Making the leap from employee to owner
Did you know that as of December 2020 there were over 4 million owner-managed Canadian businesses, including self-employed individuals?¹ So, if you or a loved one are considering making a career change and starting your own venture, you’d be in good company. But first, it’s important to think about how you'll structure your business, since choosing to operate as a sole proprietorship, corporation or partnership can impact the taxes you'll pay.
In a sole proprietorship, you as an individual own the business and are personally entitled to all the business profits. "As a sole proprietor, you can operate the business under your own name, or under a registered business name," says Jamie Golombek, Managing Director, Tax and Estate Planning, CIBC Private Wealth Management. "You're also considered to be “self-employed” but you can hire employees to work in the business."
On a T1 personal tax return, net business income is added to other taxable income (like net income from investments) to determine total amount of taxable income. Business losses can be deducted against all sources of income in the current year or may be carried back or forward.
"It's often advantageous to run a business as a sole proprietorship at first because, if losses are anticipated in the early years, they can be deducted from your other personal income," says Golombek. "Tax is levied on your net taxable income, including business income, at combined federal / provincial marginal tax rates ranging from about 20% to 54% in 2021, depending on your province or territory of residence."
Did you know?
The Canada Revenue Agency (CRA) defines a business as an activity that you intend to carry on for profit where there is evidence to support that intention.² This would include a profession, a trade, or a manufacturing operation.
Businesses are generally easy to start. If you have an idea or a skill set and the basic tools to make it happen, you can start a business. Startup businesses often need little funding and, where funding is required, government programs such as the Canada Small Business Financing program can sometimes provide assistance.
A corporation is a separate legal entity owned by one or more shareholders who are entitled to the business's profits.
"If you start a business as a sole proprietorship, you can incorporate the business at a later date by setting up a corporation and transferring the business assets to it," Golombek explains. "You can generally transfer assets to the corporation at the tax cost of the assets, so that there's no capital gain at the time of transfer."
Since a corporation is a separate entity, net business income is calculated at the corporate level and reported on a T2 corporate tax return. A Canadian-controlled private corporation (CCPC) pays tax on business income at rates ranging from 9% to 31% in 2021, depending on the province or territory in which it's earned and qualification for the small business deduction.
You can pay salary to employees, including the owner / manager of the corporation. Alternatively, after-tax income from the corporation can be distributed to shareholders as a dividend, which is reported on the shareholder’s T1 personal tax return. Since income is taxed both at the corporate and shareholder levels when dividends (rather than salary) are paid, the dividend tax credit mechanism helps to ensure that the total taxes paid by the corporation and shareholder approximately equals the amount that would have been paid had the individual earned the income directly.
In a partnership, two or more parties, such as individuals or corporations, join together to carry on a business. Each partner is entitled to a share of the business profits.
Net business income is calculated at the partnership level and is allocated to the partners according to the partnership agreement. The partners report their share of the business income as they otherwise would. For example, an individual partner includes the business income and expense items on a personal tax return, while a corporate partner reports these on a corporate tax return.
As you can see, each type of business reports income differently. There can be advantages with each type of structure from a tax perspective. For more information, read our full report Making the leap from employee to owner: Some tax considerations.
While the taxation of businesses is complex, there are also a number of non-tax factors, such as legal matters, to consider. That's why it's important to consult with the appropriate advisors, including tax and legal professionals, before implementing your business. Connect with us so we can help you to understand the financial solutions that are available for your business.
¹ "Canadian business counts, December 2020" The Daily. February 11, 2021. Statistics Canada, which is available online at www150.statcan.gc.ca/n1/en/daily-quotidien/210211/dq210211d-eng.pdf.
² CRA Publication "T4002 Self-employed Business, Professional, Commission, Farming, and Fishing Income 2020", which is available online at canada.ca/content/dam/cra-arc/formspubs/pub/t4002/t4002-20e.pdf.
This report is published by CIBC with information that is believed to be accurate at the time of publishing. CIBC and its subsidiaries and affiliates are not liable for any errors or omissions. This report is intended to provide general information and should not be construed as specific legal, lending, or tax advice. Individual circumstances and current events are critical to sound planning; anyone wishing to act on the information in this report should consult with their financial, tax and legal advisors.