Tax is not always top-of-mind when launching your business; there are just so many other pieces to the puzzle to contend with. However, taking care of some basic tax matters at the beginning can help reduce your tax headache as your business takes flight.
I. Do elect to transfer your business assets to a corporation on a rollover basis
Like many entrepreneurs, you started your business as a side project while you were still pursing your day job. Over time, the business grew and developed, adding new collaborators and partners. You now have a team in place and are ready to devote all of your resources to it. You want to incorporate and have already determined the share allocation of each founder, employee and passive investor. However, have you considered how you will transfer the existing business to the corporation?
Even if you do not realize it, your team’s work to date has generated business assets – usually intellectual property and goodwill – of a certain market value but with no tax cost. If the founders simply contribute these assets to the corporation without electing for a tax rollover, they trigger a taxable gain equal to the full value of the assets. This is particularly relevant when the incorporation is done to allow an investor to contribute capital, as at that time, a valuation of the business is made in order to determine the investor’s shareholding of the corporation. That valuation may be considered by the tax authorities to be the price paid by the corporation for the business assets it acquires from the founders.
By making the correct tax elections now to contribute the property on a rollover basis you avoid an unwelcome tax liability being assessed upon a subsequent audit by the tax authorities. Care should be taken when making the rollover elections as not all assets qualify for rollover treatment.
II. If you have a family, do consider tax planning strategies
Although there is still considerable uncertainty, based on the Department of Finance’s October 15th, 2017 announcement, it appears that it will still be possible for a spouse or family trust holding qualified small business shares to benefit from the tax exemption for capital gains up to the lifetime limit of $835,716 (this limit is indexed annually). Therefore, when incorporating your business, consider the benefits of issuing shares, at the relatively low subscription price at that time, to your spouse and/or establishing a family trust to hold shares of the business for the benefit of your spouse and or children.
Waiting to do this later may be more complicated or expensive. As the value of the business increases, your spouse or family trust will need to have a separate source of revenue to subscribe for those same shares or you will need a more complex tax structure to achieve the same result.
III. Do not neglect your sales tax obligations
Whether your business is incorporated or not, if you make supplies of goods or services in Canada in excess of $30,000 in the year you are required to register for and, subject to certain exceptions, collect the Goods and Services Tax/Harmonized Sales Tax (GST/HST) and Quebec Sales Tax (QST) on those supplies. You are also required to issue receipts to your customers showing certain prescribed information such as your name, tax registration numbers, and the amount of GST/HST and QST charged.
Exceptions can apply when you sell or lease certain goods (e.g. certain foods or medical devices) or supply services to non-residents. These rules can be complex and it is important to get qualified advice if you think an exception applies to your business.
GST/HST and QST collected by your business does not belong to you; you only hold the monies in trust for the relevant government body. Consequently, if your business fails to remit the amounts it collects you can be held personally liable for those amounts and the applicable interest and penalties.
If you operate your business through a corporation, then the directors of the corporation will also be liable and the tax authorities can pursue an action against them for up to two years after they have resigned. It is therefore important when you are a director to make sure that any sales tax collected is remitted to the tax authorities on time and, if you resign as director, that you ensure the corporate and tax record reflect your resignation.
When expanding into other provinces in Canada or new markets outside Canada, even when you sell goods or services electronically, also consider whether local value added taxes (VAT) or retail sales taxes (RST) apply.
IV. Do not neglect your payroll obligations
As an employer, your business is required to be registered for a Federal and a Quebec payroll account. It is also required to make payroll withholdings and remittance and pay employer contributions under social security is the case for the GST/HST and QST, the amounts of payroll withholdings are held in trust for the relevant government body and must be remitted to them. In the same manner, the directors are personally liable for the withholdings, plus penalties and interest, if the remittance is not made on time. It is therefore important for directors to closely monitor the corporation’s compliance with its payroll obligations.
It is also important to remember that even when the founders are the corporation’s only workforce, if the founders compensate themselves through a salary or year-end bonus, those amounts are still subject to payroll withholdings and employer contributions in the same way as any other employee remuneration.
V. Do carefully follow the proposed changes to dividend sprinkling
If you issue shares to your spouse and or children and were planning for them to receive dividends from the corporation in order to benefit from their lower marginal tax rates, consider obtaining tax advice regarding the impact of the Department of Finance July 2017 proposals. As announced, if the new rules apply, they could subject the dividend to the highest marginal tax rate, rather than the lower marginal tax rate of your child or spouse. This is a developing issue and the Government has announced more refined amendments to the proposals in the coming days. Stay tuned!