Incorporations

Incorporation Documents "Articles of Incorporation"

WHY INCORPORATE | SMALL BUSINESS GUIDE
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Companies, especially the financial aspects such as share issuances and ownership, fall under the scrutiny of legislation which exists in whichever jurisdiction they are incorporated. The provinces as well as the federal government each have passed "Acts" of legislation for this purpose. In Ontario the "Company Act" sets forth many details relating to the operation and governance of incorporated companies. These constitute a set of rules by which one must abide. Additionally, when you incorporate a company, you will adopt a set of "Articles", or rules, by which you must abide. This entails several pages of documentation and covers matters relating to the issuance, transfer, purchase and sale of shares, rules pertaining to the calling of meetings, definitions of decision making powers, and many other aspects of corporate governance. These rules are useful insofar as they clearly set out what companies may or may not do. Often, the shareholders of a company will enter into a "shareholders' agreement" among themselves and this may further define certain details about how a business will be run and how ownership issues will be handled. However, such agreements are optional whereas the articles of incorporation are mandatory. It is a good idea to fully understand these articles and to become knowledgeable about corporate governance matters.

Corporate Jurisdiction

In Canada companies are generally incorporated at a provincial level. If you intend on conducting business in other provinces it may be advisable to incorporate Federally, however if you are planning to conduct business in only two provinces you can apply for an extra-territorial license for that province, avoiding the expensive cost of federally incorporating. There may even be some corporate tax advantages in doing business in jurisdiction outside Canada because of international tax treaties which exist among trading nations. Obviously, this is an area in which some competent legal and accounting advice will serve you well.

What's in a Name?

How should you choose a name for your company? You are going to have to live with a name for a long time - especially if you advertise and promote the name heavily in which case it will take on value. For example, look at the value in a name such as "Kleenex". A corporate name should be carefully chosen. In some legal jurisdictions, you may be restricted with your choice in names. In most provinces, the rules are rather specific:


Share Classes and (i.e. Capital Structure)

One of the details of incorporation, relates to classes of shares. A company has the right to define its "capital structure" in many different ways, i.e. it can define various classes and types of shares which it will issue. For example, companies usually issue one class of shares, namely "common" shares. These shares are precisely that: "shares" of ownership. Each share entitles shareholders to one vote at shareholder meetings and each share entitles its holder to one share (i.e. 1 divided by the number of shares issued in total) of the corporate profits. You may have heard of "Preferred" shares. Such shares have certain "preferred" rights. For example, they might entitle the holder to a fixed dividend rate. They may also entitle the holder to a conversion into common shares (at a given ratio or formula). They can be used to give investors special rights or additional security in order to attract their investment dollars. Sometimes different types of shares, common or preferred as described as Class A or Class B (or Class C...etc) shares. There are no universal definitions relating to Class A vs Class B. For example, one company's Class A shares might be quite different from another company's Class A shares. The different classes permit companies to assign different rights to the shareholders of these securities, e.g. different classes may have different voting or liquidation rights.

Benefits of Incorporating

When you incorporate a company you are really creating a new legal entity -  i.e. a new, taxpaying corporate body with its own "soul" and presence.  Incorporating a company offers you many advantages, even if you are a one-person business.

·  personal liability protection (to a large degree)
·  substantial tax advantages  (especially when you sell a business)
·  a high degree of flexibility in personal financial planning
·  greater control in transferring ownership
·  easier to bring in outside investors and other partners
·  a company survives human death (i.e. may last indefinitely)

Three main reasons why you should incorporate your business are:

Save Your Money

  • Shareholders of corporations have limited liability for business risks.

  • You can use a corporation to save tax or to defer paying tax to a later date because the small business corporate tax rate for the first $500,000 of active business income is about 13.5% compared to the top personal tax rate of about 44% (other provinces differ somewhat).

  • Unlike partnerships where partners are usually personally liable for the business acts of their partners, in a corporation shareholders are not personally liable for the acts of the directors, officers or other shareholders (except in certain rare exceptions).

  • Corporations don't have withholding taxes, CPP or EI deducted by the companies that hire their services.

Improve Your Business Image

  • Incorporated businesses have a better "image" than unincorporated businesses.

  • Incorporated companies are more likely to attract investors than a sole proprietor or partnership.

  • A Canadian corporation is well respected worldwide and is particularly well suited to market goods and services in North America.

