So you’ve decided to incorporate your business, and are now thinking about whether you should incorporate provincially or federally. You most likely have a lot of questions, and a common one we hear is how to choose between federal vs. provincial incorporation. Thankfully, Ownr can help with both, and we’ve got a list of everything you need to know to make the best decision.
What does incorporating a business mean?
First, what does incorporating your business even mean? A few things, actually.
Incorporating a business means legally separating that business from its owners, aka you. As a sole proprietor or partner, you are no different legally or for tax purposes than your business. All the income your business earns is income you earn, and is therefore taxed at a personal income rate. So, it only makes sense that, if your business earns a swell of profit, your personal income tax bracket also skyrockets. By incorporating, your business income becomes separate from your income, and you will draw a salary.
Incorporating your business also protects your personal assets, as everything you own is legally separated from your business. Owners whose businesses aren’t incorporated are personally liable for all their business operations. This means if there are ever any debt collections or lawsuits, those actions can be brought against you as the owner rather than just the business itself.
An incorporated business is governed by legislation in the region in which it’s incorporated, either federally or provincially. A corporation also has directors and shareholders, and legal responsibilities to keep their incorporation documents filed and up to date.
Why do sole proprietors choose to incorporate their business?
Some entrepreneurs choose to incorporate their business for a few reasons:
Limited liability
As mentioned earlier, some sole proprietors are concerned about personal liability for a variety of reasons. Regardless of those reasons, ensuring your personal assets and credit are sound is top priority. As a sole proprietor, all your personal assets are exposed should you ever face legal action. While this may seem very unlikely, the simple comfort of knowing your home, vehicles, and personal savings are secure and separate from your business can be reassuring.
Keep in mind there are some situations where, regardless of incorporation status, as a director you can still be held personally liable:
- Any unpaid employee wages and vacation pay, up to six and 12 months, respectively.
- Employee deductions and remittances, including source deductions for employee income taxes, and EI and CPP contributions.
- Any GST/HST collections that have not been remitted.
Tax advantages
Because corporations fall under a different legal jurisdiction, tax rates are different for corporations than they are for individuals. In Canada, corporations are taxed at a lower rate than individuals, which can save your company a lot of money. This can be used to the directors’ advantage in multiple ways and can also help you grow your business more quickly.
As a director, you’ll draw a salary from the company, which will then be taxed as personal income separate from the company’s tax obligations. However, if your income falls into a higher tax bracket, it may be beneficial to take a smaller salary, leaving that money in the company, and thus paying a lower income tax. Whereas, as a sole proprietor, all the income your business makes will be taxed at a personal income rate, regardless if you draw a salary or not.
Once you reach a tax threshold, you may want to consider incorporating, thus saving money you can invest back into your business. Win, win!
Raising capital
Growing a business is expensive. At some point, you’ll likely need credit or loans, or seek out grants or investors. Sole proprietors can struggle to raise capital as some lenders may not want to work with an unincorporated business and investors won’t invest in a business that can’t sell shares to them.
Once you make the decision to incorporate your business, your next step is to decide if you want to incorporate federally or provincially, which starts with understanding the difference between the two.
Choosing between federal vs. provincial incorporation
While the primary difference between incorporations and sole proprietorships is the separation of legal entities, including finances, there are also differences between incorporating federally and provincially. Choosing whether to incorporate your business federally or provincially can depend on several factors:
Ability to conduct business in all provinces and territories
Federal incorporation in Canada is governed by Corporations Canada, and offers generally wider protections. It allows you to conduct business in all provinces and territories, but requires you to register extra-provincially. Provincial Incorporations are considered foreign corporations in provinces outside of the jurisdiction in which they were incorporated. That doesn’t mean they cannot operate extra-provincially, however. It simply means that they must also register as extra-provincial corporations in provinces in which they do business, and that the provinces allow foreign corporations.
Protection of company name rights
The ability to conduct business across Canada also spills over to business name protection. For example, if you incorporate in Ontario, but find you also need to incorporate in British Columbia, there’s a chance you’ll have to operate under a different business name.
If you only have name protection in the province you operate in, there also may be another business in another jurisdiction operating under the same or a very similar name as yours. However, if you don’t intend to conduct business in any other province or territory, provincial incorporation may be the ticket for you.
The overall time and cost to initiate and renew incorporation status
Federal incorporation requires more annual paperwork than provincial incorporation, and the initial cost of incorporation is higher than provincial.
Overall, the time and cost it takes to incorporate federally is higher than provincially, so deciding which is best for your business depends entirely on your goals.
Making the final decision: federal or provincial incorporation
Making the final decision to incorporate your business can be a tough one. You will likely want to consult some colleagues and other business owners in your community. Finding a mentor is also a great idea, if they are savvy in the business world and can help guide you through these decisions.
Overall, here are the main differences between federal and provincial incorporation:
- Federal incorporations have a right to operate anywhere in Canada, and are not considered foreign in any province. Provincial incorporations are considered foreign in other provinces, but can still operate extra-provincially, so long as the law of the province in question allows foreign corporations.
- Provincial incorporation protects your business name in that province only, whereas federal incorporation protects your business name across Canada.
- Provincial incorporation is usually less expensive and time consuming than federal incorporation which requires multiple incorporation processes and separate annual filings.
- Federal corporations will need to register extra-provincially in the provinces in which it operates, including the province in which it has its head office. If the business only operates in one jursidiction, it may be simpler to maintain the head office of the corporation in that province, but it is not a requirement.
A few questions to ask yourself are:
- Am I looking to expand into other provinces in Canada?
- Do I want name protection across Canada or just my province?
- What resources do I have available to undertake incorporation?
Regardless of whether you incorporate provincially or federally, you’ll most likely need some guidance. Lawyers can be very expensive, and doing it yourself can be more costly and time consuming than it’s worth, not to mention the potential for errors.
This article offers general information only, is current as of the date of publication, and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by RBC Ventures Inc. or its affiliates.