Deciding on a Share Structure for a Canadian Small Business
Incorporating your business is a significant step, and understanding the implications of your share structure is crucial to ensure you have the right options and flexibility for compensation, control, and unforeseen circumstances.
It’s quite common for a new business owner to rush to a registry and incorporate a company without putting much thought into the significance of their choices, which can require expensive share capital reorganizations down the road to fix.
This guide delves into the tax implications and benefits of different share structures for small businesses from an accounting perspective to help you avoid those common mistakes.
The Impact of Share Structure on Your Business
The structure of your company’s shares has significant implications for legal ownership, control, and distributions of the company’s earnings as dividends. As CPAs, we’ll focus on the tax outcomes of different share structures for this article.
Share Attributes
Shares represent ownership in a company and come in various forms:
Voting vs. Non-voting Shares: Voting shares grant decision-making power and the ability to effectively control a company, while non-voting shares tend to be for passive investors.
Common vs. Preferred Shares: Generally, common shares are tied to the company’s growth, whereas preferred shares often have fixed values and priority over common shares.
Share Classes (A, B, C, etc.): Many different classes can be created, each with unique attributes for voting, dividend rights, etc.
These distinctions are vital for tax planning, or when corporate reorganizations are performed such as estate freezes and rollovers, ensuring each shareholder's interests and contributions are properly managed.
Share Structure and Dividends
When a company distributes dividends, it does so according to its share class ownership. The options for distribution are critical for tax planning.
Example Scenario:
You and your spouse each hold 50 Class A common shares.
You decide to withdraw $60,000 from the company as dividends.
Each of you receives $30,000 in dividends, which must be divided equally due to your equal ownership of Class A shares.
This equal split can result in very unfavorable tax consequences, particularly with recent changes to tax on split income (TOSI) rules if your spouse is not actively involved in the business.
Tax Impact:
You pay almost no personal tax on your $30,000 dividend from the corporation, as you’re reinvesting in your business instead of drawing out most of its earnings and this is your only source of income for the year.
Your spouse pays over $10,000 in personal tax on their $30,000 dividend due to the TOSI rules, which cause the income to be taxed at the highest marginal rates.
With separate share classes, this tax outcome can be avoided because it provides you with the flexibility to pay different dividend amounts to the different classes, and avoid tax catastrophes like TOSI. For instance, if you held separate share classes and instead declared the entire dividend on only your class of shares, it could cut your family’s tax bill in half.
Issued or Authorized?
Authorized Shares: These are shares that a company is allowed to issue, but they aren't necessarily owned by anyone. The company can specify or authorize an unlimited number of shares, and many different share classes with specific attributes to keep options open for new investors or business reorganizations down the road.
Issued Shares: These shares have been “subscribed” to by the shareholders, indicating actual legal ownership.
Final Thoughts
Deciding on an optimal share structure is essential to minimize your tax liabilities and maximize your flexibility. There are also significant legal implications, which are outside of the scope of this article.
In general, it’s often beneficial to ensure that separate share classes are subscribed to by the founding shareholders of a company, and that many additional classes are authorized to provide for flexibility down the road. You’ll also want to be certain that control of the corporation is properly assigned or divided through the voting shares that are issued.
It’s also a great idea to consult with your accountant before making share issuance decisions. A five minute conversation can save significant time and money, ensuring your business is setup for success from day one, or that you aren’t triggering unintended tax consequences down the road.
For tailored advice on setting up or changing your corporate share structure, please don’t hesitate to reach out to us at Clearpath Accounting - we’ve helped many clients through this process, and would be happy to help!
Clearpath Accounting provides resources such as this for general information purposes. The topics are dynamic, time-sensitive, and complex, and may not apply to your particular facts and circumstances. The information provided should not be relied upon as a substitute for specialized professional advice in connection with any particular matter.