Tax Deferral: A benefit of incorporation in Canada

In this blog post we will cover a common question we get from clients.

That question is: “What is the advantage of incorporating in Canada?”

The common answer most accountants will give you is the following: “Incorporation doesn’t allow you to save taxes but rather, is allows you to defer taxes”.

What does “defer taxes” mean?

Let’s take a closer look at understand what tax deferral means.

What is tax deferral?

In plain English Tax deferral means, you “defer” taxes so that you don’t pay income tax on all of your income today, instead, you can leave the income you earned inside a corporation and pay personal tax on it when you withdraw the income at a future date.

Still confused?

Not to worry, we will look at a real-life example and understand how this works. But first, a note about corporate and personal tax rates in Canada.

Corporation Tax Rates vs. Personal Tax Rates

When it comes to tax rates, corporate tax rates in Canada are much lower than personal tax rates. 

If you’re a Canadian resident and own a corporation, it will likely be eligible to qualify to be a Canadian Controlled Private Corporation (“CCPC”) which enjoys preferential tax rates for small businesses when compared to tax rates paid by individuals.

For a quick comparison, if you’re a doctor earning $300,000 in Ontario, your average tax rate will be ~39.08%.

On the other hand, a CCPC enjoys preferential tax treatment whereby, income up to $500,000 will be taxed at ~14.20%.

Therefore, all things being equal, if you’re a doctor earning $300,000 you would rather try to pay tax at ~14.20% than paying tax at ~39.08%.

A Real Life Example

Let’s continue our discussion from the above section and look at a scenario where our doctor who earns $300,000 doesn’t need all of the income in a single year.

Instead, he will personally take $100,000 and leave the rest of the funds in his corporation.

In this case, the total tax burden will be lower at $50,058 vs. earning this income and paying tax personally of $117,245. 

Therefore, in any given year, our doctor will pay less tax on a combined basis i.e. personal and corporate tax rather than, earning all of the income personally. 

A note about the examples above, they are meant to be simplistic and illustrative, real-life scenarios could result in some differences from the example above.

Why is tax deferral helpful?

The main reason why tax deferral can be quite helpful to a business owner is that you save on paying taxes today. This allows you to push the tax liability you owe to a future date, and it allows your corporation to have more after tax dollars to invest in your business.

Using the example above, we can calculate the after-tax cash flow left for our doctor when he is not incorporated vs. when he is incorporated.

You can see from the above, that the doctor who is incorporated has much more after-tax cash flow left over. Therefore, these extra funds can be used to invest in your business so that it can grow, or you can use the extra funds to make other investments.

The bottom line is this: Instead of paying more taxes to the CRA today, a corporation allows you to defer tax, and therefore keep more of your after-tax cash flow which can be invested sooner, and it can grow. Instead of paying more to the taxman, you use the tax deferral to help your business grow!

If you’d like to learn more about the reasons why you should incorporate, be sure to check out our blog post covering the top 5 reasons why you should consider incorporation here.

Are you thinking of incorporating your business? Let us help you. Get in touch with us here or sign up to get more accounting and tax tips in our newsletter here.

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax circumstances and/or objectives.