, and even more so Canadian-Controlled Private Corporations (CCPCs), tend to have preferential tax rates, as compared to businesses conducted as sole proprietorships and partnerships in Canada, due to the Small Business Deduction (SBD) and the ability to defer personal taxes.
Small Business Deduction (SBD)
Sole proprietorships and partnerships are unincorporated businesses, meaning the business income is treated as the owner's personal income and is taxed at their personal marginal income tax rate (which can be as high as approximately 50-54% for top earners, depending on the province).
Conversely, a corporation is a separate legal entity and pays its own tax. Eligible CCPCs can claim the Small Business Deduction, which significantly lowers the corporate tax rate on the first $500,000 of active business income.
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CCPC Corporate Rate: The federal corporate tax rate for active business income up to the $500,000 limit is a significantly reduced rate (currently 9% federally, plus a low provincial rate).
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Personal Rate: The lowest personal tax rate is usually around 20-25% when federal and provincial rates are combined, and the rate increases progressively with income.
This lower corporate tax rate allows the business to retain more after-tax earnings for re-investment and growth, which is a key policy goal of the SBD [more on tax rates].
Tax Deferral
This is a significant advantage of incorporation for business owners who don't need all the business's profits for personal living expenses.
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Corporation: The income that is left inside the corporation (retained earnings) is taxed at the low small business rate (e.g., around 9% to 18% combined federal/provincial). The owner can decide to pay themselves later. The personal tax on that income is deferred until it's actually paid out to the owner as a salary or dividend.
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Sole Proprietorship/Partnership: All the net business income is taxed in the owner's hands immediately in the year it's earned, whether they take the cash out of the business bank account or not.
By deferring the personal tax, the business has more capital to work with for longer, effectively putting the government's future tax money to work for the company in the interim [more on tax deferral].
Canada's tax system aims for "integration", with the idea being that the total amount of tax paid on business income should be roughly the same whether it's earned through a corporation and paid out to the shareholder or earned directly by an individual (like a sole proprietor). However, the timing of the tax, due to the deferral, is what provides the major financial advantage for a growing, profitable corporation.
So if you are looking to incorporate a new corporation or deal with the corporate legalities impacting your company, contact our law firm to schedule a confidential consultation with a lawyer experienced in the legal intricacies of business incorporation and commercial business development at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
