Effective January 1, 2012, Canada's federal general corporate income tax rate fell from 16.5% to 15% under the five-year tax reduction plan the federal government announced in 2006. Most provincial governments also have been lowering corporate tax rates, though not quite as quickly as some had promised.
The goal here is to promote both investment and job creation in Canada.
The federal plan included a faster corporate income tax rate reduction for small business, a tax-free rollover for small business investments and a reduced inclusion rate for capital gains. As well, most provinces have increased the income threshold up to which companies can qualify as small business and therefore access the lowest corporate tax rates.
What do these tax changes mean to farm and small business owners? It's simple. They make incorporation look even more attractive, for even more business owners, than ever before. And, over the next couple of years, as corporate tax rates may drop still further, the picture could get brighter still.
One caution: the tax benefits of incorporation may be questionable if you need to distribute all your company's profits for personal and living expenses. But, if you routinely retain some surplus profit, either for reinvestment back into the business or to make other investments, incorporation definitely makes sense.
Taxes on such reinvested profits are deferred, almost indefinitely in some cases, while you use the funds to increase the value of your farm operation. You might add land and buildings or increase the efficiency and productivity of your farm output.
You can see from the chart of current tax rates how much you pay at personal rates if your business is structured as either a sole proprietorship or a partnership. And you can see how much less you pay at the lower corporate rates.
The differences between personal rates and rates for small business corporations with under $200,000 net income are particularly dramatic.
Corporations can cut their tax bills by 20% to 30% on net income below $500,000 per year. By incorporating, a farm that generates $500,000 of net income a year could have as much as $150,000 for business reinvestment.
|Highest Personal Tax Rates as of 2012 (%)||Highest Corporate Rates (%)|
Manufacturing & Processing
|Small Business (Under $500K net income)|
|Alberta (post April 1)||39.00||25.00||25.00||14.00|
|Prince Edward Island||47.37||31.00||31.00||12.00|
In addition to the improved tax breaks offered by the corporate tax system, incorporating your business has other advantages. Consider these examples:
- Limited liability: You can creditor-proof your personal assets to some degree in case of business failure, although many financial institutions now request personal assets to secure business loans.
- Fiscal year flexibility: You can choose a non-calendar fiscal year for income tax reporting should you want one that better suits your business cycles.
- Group insurance and retirement benefits: Corporations can create a registered pension plan and obtain tax-deductible group health and life insurance plans for their employees and family members.
- Income splitting flexibility: If your spouse or children are involved in the business as employees, shareholders and/or directors, funds can be distributed to them in a number of ways. These include salaries, consulting fees, dividends, and directors fees.
- Additional means of compensation: You can take money out the business in various forms, including rent, capital dividends and a retiring allowance. This could have tax benefits.
While incorporation looks very attractive indeed, you need to note the negatives. These include more accounting and legal requirements, which can be costly. You must make regular tax filings for both the corporation and the individual owners. As well, the levels of government scrutiny and regulatory compliance increase substantially. And winding up a corporation is no picnic.
All that said, however, the ability to build future net worth by using before-tax dollars to reinvest in your own corporation remains very appealing indeed.