Certain tax and legal principles for corporations illustrate the advantages and responsibilities of operating a full-blown corporation. Companies are legal entities with limited liability; Private corporations which are majority Canadian-owned and "active" - - C.C.P.C.s - - get tax reductions and owners may exempt up to $750,000 of gain on the sale of common shares; There is more flexibility for income-splitting and deducting expenses with a corporation; and,· Shareholders are generally paid on only a salary or dividend basis but taxes may be minimized.
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 for unremitted payroll deductions, GST and PST as these monies 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. Insurance protection should be provided for directors and to protect the value of a successful corporation.
Active Canadian-Controlled Private Corporations (CCPCs) - - at least 50% of the voting shares held by Canadians - - will enjoy lower tax rates, and provide up to $750,000 tax-free per taxpayer on the sale of common shares held for 2 years. Corporations are treated as active when they deal with the public no matter how few employees there are. A corporation only owning rental-income properties, to be treated as active, must employ at least five full-time employees throughout the year (ITA s.s. 125(7) (e)).
The goal is to minimize taxes getting money out of a corporation. A dividend/salary threshold determines the optimum balance between the two types of income for individuals and within families. It tracks RRSP contributions, CPP contributions and other income.
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.
Corporate bonuses may be deducted immediately by the corporation and paid to the recipient within 6 months. This reduces corporate tax and defers personal taxes.
To split income, spouses and children may be paid wages as employees and/or directors. They must be paid on a FMV basis. They may also receive dividends if they own shares. 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. Therefore, the only tax is the corporate tax paid on profits - - 21.5% in year 2000.
For active CCPCs, the Small Business Deduction (SBD) in year 2000 reduces combined basic Federal/Ontario taxes from the full rate of 43.95% to 20.45% (13.12% Federal plus 7.33% Ontario) on the first $200,000 of taxable income. For 2001 through 2005 the Ontario government has scheduled changes to both the SBD tax rates and levels of taxable income subject to the SBD. The Ontario SBD rate will decrease by ½% per year from 7% in 2001 to 5% in 2004, and then to 4% in 2005. At the same time the level of taxable income subject to the Ontario SBD increases by $40,000 per year from the $200,000 in 2000 to $400,000 in 2005. (Note that the Ontario changes are effective on January 1st each year and are pro-rated for fiscal year-end dates other than December 31st.) The Federal government has not scheduled any changes in the SBD rates on the first $200,000 of taxable income, but has introduced a new SBD rate of 22.12% for taxable income in the range of $200,001 to $300,000. This is really an interim measure as the Federal full tax rate of 29.12% is scheduled to decline to 22.12% by 2004 at which point it will match, and thus eliminate, the new SBD rate in the range of $200,001 to $300,000. For 2001 the Federal tax rates are: SBD rate of 13.12% up to $200,000; SBD rate of 22.12% from $200,001 to $300,000; and, 29.12% full rate over $300,000. The combined Federal/Ontario tax rate for corporations with up to $200,000 taxable income will be 19.62% in 2001. This combined rate will decrease by ½% for each of the next 3 years, then a further 1% in 2005. Corporations with taxable income over $200,000 will have to take into account the combination of new rates and the different SBD taxable income limits set by the Federal and Ontario governments.
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.
Common shares of active CCPCs qualify, on sale, for a capital gains exemption of up to $500,000 per taxpayer under the Lifetime Capital Gains Exemption. Make shares more `saleable' by: adding employees to increase revenues and to provide continuity; selling shares tax-free to employees to give them equity; and, using corporate after-tax dollars to build up 'hard' assets. You can buy your primary place of business which gives you the added advantage of reducing overhead.
Corporations must file Federal (T2) tax return within six months of the year-end and are required to use the accrual basis for accounting purposes.
Business Numbers (BN) replaced GST numbers in 1996 and are used for GST and payroll remittances and for personal and corporate taxes. If annual revenues are under $30,000, you must still complete the BN application to exempt yourself from charging and remitting GST.
You must use the accrual method that reports income if invoiced in the fiscal period - - use closing dates - - and deducts expenses incurred in the period.
GST & Recordkeeping
When you apply for a Business Number, declaring annual GROSS revenues under $500,000 will result in your being assigned an annual filing period based on the calendar year. Quarterly filers must finish the year then elect onto an annual filing for the beginning of the next year. Note: If you are an annual filer and your total remittance to GST was greater than $1,500 in the previous year, you must submit quarterly GST installments equal to 1/4 of the total GST remitted in the prior year. GST is simply an extra 7% pool of cash you receive and must account for.
1. Detailed GST Method. Those with revenues of more than $500,000 must use this method. It requires a lot of work with every revenue and expense item entered with the amount and GST and PST components separated.
2. Quick GST Method. To use this method, your revenues plus GST are bundled together and must not exceed $200,000. For the quick method, remit 4% of the first $30,000 of revenues plus GST, and 5% on the amount over $30,000. So, $1,200 on the first $30,000, then 5% of the excess. Reduce the amount payable or increase a GST refund by claiming the GST paid for capital purchases. You can elect to use the Quick Method by filing the proper election form within the first 90 days of a fiscal year but you must use the method for at least one full year. The Quick Method benefits corporations where GST-subject expenditures are less than about 29% of revenues excluding GST, and benefits mainly corporations with revenues in the range of $100,000 to $200,000. You must factor out GST from revenues and expenses even if using the Quick Method.