Make Your Business More Desirable to Customers

  • Employers in many business sectors, particularly motion picture and TV production, IT services, and construction, prefer to hire corporations rather than individuals to save money and increase certainty.

  • Corporations cannot be deemed to be employees as often happens when employers hire individuals as independent contractors.

  • It is easier to find work if you offer your services as a corporation. Some technical tax rules make this trick work better if you have a number of different businesses that hire your corporation's services (and potentially harmful if you work for only one company).

  • Customers in North America are often reluctant to buy goods and services from foreign based corporations. If you live outside North America but wish to sell your goods and services here, consider setting up a British Columbia corporation with a virtual office in British Columbia. British Columbia allows 100% of the directors, officers and shareholders of the corporation to be non-residents of Canada (though certain tax and other reporting issues will occur).


PROTECT YOUR ASSETS

Shareholders are not personally liable to pay the debts of corporations. If you incorporate, your personal assets are safe from business risks with few exceptions.

If your business activity carries even a minor risk of causing a catastrophic loss, such as business using dangerous machinery or chemicals, you should incorporate. It is unwise to rely on insurance to protect you from business risks because insurance policies provide limited coverage.

This is the number one reason why many people incorporate. In case of a lawsuit or judgment against your business, no one can seize your personal assets, e.g. your house, car, boat, bank accounts, etc. unless you have pledged these as collateral. Incorporation is the best protection for personal assets that you can get in business. However, there are other liabilities which you may not be able to avoid by incorporating. For example, if you do not remit certain taxes, you could be held liable as a director of the company. Note that shareholders are not necessarily held liable - only the director(s) and they are not necessarily the same person although in startup companies usually the shareholder(s) and director(s) are one and the same.

Typically, your personal liability for business risks is limited to the personal guarantees you give to others in the course of your business dealings.

FIRST IMPRESSIONS

Incorporated businesses are seen as being more serious, more long lasting and more committed to business than unincorporated businesses. Just the fact that your business name ends in a corporate extension -- Inc., Corp., or Ltd. -- makes a big difference when your customers make initial business contact.

Looks aren't everything, but...

Incorporated businesses will often attract more business because the customer, whether the end consumer or another business, subconsciously and almost instantly believes a corporation has more credibility. You will of course need to support that belief with a strong operations and reliable management, but why not use it to your advantage?

TAX DEFERRAL

Small businesses enjoy a favorable tax environment in Canada. Take advantage of it. Certain kinds of corporations enjoy very low tax rates for the first $500,000 in business income, and the tax rates are dropping.

Use your corporation to average your personal income. If your personal income fluctuates between tax brackets your tax savings can be dramatic.

Defer taking personal income by leaving income in the corporation. Since the tax rates in corporations are usually less than one-half of the personal tax rates, you have use of money which would otherwise have been paid to the government until you pay the money out of the corporation to yourself.

Use your corporation to split capital gains by giving shares in your corporation to your spouse and children. Spouses and children accrue capital gains by holding shares in your corporation and selling them in the future at a profit.

There is a $750,000 lifetime capital gains exemption available for capital gains earned from the sale of shares in a qualifying small business.

EASER TO RAISE CAPITAL

Let's face it: every business needs capital (money) to grow. Investors are more likely to invest in corporations than sole proprietorships or partnerships. The reason an investor may want to invest in your corporation is because the investor wants to make money, either from income generated from the business during its life or from capital gains, once the business grows in value and the investor's holdings can be sold to another person.

You can sell portions of the corporation's stock to investors and offer solid exit strategies that protect both the corporation and the investor. All investors want to know how they can get their money back out. This is much easier to set up with a corporation compared to a sole proprietorship or partnership.

·  personal liability protection (to a large degree)
·  substantial tax advantages  (especially when you sell a business)
·  a high degree of flexibility in personal financial planning
·  greater control in transferring ownership
·  easier to bring in outside investors and other partners
·  a company survives human death (i.e. may last indefinitely)

Risk of Incorporating Online!

With increasing frequency, we come accross individuals that have incorporated their companies online. Typically, people decide to incorporate online due to convenience, some urgent business need or to save a little, if not a bit of money.  All of the above reasons are understandable. 

Consequently, what business seekers do not know is that they are missing important elements of the incorporation, pre and post-incorporation, a process which can place them and their companies exposed to problems with provincial legislation or the Canada Revenue Agency (“CRA”).  Such deficiencies can result in significant negative consequences down the road.

