Compelling Reasons Why You May Need a Business Lawyer

I want to become an entrepreneur and start a business. Should I incorporate now, or start as a sole proprietorship and delay incorporation to a later date?‍

The advisability of incorporation is dependent on the particular facts and personal preferences of the entrepreneur. The role of the Lawyer and other professional advisors is to help draw out the relevant facts and explore personal preferences to assist the entrepreneur in making the decision that is right for her. Some of the relevant factors include:

‍Risk. Is the proposed business inherently risky? The shield of limited liability that an incorporated entity provides to the entrepreneur is an important benefit (note that the shield from liability is not absolute);

‍Tax. A valuable attribute of an incorporated entity is the relatively low tax rate (approx. 16%) payable on the first $500,000 of net income. This allows a profitable incorporated entity to grow much quicker using internally generated working capital than a similarly sole proprietorship where a marginal tax rate in excess of 50% of profits may be payable. An exception is where the sole proprietor has other sources of income and it is anticipated that the new business will suffer losses in the start-up year(s) – it may be possible to set off the losses against the other income and thus reduce the overall tax burden;

‍Costs. Incorporation of the business at an early stage is less expensive than incorporation once the business is up and running. Once the business (sole proprietorship) is up and running it is generally necessary to use a “rollover” transaction to transfer the business from the sole proprietorship to the corporation.

‍Separate Existence. An incorporated entity has a legal existence separate and apart from the entrepreneur. This provides for a number of real and perceived benefits including (generally): broader alternatives for raising capital; easier salability of the business and possible availability of lifetime capital gains exemption to avoid tax on sale, continuous existence past the life of the entrepreneur, public perception of greater substance, and easier separation of personal and business dealings.

I am the sole proprietor of a profitable construction business that I want to expand. I’m nervous about the risk associated with the business and its expansion. Should I incorporate?

We would strongly recommend incorporation. Incorporation provides you with limited liability to protect your personal assets from creditors, and tax advantages that will help you grow your business and your wealth.

‍Limited Liability

‍A corporation is a legal entity distinct from its shareholders. The obligations, debts and liabilities of the business are those of the corporation and not of its shareholders. The protection from creditors is a significant advantage, particularly for businesses that are inherently risky. As the sole proprietor you are currently liable for every debt, liability, obligation and claim against your business. In your construction business, an inadvertent error or mistake by a sub-contractor, or simply the failure of the project caused by others, could result in huge liabilities for which you are personally exposed to creditors, risking loss of your house, savings and other assets. Incorporation of your business creates a significant barrier of protection. (Note: there are statutory and other limited exceptions to the protection provided by a corporation)

‍Income Taxes

‍Active business income earned by a corporation is taxed at a much lower tax rate, approximately 15.5% in Ontario on income up to the small business limit of $500,000. This presents two wealth planning opportunities. Firstly, a growing business requires working capital. As a sole proprietorship, growing working capital is hard because profits are taxed at your personal marginal rate of taxation which may be in excess of 50%. By incorporating, you can grow your working capital, and thus expand your construction business, at a much faster rate because of the low rate of corporate tax. Secondly, by leaving profits in the Corporation in excess of your personal needs, you can grow your retirement savings in the corporation at a much faster rate. (In subsequent publications, we will talk about how to creditor-proof these savings).

‍Tax Splitting

‍A corporation provides for legal tax splitting with members of your family, if they are made shareholders of your corporation. The shares of your corporation may be structured so that you remain in control of the corporation notwithstanding shares issued to family members.

I have a corporation the shares of which are held only by me and members of my immediate family. Do I really need to have annual minutes?

‍If your corporation is audited by the CRA and matters, such as the declaration of dividends, have not been formally documented by a written resolution of the directors or in annual minutes, the consequence can be severe. There are other risks that may be avoided by having minutes prepared annually. This is analogous to your dentist who encourages you to have good dental hygiene and periodic check-ups so that small problems do not become big problems. Practicing good corporate hygiene just makes good sense.

The minimum legal obligation of a corporation is to hold an annual meeting of shareholders to consider the financial statements, elect directors and to appoint (or dispense with the appointment of) the auditor. In practice, and as permitted by statute, narrowly held corporations often dispense with an annual meeting in favor of signed resolution of all of the shareholders. The failure to hold annual resolutions, or obtain written resolutions in lieu, can lead to legal action from disgruntled shareholders.

The practice of holding annual meetings (or resolutions in lieu) also tends to ensure that corporate matters requiring attention are addressed, such as share transfers, changes to directors, and address changes, which if left unaddressed could become significant problems.

An effective method of ensuring good “corporate hygiene” is for the corporation to instruct its accounting advisors to provide legal counsel with an annual letter of instructions to document applicable financial matters.

It is not uncommon that a new client brings us a minute book that has not been properly organized, or that has not been updated for many years. It is not a cause for embarrassment. We strongly encourage that the minute books be updated before an issue arises, such as a CRA audit.