Incorporation and tax considerations nova scotia-2013.v2

Should I Incorporate?

Sole proprietorship – Partnerships – Incorporation under Companies Act (Nova Scotia) - Income Tax Act (Canada)

Prepared for a presentation at Hub South Shore, May 9, 2013

Christian Weisenburger Law, Inc.

OUTLINE

CostsTransferring existing business to a CompanyLiability ImplicationsIncome Tax CreditsInvestment and Transferability

COSTS


start-up costsSole proprietor Partnership Company

Name Search and Reservation $62 Contact myself or Deb McLellan at [email protected] to make process easier

Fees to Registry $61.66 $422Corporate Minute Book $80Corporate Seal $55Legal Fees to Incorporate $550Start-up Costs (plus tax) $58 $120 ~$1050 (without seal)

Shareholder/Partnership Agreement

$500 - $3000 (often ~$750 - $1,000)

mailto:[email protected]


ongoing and wind-up costsSole proprietor Partnership Company

Ongoing costs

Registry Annual Fees $66.55 $66.55 $114.90 + legal fees

Accounting fees Depends (ask John)

Bookkeeping Depends (ask John)

Wind-up costs

Registry $133.05

Advertisement Costs $200

Legal and Accounting Low Medium Greatest e.g. $1500+(although, often companies are abandoned without cost)

COSTS AND COMPLEXITY TO CONVERT TO A COMPANY FROM A PARTNERSHIP OR SOLE PROPRIETORSHIP


transfer of existing business to Newco

Newco

Business AssetsTangible assetsAccounts ReceivableWork-in-progressIntellectual PropertyGoodwill

Tax ConsequencesWithout tax-planning, capital gains tax, recapture, HST and other negative tax consequences can be triggered on the transfer as transferor is generally deemed to have disposed of such assets at their fair market value (i.e. and not their original cost amount)

Tax saved due to losses claimed in relation to the business in the past may be now payable

Sole proprietor orPartner

Transferred


assignment of contractual rights to Newco

Newco

RightsReal Property LeaseEquipment Leases - e.g. photocopierSupply ContractsPurchase ContractsWarranty RightsBusiness licensesFranchise or IP rights

Assigned(often requires consent of other party to be assigned)

Sole proprietor or Partner

» agreements often cannot be transferred without the other party’s consent» watch out for clause in some leases that allow lessors to walk away from

agreement in the event of transfer (and rent to someone else for more if they elect to do so)

» Newco may not be entitled to warranty rights (i.e. if transferred equipment later breaks)

» insurance policy, business licenses, tax accounts (e.g. HST) (often) cannot be assigned and have to be applied for by Newco


assumption of obligations by Newco

Newco

ObligationsDebtsObligations under contacts (e.g. pay amounts required under lease)

Assumed(requires consent of creditor for assumption to be binding)

Sole proprietor or Partner

» obligation to pay interest on debt must be assumed by Newco for the payment to be tax deductible to Newco

» failing to get consent for the loan assumption may put the loan in default, making it immediately payable in full

» likely creditor will not consent to assumption unless transferor agrees to personally liable as well (i.e. personal guarantee)

» tax considerations may come into play if amount of liability assumed by Newco is greater than the value of the business assets transferred to it


conversion costsSole proprietor Partnership Company

Accounting and legal fees to to review tax consequences and transfer business to Newco

depends

Transfer fees payable by terms of contracts to party to give consent to transfer

depends (e.g. some lessors require lessee to pay any legal costs they incur in the course of consenting to the assignment)

LIABILITIES


examples of business liabilities• Breach of contract, e.g:

– failure to perform as required or on time– failure to repay loan as required

• Breach of Intellectual Property rights, e.g.:– using copyright without permission (e.g. source code)– using similar trademark to one registered by others

• Tort, e.g.:– slip and fall (occupier’s liability)– negligence– libel

• Environmental and Regulatory• Tax• Vicarious, e.g.:

– liability for acts of employees


liabilities – sole proprietor

AccountsReceivable

Sole Proprietor

BUSINESS LIABILITIES

personal assets business assets


liabilities – partnership

AccountsReceivable

Partnership


personal assets

business assets» partners are each personally liable for all of the obligations of the

partnership, even if the obligations were entered into by another partner without their approval

» merely investing in a friend’s business (other than as a loan) likely makes you their partner

» you can be deemed to be a partner even if the partnership is not registered at the RJSC

» for these reasons, most investors require incorporation


liabilities - company

AccountsReceivable


personal assets

business assets

Newco

Shareholder

» However, corporate shield does not protect against:

Fraud Director liability (e.g. HST, unpaid

source deductions, environmental, workplace)

Certain torts like inducing breach of contract

» Lenders and lessors often require personal guarantees, which circumvent the protection of the corporate model

personal assets are shielded from corporate liabilities


tax incentives to use a company

The following tax incentives are only available if the business is incorporated:

• $750,000 capital gains exemption– growing the business in a company can save each owner tax they would have paid

on up to $750,000 of capital gains as the business grows and is subsequently sold – also would apply to save capital gains taxes that might otherwise be applicable on

the death of shareholder • 3 year tax holiday – NS small business tax credit

– requires 2 employees, 1 being full time and at arms length• NS equity tax credit

– tax credit equal to 35% of equity investment into qualifying companies, deductible against NS personal tax of shareholder

INVESTMENT AND TRANSFERABILITY


investment and use a company• Usually companies are financed by a nominal payment from shareholders

(e.g. $10) as equity, and the remainder is debt financing, however– certain banks and institutions (e.g. BDC) require a minimum equity investment– NS Equity Tax credit is available only for equity investments

• Investors often require incorporation:– so that they are not at risk of being deemed to be a partner (i.e. making all of

their assets available to creditors of and claimants against the business)– corporate legislation and constating documents are long and relatively worked

out (i.e. allowing for proper corporate governance)• in contrast, the Partnership Act (Nova Scotia) is short and not as many protections to

investors apply by default

– rules applying to the transferability of ownership interests in companies is more settled than those of other business structures

– partnerships technically terminate with each change in partnership; whereas companies are stable and shareholders death or change in ownership has no effect on existence of entity


investment and use a company

• Securities law restrictions:– you cannot sell or issue shares in a private company to persons who are

not:• Employees• Close personal friends• Accredited Investors (e.g. $200,000+ income per year or $1 million+ in net assets)• Buying enough shares to take over control• Other prescribed persons

– i.e. once you buy shares of a private company, you are generally stuck with them if you can’t find someone in these categories to sell to

– (Same prohibitions apply with respect to purchasing partnership interests)


summary

incorporate do not incorporate

Losses can immediately be offset against other income

of the owner

Winding-up costs

Annual fees and corporate tax returns

Set-up costs

Ease of investment and transferability of ownership

Tax Credits and Exemptions

Tax Savings by Income Splitting

Personal Asset protection (to extent guarantees aren’t

required)

Economy & Finance

Incorporation and tax considerations nova scotia-2013.v2