| | Advantages of a Corporation | Disadvantages of a Corporation | Certain tax disadvantages | Company-owned Houses | Loans
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A corporation (or company) is another form of business organization a farm can use. A corporation is considered a separate legal “person” for income tax purposes.
Where a farmer decides to use this form of carrying on business, tax deferred rollovers and appropriate elections for income tax and the goods and services tax are often necessary to avoid immediate tax on transferring assets to the company. The individual farmer who decides to incorporate will then often become an employee of the corporation.
Advantages of a Corporation
The current tax rate in Alberta for active business income is approximately 27 per cent on the first $500,000 of taxable income each year. The tax rate on active business income above $500,000 per year is approximately 28 per cent. Investment income such as interest, rent and capital gains are taxed at a rate of approximately 46.67 per cent.
Limited liability - A corporation offers limited liability such that legal action taken by creditors can only be against the assets owned by the corporation. For the farmer with assets outside the company, this restriction offers protection.
However, where the farmer has given a personal guarantee on a loan to the corporation, the advantage of limited liability is greatly reduced. In addition, directors of corporations can be held personally liable for certain company debts - for example, payroll remittances.
Income splitting - The corporation may pay both spouses a salary for services rendered. In addition, dividends may be paid to shareholders even though they may not be active in the operation. This way, income splitting can result with the advantages of using low marginal tax brackets and available personal exemptions. See section on Income Splitting.
Continuity - A corporation can live forever, and therefore in an estate situation, the individual who has passed away may have simplified his or her affairs.
Disadvantages of a Corporation
Additional costs - Starting a company means incurring both legal and accounting fees as well as ongoing annual fees to maintain the company.
Additional administration - With a corporation, more formal documentation such as a complete set of financial statements including a balance sheet is required.
Certain tax disadvantages
- lack of principal residence exemption for houses owned by the company;
- taxable benefits for any personal use of company assets such as cars or houses;
- corporate losses cannot be transferred and used personally;
- "750,000 capital gains exemption" to "lifetime capital gains exemption"
- companies are not eligible for the $750,000 capital gains exemption on the sale of any farm assets. Shareholders may be eligible for the exemption on the shares of the company if qualified, but this exception does not assist the company on a sale of a company asset.
- without proper planning on death, two levels of tax could result - once on the deemed disposition of the shares of the company if it does not meet any special rollover rules and secondly, on extracting funds from the corporation.
Company-owned Houses
Individuals who live in a company-owned house will also be subject to a taxable benefit. The amount of this benefit is not always clear. Often, the benefit is equal to what an arm’s-length person would have paid for the use of the house. However in some cases, The Canada Revenue Agency has taken the view that the taxable benefit should be based on the greater of the fair market value or cost of the house times an interest factor. This approach can lead to a very significant taxable benefit.
Loans
Low-interest or interest-free loans from a corporation to an employee also result in a taxable benefit based on the prescribed rate set quarterly by the Canada Revenue Agency.
Where the individual receiving the loan is a shareholder (or connected thereto), the entire amount of the loan may be included in personal income. In effect, this is double taxation since the company receives no deduction for this loan. To avoid this problem, the loan must be repaid within one year of the end of the corporation’s taxation year in which the loan was made. In addition, the repayment cannot be a part of a series of loans and repayments. If not repaid, the income inclusion is for the taxation year in which the individual received the loan.
Certain loans to shareholders may be exempt from this income inclusion if they are:
- qualifying loans made in the ordinary course of the lender’s business;
- a qualifying loan to purchase a home;
- a loan to purchase shares in the employer (company);
- or a loan to purchase a car to be used in employment.
Even if the loan is for one of these qualifying purposes, certain additional conditions must be met. These conditions include bona fide repayment terms, and the reason for the loan should be because of the shareholder’s employment versus shareholding.
Loans to shareholders included in the shareholders’ income are not subject to the deemed interest benefit; however, all other loans are subject to an interest benefit.
Note that if an individual uses a loan to make an investment that will result in taxable income, the interest benefit on the loan from the company is also eligible for deduction in the hands of the individual as a carrying charge. |
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