One of the most common questions we accountants get from our farming clients is whether to structure their business as a proprietorship, partnership or corporation. To determine which structure makes the most sense to you, there are a variety of factors you need to consider:
Simplicity and administrative costs
Partnerships and proprietorships are a lot simpler to administer than corporations. For example, financial statements are not always required, thereby reducing accounting and bookkeeping complications and costs. Another example is that no separate corporate tax return needs be prepared for the business as it’s just included with the personal tax return.
In the case of partnerships, legal advice may be required to register the partnership’s name and prepare a partnership agreement.
For corporations, accounting and bookkeeping costs will be higher because of the added complexity of the corporation and the necessity to prepare financial statements along with separate corporate and personal tax returns. Additional legal costs will also be incurred to set-up the corporation and prepare annual shareholders’ resolutions.
With partnerships and proprietorships, all personal assets (not just the business assets) can be exposed to the creditors of the business. Additionally, in the case of partnerships, each partner is jointly and severally liable for the actions of the other partners. This means that even if only one of several partners is negligent, all of the partners can be exposed to the accompanying loss.
The corporation, because it is a separate legal entity, provides protection of personal assets from creditors. It should be noted though that lenders often require personal guarantees for corporate debts anyway that would offset some of this protection.
Canada Pension Plan
Like employees, proprietors and partners must make Canada Pension Plan (CPP) contributions on their business income. However, unlike employees, self-employed individuals must pay both the employer and employee share of the CPP premiums. For example, the self-employed maximum CPP contribution in 2018 (assuming at least $55,900 of income per individual) would be $5,187.60, compared to $2,593.80 for an employee.
However, even though the self-employed individual pays double what an employee would pay, the benefit they will receive from CPP will be the same. For this reason, the return on investment for self-employed individuals on the CPP is not great. This is especially true if the business owner happens to die prematurely. While there is a CPP benefit for survivors, it only brings the survivors income up to the maximum CPP an individual can receive. In other words, if the survivor is already receiving the maximum CPP benefit based on their own contributions in the past, they will receive nothing more upon the death of their spouse.
For corporations, CPP also has to be paid if salaries are paid to the shareholders. However, shareholders also have the option of being paid dividends instead of salaries. Since CPP contributions are not required on dividends, shareholders could instead invest the CPP premiums saved in an investment account (such as an RRSP or TFSA) that could potentially provide a higher return than CPP for disciplined individuals. This option of being paid dividends to save CPP is not available to proprietorships and partnerships.
Workplace Safety and Insurance Board (WSIB)
To split income with family members in a proprietorship or partnership, you need to pay them a salary. This salary would not only be subject to tax withheld and CPP but also to WSIB insurance premiums.
With a partnership, the partners do not have to pay WSIB on their income allocations. However, any wages to non-partners (such as the owners' children) would be subject to WSIB.
With corporations, it is possible to avoid WSIB on wages to children if they are made directors or officers of the company (as long as they are active in the business). These children do not have to be shareholders in the company to be appointed as directors or officers.
Deductibility of losses
For proprietorships and partnerships, any losses for tax purposes from the business can be deducted against other sources of personal income. For corporations, losses can only be used to offset business or property income within the corporation.
If losses are expected in your farming business and you have other income sources (i.e. from off-employment), it may be preferable to have a proprietorship or partnership over a corporation to be able to use these loses against your employment income. However, it should be noted that the amount of proprietorship or partnership losses that can be deducted against personal income may be restricted or even denied entirely by the CRA if it can be established that there is no reasonable expectation of profit.
and partnerships are exposed to progressively higher tax rates as taxable income increases. This means that profitable businesses could be paying income tax at rates over 50%, therefore limiting the amount of after-tax cash available to invest in the business.
Corporations, on the other hand, have a flat tax rate of only 13.5% in Ontario (reducing further to 12.5% in 2019) up to $500,000 of taxable income. This low rate of tax means there is more money available in the business to pay off debt, invest in assets and meet working capital obligations compared to partnerships or proprietorships.
As an example, let's assume the business has a $250,000 interest-free loan. Owner A is incorporated with a tax rate of 12.5%. Owner B is not incorporated and has a tax rate of 40%. Owner A would require $285,715 in profits to retire this loan at 12.5% tax. Owner B would require $416,667 on profits to retire the same loan. In other words, Owner A would be well on his or her way with their next asset acquisition before Owner B can handle another loan. The addition of interest in this example would only make the Owner A scenario even more attractive.
If should be noted that this deferral advantage would be lost if all the corporate profits were paid out to the shareholder. However, this is not a concern if the goal is to re-invest and grow the business as is often the case with farming businesses.
It should also be noted that the deferral advantage for corporations increases as income increases. For businesses with lower incomes, there may be little to no tax deferral advantage at all.
Capital gains exemption on farm property
There is a $1,000,000 capital gains exemption per individual on the disposal of eligible farm property (i.e., such as land and quota).
It is easier to realize this gain with a proprietorship or partnership as individual assets can be sold outright and the exemption can be claimed. Each individual is entitled to this exemption, so it is an advantage to have a partnership over proprietorships as the capital gain exemption would be multiplied (i.e., two partners would have a $2,000,000 capital gains exemption, compared to only $1,000,000 with a proprietorship).
For corporations, it is more complicated to claim this exemption on individual property as compared to proprietorships and partnerships. This is because the corporation itself does not have a capital gain exemption - only the shares of the corporation qualify. Therefore, to claim the exemption on individual property, the asset must first be rolled into another corporation. This creates additional administrative costs, lack of flexibility and other complexities that you would not have with a proprietorship or partnership.
Note that is possible to hold certain assets, such as land, personally and also have the active businesses operated in a corporation.
Many government benefits, such as the personal HST credit, Employment Insurance (EI) maternity benefits, the Canada Child Benefit and Old Age Security are affected by the amount of income reported on the personal tax return. In the case of proprietorships and partnerships, all of the income generated from the business has to be reported on the personal tax return regardless of whether it is actually needed for living expenses and this could limit or eliminate these benefits.
a corporation, you can limit the amount of wages and dividends paid to the shareholders and therefore it is much easier to qualify for these benefits.
Corporations can choose a non-calendar year-end for tax purposes. The main advantage of this is to provide a window of time to plan in advance for personal taxes which are always based on the December 31 year-end. Another advantage is that the year-end can be chosen at a time when the business is not as busy and you have more time to attend to the year-end administrative work.
and partnerships cannot choose a non-calendar year-end without suffering adverse tax consequences.
Under Ontario law, secondary Wills can be set-up to address the shares of private corporations. The advantage of doing so is that the assets of the corporation would not subject to probate tax upon the death of the shareholder which can be up to 2% of the value of the business.
It is not possible to set-up a secondary Will to deal with the business assets of proprietorships and partnerships. Therefore, the probate tax cannot be avoided.
This article outlines only some of the major advantages and disadvantages of each type of business structure. There are many additional complexities that cannot be addressed in a single article. Therefore, it is important to get professional advice to determine which business structure is right for you. Collins Barrow can provide that professional advice to make sure you make the right decision.