Here are a few of the things that can go wrong with incorporating online:

Lack of an Incorporation Agreement.

Pursuant to Section 15(1)(a) of the Business Corporations Act, a “completing party” (i.e. the individual(s) that is/are filing an incorporation, prior to filing (online or otherwise), an incorporation application (Articles of Incorporation with the Ministry of Business and Consumer Services, is required to:

  • examine the articles and incorporation agreement to ensure that both are properly signed;

  • designate as incorporators in the incorporation application all those persons who have signed the articles and the incorporation agreement; and

  • complete the “completing party statement” in the incorporation application.

In general, the incorporation agreement sets out the agreement on the part of the incorporator(s) to form the company, take shares in its capital and the form of articles that will be used (in the absence of a form of articles, the statutory Form 1 articles of incorporation will apply).

In most of the cases where an individual has incorporated online, no incorporation agreement has been signed.  If the filing party's statement is false or misleading in a material respect, they have committed an offence and is liable to a fine not to exceed $10,000.

No Shareholder or Director Meetings

Once a company has been incorporated, it must hold an initial shareholder and director meetings to organize its affairs.  Typically, the first meeting(s) are done by way of consent resolutions in writing signed by the incorporator(s).  For example, the issuance of shares, fixing of the financial year end, appointment of officers, waiver of an auditor and adoption of any pre-incorporation contracts.  The Act provides that a company must hold its first annual general meeting not more than 18 months after the date on which it was incorporated.

Often in the case of online incorporations, such meetings or consent resolutions have not been held, which can create compliance issues and, in fact, legal issues.  A lack of organizational formalities can have a serious impact on parties in the event of a later dispute, e.g. if a party is under the belief that they have shareholder rights and, in fact, may not even be a shareholder.

No Evidence of Paid-Up Capital in Shares


Relating to the lack of organizational meetings abovementioned, are also deficiencies that can arise when shares are not properly evidenced or paid for (not to mention whether such shares have been properly issued).  For example, even if the directors of the company have held a meeting, or signed a unanimous resolution to issue shares, has the appropriate amount of consideration passed between the shareholder and the company?

Section 64(2) of the Act states that a share must not be issued until it is fully paid for by the subscriber.  In fact, directors may be held personally liable in the event that shares are issued in infringement.

One of the things that CRA may examine in a company audit is whether the shares were fully paid-up at the time of issuance (e.g. by way of a cheque from the subscriber to the company).  If shares have not been fully paid-up, then any dividends issued in connection with such shares may be re-characterized by CRA as loans or some other form of individual benefit.  Such re-characterization can have significant tax consequences for the company and the individual(s) in question.

Lack of a Central Securities Register

Another problem that we have noticed in connection with online incorporations is the absence of a central securities register for the company.  Pursuant to Section 111 of the Act, companies must maintain a central securities register and include in it all shares of the company which are issued or transferred, together with the following information:

  • the name and last known address of each person to whom the shares have been issued or transferred;

  • the class, and any series, of the shares;

  • the number of shares held by each person to whom the shares have been issued or transferred; and

  • the date and particulars of each issue or transfer.

Another issue that become a serious problem is that of investors. Investors will not consider investing into a company that is not properly structured and in accordance with provincial regulations. Therefore if you are looking to attract lenders your hopes have now come to an end.

Conclusion

Although online incorporations are convenient, there are risks involved which incorporators should be aware of.  The foregoing list represents only a few of the risks with incorporating online.   There are many more, especially in situations where a company requires any sort of customized legal or tax structure.

The costs associated with reorganizing a company, which was poorly organized online, can far exceed the costs associated with receiving timely legal and financial advice at the outset of the company’s formation.

Choosing to conduct business as an incorporation is the recommended coice and KAL can assist you.

- Articles of Incorporation
- By-Laws #1 & 2
- Opening Resolutions
- Shareholders Ledger
- Shareholders Register
- Directors Register
- Officers Register
- Share Subscriptions
- Share Certificates
- Initial Notice
- Business Number

EXTRAS Include;

- Articles of Amendment (if applicable)
- Certificate of Incorporation
- Corporate Seal
- Chart of Accounts
- GST/HST Registration
- Payroll Registration
- Import/Export Registration
- WSIB Registration

This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on general laws surrounding incorporations.