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Certain tax and legal principles for corporations illustrate the advantages and responsibilities of operating a full-blown corporation. The biggest companies are listed on the various stock exchanges and thus referred to as publicly-offered companies. All companies are legal entities with limited liability. Owner/shareholders are generally paid on the basis of a mixture of salary and dividends depending on what steps need be taken to minimize corporate taxes as well as personal taxes.
For small businesses which incorporate, the most favorable status is to qualify as a Canadian Controlled Private Corporation (CCPC). These private corporations must be at least 51% Canadian-owned and “active” in offering their product or service to the general public. Furthermore, the corporations 90% of its assets must be used in the “active” business in Canada. If you are going to build and sell new homes, you are active but all income is tax fully as revenue. Active CCPCs get tax reductions and owners of shares of such companies may, under special capital gains rules, exempt up to $835,714 of gain on the sale of their common shares for sales after March 2017. Corporations are treated as “active” when they deal with the public no matter if they have only one officer/director/shareholder.
A general rule is that it is a mistake to incorporate to hold investment properties to generate rent and then later sell at a profit. This would include single-family homes, condominiums, duplexes, 4-plexes or even small apartments up to 30 or 40 units. These properties should be bought individually, jointly with a spouse or personally with a group of investors, in each investors personal name in a partnership arrangement. You should then take the precaution of paying several hundred dollars in insurance premiums each year to get extra liability insurance for slip-and-fall actions and wrongful death in the event tenants die in a fire. This will protect you and the assets of the company as the insurer will cover the cost of lawsuits. The reason for avoiding incorporation is that when the primary source of income for a corporation is rental income, the company does not qualify as an active corporation and will enjoy none of the benefits of a CCPC. In fact, rental income is treated as passive income along with interest and dividend income and these forms of income are taxed at a punitive rate under the Income Tax Act at about 46%.
When a company owns real estate and its primary source of income is rent, it will be deemed to be a property management company” and thus active and enjoy all of the benefits of a CCPC, ONLY IF it has at least six full-time employees. (ITA subsection 125(7) (e)). You would have to buy a 500-unit apartment building or up to a $50 million commercial building for you to need the services of six employees. We call this the five janitors plus a property manager profile. So, DO NOT INCORPORATE to hold one or several rental properties. You will pay about 46% corporate taxes PLUS at least 15% more on the after-tax dollars issued to shareholders as dividends. This creates combined corporate and personal taxes of over 60% compared to the highest personal tax rate of 53.5%. It is a tax and financial disaster.
There is more flexibility for income-splitting and deducting expenses with a corporation. To split income, spouses and children may be paid wages as employees and/or directors. With many small companies, spouses are set up with 50/50 ownership of the common shares so that EACH will qualify for the $835,714 Lifetime Capital Gains Exemption on the sale of these common shares after March of 2017. If they are not shareholders, spouses and children must be paid by the corporation on a Fair Market Value basis for services rendered. In Ontario, individuals 18 and over may operate as directors of a corporation. The owners of highly profitable private companies may thus make their children 18 and over directors of the company, and, for instance, pay them $10,000 a year in directors fees. Nice money to help with university costs. Make sure to hold at least one annual directors meeting so that the directors are seen as active in company affairs. An annual directors meeting is often held solely to approve the annual Financial Statement and the Federal and Ontario corporate tax filings. Once done, someone moves to close the meeting.
However, the current Federal Government has proposed changes to tax laws that include limiting CCPC owners from income splitting to spouses and children over 18 years of age. Currently, the owner of a corporation can “sprinkle” income to their family by way of dividends, thus reducing the amount of personal tax payable for the business owner. However, under the new rules, spouses and children would be required to pass a “reasonableness test”, meaning they are actively contributing to the business. As such, any amounts received by family members must be considered reasonable for the work they perform.
Corporations are separate legal entities with limited liability. Creditors are restricted to seizing corporate assets although major creditors will frequently require that officers/directors provide personal guarantees on corporate debt. Otherwise, shareholders, officers or directors are not personally liable for corporate debts unless they engage in criminal conduct or are grossly negligent. Directors may be held liable by the Canada Revenue Agency for un-remitted payroll deductions and any GST balances owing. The Ontario government will also hold them liable for any PST balances owing. Payroll, GST and PST are monies which are considered to be trust amounts held for the government. If a director has no knowledge of non-remittances and is not involved in day-to-day activities, a ‘non-active director’ defense may be raised if the Directors are deemed to be liable for such amounts. Insurance protection should be provided for directors and to protect the value of a successful corporation.
