Employee deductions and expenses as an owner-employee.
While employees at arms-length have been permitted to deduct certain employment expenses pursuant to section 8 of the Income Tax Act, the Canada Revenue Agency has taken issue with employees who are also shareholders of the corporate employer. That is, employees who are sole directors, shareholders and officers of the corporation have been increasingly scrutinized by the CRA.
Back in 2009, the case of Adler v. R, 2009 TCC 613 (informal procedure), the Tax Court of Canada held that since the appellant was the sole officer, director and shareholder of his employer, a refusal to incur the job related expenditures would yield no adverse consequences for him. On the basis of this reasoning, the Court dismissed the appeal.
So can I deduct my employment expenses?
It is arguable that this case should be limited to its facts and possibly not applicable in all situations. Firstly, the decision in Adler is silent on whether there was an employment contract in place explicitly requiring the employee to incur certain costs. Secondly, the Courts interpretation of “adverse consequences” is quite narrow indeed, appearing to be limited to an action for breach of contract, disciplinary action, and / or poor performance review – quite simply, this cannot be true as there may be negative financial consequences such as lost profits, inability to meet third party obligations, or the inability to pay salary to arms length employees.
What is required before I deduct employment expenses?
One thing is certain, section 8 of the ITA details some specific requirements before any employee can deduct certain employee expenses – among other things, a good starting point is to always have an employment contract with specific provisions detailing what are the requirements of the job is and what expenses the employee may be responsible for without reimbursement.
If you are a sole director, shareholder, and officer of a corporation and are considering becoming an employee of your corporation, let the lawyers at Erudite Law LLP assist you in reviewing your options. Please feel free to contact us – https://eruditelaw.com/#contact.
The Benefits of Incorporation
Are you a small business owner? Have you put your blood, sweat, and tears into growing your business and pursuing your passion? Perhaps profits have been rising, and you have surpassed that 2 year mark, a milestone which 30% of small Canadian businesses fail to ever reach. If any of this resonates with you, then it could be time to start considering making structural changes to your business, and giving greater thought to the benefits of incorporation.
There are many different ways you can do this and at Erudite Law we can help you figure out what makes the most sense for you and for your business. If incorporation is the next logical step for your business to take, then keep reading and let Erudite Law help you understand what it is and how it works.
Taking the step to incorporate a for-profit corporation can be complicated and daunting to those who are not entirely familiar with the process. You will need to decide if you want to incorporate provincially or federally. You will need to decide on the name you wish to adopt, determine if it is available and if it complies with the laws of Canada and the Province of Ontario. You will need to consider share provisions, and organizational structures. Choosing the right law firm can simplify this process; by placing the burden of these considerations on us, you will be able to free your mind and your time so that you may focus on growing your business.
Corporations protect the personal assets of shareholders
A corporation protects its shareholders through what is known as ‘limited liability’. The act of incorporation places a “barrier” between the individual and the corporation, protecting the shareholder’s personal assets from the risks of the business. For example, in the event of bankruptcy, the losses of the shareholders will be limited to what they have invested in the corporation. To put it simply, in the unfortunate event that a business goes belly up, the shareholders will be protected from losing their personal assets, such as their cars or their homes, to cover the debts of the corporation.
Corporations can produce attractive tax benefits
There are many tax benefits that come with having a corporation. For example, family members may be employees of the corporation. This would allow the corporation to pay a salary to their spouse or child and deduct the salary as an expense of the corporation, reducing the corporation’s earnings and the amount on which it will be taxed. You also have the opportunity to decide how you would like to pay yourself, through a salary as an employee or through dividends as a shareholder. Additionally, the corporate tax rate is generally lower than personal tax rates, depending on which tax bracket you fall into. If you decide to pay yourself through a salary, you may modify your salary to allow for a smaller sum to be taxed at your personal tax rate and leave a larger amount of the corporation’s profits to be taxed at the corporate tax rate. As a simplified example for illustration purpose only, if a business makes $400,00.00 a year in net profits, as a sole proprietorship all of these earnings would need to be taxed at your personal tax rate. Whereas with a corporation, you may pay yourself a minimal salary, leaving the remainder in the corporation to be taxed at the, often lower, corporate tax rate.
Corporations are better at raising needed funds
In the event that you are able to secure investors, a corporation would allow you the ability to sell various kinds of shares in the corporation in exchange for dividends on the profits of the corporation or even voting rights.
Corporations have the capability of living forever
Lastly, corporations have what is known as perpetual existence. Essentially, this means that a corporation will continue its existence even if the owner of the corporation changes. This allows an exit strategy for owners and for simplified estate planning. For example, if your business does incredibly well and you find someone who is interested in purchasing it from you, you will be able to sell all of the shares of the corporation and change ownership with minimal disruption to the day-to-day operations of the business. This also offers an exit strategy upon retirement. Additionally, you may leave the shares of your business to your children or grandchildren in your Will allowing the business to continue and giving your successors the benefit of the goodwill you worked so hard to create.
For information on Professional Corporations, check out our Professional Corporations blog post.
Let us help you!
Having the right guidance, as you grow your business and plan for your future, is imperative to success! Let Erudite Law guide you through the process, so that you can remain focused on your business. If incorporation does not sound like the right option for you, stay tuned as we explore various other business structures (or give us a call for more information)!
For more information, call us at 905-471-6161 or email us at firstname.lastname@example.org.
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