The goal is to minimize taxes getting money out of a corporation. Balancing salary with dividends is frequently the optimal approach. Taxable benefits result if you get a company car or receive interest-free loans to purchase a home or shares in the corporation. These arrangements are advantageous. You can defer personal taxes on bonuses paid to you by a corporation. Corporate bonuses may be deducted immediately by the corporation and paid to the recipient within 6 months. When a company has a year-end in the last 6 months of a year, it can declare immediately-deductible bonuses and pay them in the next calendar year to the recipient. This reduces corporate tax and defers personal taxes. Dividends from any Canadian corporation are taxed preferentially since the Dividend Tax Credit partially offsets corporate taxes paid. A spouse receiving only Canadian dividends, would pay no personal taxes on about the first $25,000.
For active CCPCs, the Small Business Deduction (SBD) will result in a combined Federal/Ontario corporate tax rate in 2017 corporate filings of as low as 10.5% on the first $500,000 of corporate taxable income and any additional income would be taxed at the combined rate of about 15%. Companies with pre-tax profits in excess of $500,000 should pay salaries to the shareholders to reduce taxable income down to that $500,000 threshold. This is smart since you will pay over 36% tax on taxable income over the threshold plus another 15% plus in personal taxes on dividends paid with the after-tax dollars. The taxes paid will thus EXCEED the highest personal tax rate of 53.5%. So, pre-tax income over the $500,000 level will be taxed at a lower rate in personal tax returns if paid out in the way of salaries or bonuses.
Under the “Rule of Association”, the SBD must be apportioned among “associated corporations” where there is common ownership. The test is “control” and Revenue Canada will decide the degree of ownership that gives de facto control. Check share ownership of investors. Spouses owning different corporations will be treated as associated.
You can do things to increase the value of common shares of active CCPCs qualify, on sale, for a capital gains exemption of up to $$835,714 per taxpayer under the Lifetime Capital Gains Exemption (LCGE). Make shares more `saleable’ by: adding employees to increase revenues and to provide continuity; selling shares tax-free under the LCGE to employees to give them equity; and, using corporate after-tax dollars to build up ‘hard’ assets. You can use after-tax dollars accumulated by the corporation to buy a condominium suite or building from which to operate your business. This gives the company a real estate asset increasing the book value of a company.
INCORPORATION FOR REAL ESTATE AGENTS
The Tax Fairness for Realtors Act, (TFRA) passed second reading of three required readings in March of 2017. The Act amends s. 30 (c) of the Real Estate and Business Brokers Act, 2002 (REBBA) and allows agents to incorporate. The Act requires that the agent own ALL of the “equity shares” – – voting shares – – of the corporation and reads that non-equity – – non-voting shares – – can be issued to “… the members of the immediate family of that person…” This confers the huge benefit of being able to favourably split both salary and dividends with family members.
There are benefits to incorporating as well as bookkeeping and audit problems which might arise. You get lower taxation by getting the commission income of the corporation into the hands of shareholders while paying the least taxes possible – – also referred to as ‘tax optimization’. Get a corporate credit card and pay all expenses from the corporation but NEVER commingle personal expenses in with business expenses.
The Dividends/Salary ‘Mix’ and CPP Premiums
You and your spouse, if applicable, MUST be employees of the corporation – – see the Wiebe Doors case. You cannot bill your corporation for services as an independent contractor. You can select the blend of salary and dividends which is most favourable in tax terms. Salary payments are subject to tax and Canada Plan premiums withholding. The employee and the corporation must make matching CPP contributions up to the 2020 limit of $58,700. Do not withhold CPP premiums beyond the limit as the excess amounts will be repaid to the employee but the corporation will get only a deduction on the excess amounts saving at ONLY the 12.5% tax rate.
Individual Pension Plans
Each employee of a corporation can set up an Individual Pension Plan (IPP). These plans are separate from RRSP plans but the contribution room is about 50% more generous than with RRSP plans and there is no taxable benefit levied. The higher earners and full-blown brokers should have an IPP. The corporate contributions are fully deductible to the corporation and ‘top-up’ contributions must be made to provide an annual 7% return. Get advice as there are several conditions which must be complied with including a defined minimum salary to qualify to set up an IPP.
Benefits from Incorporation
The designated HEAD OFFICE of the corporation will be your home address. You can get an annual non-taxable reimbursement from the corporation for its proportionate usage of your home and the corporation can deduct the payment as a rent expense and save 12.5% in taxes. Nice!
There is a taxable benefit called a “STAND-BY CHARGE” calculated when an agent is driving an employer–provided vehicle and the corporation is paying ALL vehicle expenses. The general calculation is two-thirds of the capital and operating costs but you can use a second calculation where the benefit corresponds to the ACTUAL personal usage which might be only 8% to 12% of total driving. Get Odotrack.
You can ’roll’ furniture, computers and vehicles into a corporation and the corporation will owe you an amount equal to their value.