PHASE ONE – START UP
You will have to decide whether to incorporate a limited company with which to carry on the business. Only one shareholder is needed to legitimately form a company. A corporate entity affords “limited liability” to certain creditor claims. Lending institutions usually circumvent this by requiring personal guarantees on loans, so the limited liability may not be worth much, except against third-party injury claims. The alternative is to operate as a self-employed sole proprietor (or partnership, if there is more than one owner). It is cheaper and easier to initiate an unincorporated venture.
Part of your decision to incorporate should consider the tax implications of each alternative. There is no simple rule here. Much of the Income Tax Act applies equally to both forms of organization. Whether the differing tax rules favour one form over another depends upon the particular circumstances, for instance:
- What, and how much, are your other sources of income?
- Is there a possibility of income splitting with a spouse or other family member?
- What is the nature of the business?
- What are the short and long term income potentials?
- Is there potential for tax deferrals?
- Are there specific incentives in the Income Tax Act?
The decision to incorporate is not irrevocable. If you decide to operate initially unincorporated, there are provisions to create a company at a future time and “roll” the business assets into the company.
If you do incorporate, you will have to decide how to capitalize the firm. It is most common today to capitalize with low share capital and lend the balance of the funds required as a “shareholder loan”. These latter amounts can be repaid to the shareholder in the future without tax implications. Interest can be paid by the corporation to the shareholders on such loans; however, there is no legal requirement to do so.
In an unincorporated venture, the owners will capitalize the business simply by way of cash advances, usually termed “contributed capital”. Similarly, there are no direct tax consequences to the repayment of contributed capital.
Either form of organization can be financed by outside sources, like financial institutions. Interest will be deductible for tax purposes if the money was borrowed for business purposes. It is unlikely that a lending institution will finance 100% of a firm’s capital needs. It will look for a commitment of resources by the owners. Any lender will likely require a document frequently called a “business plan”. This document will attempt to “sell” the lender on the business, by providing a synopsis of the key factors, such as financing, marketing, product line, personnel expertise, management experience, etc.
PHASE TWO – UP AND RUNNING
The day-to-day book-keeping requirements are essentially the same for all forms and sizes of business organization. Your book-keeping activities need to account for the following activities:
- Cash receipts
- Cash disbursements
- Accounts receivable
- Accounts payable
You may wish to keep a separate journal for each of the above. In many small businesses, the book-keeping system compresses into only two journals; a payroll journal for wage records and a “synoptic” for all of the rest. Essentially, the synoptic captures all of the transactions that go through the bank account(s). A synoptic can be simply a columnar pad. Each transaction that goes through the bank account is entered in a column to reflect the nature of the transaction, eg rent, wages, etc. Periodically, the synoptic should be reconciled to the bank statements and the columns should be added down and balanced.
Such a system operates very satisfactorily on a manual basis; however, you may contemplate computerizing your record-keeping. A computer does not necessarily remove the drudgery and detail from maintaining a book-keeping system. Typically, a computer is useful in a small business when:
- There is a very large volume of transactions
- The management style prefers regular and up-to-date information
For tax purposes, you are required to keep the following records for six years:
- Bank statements and cancelled cheques
- Deposit books
- Books of entry
- Payroll records
The routine expenses that you will incur may include wages, supplies, interest, repairs and professional services. There are other expenditures which you incur which may qualify as business expenses, for instance;
You should retain your gas, insurance and repair bills. Paying these bills by credit card provides a simple, accurate monthly summary. You must estimate how much of your total mileage driven is for business purposes; this proportion can be written off. In some circumstances, it would be beneficial and wise to depreciate your car as well.
If you maintain an office in your home, you must set aside space strictly for business purposes. You may write off a portion of your rent, utilities, insurance, mortgage interest or property tax, as applicable.
You are entitled to write off certain expenditures of a promotional nature. Membership fees in clubs is not allowable.
PHASE THREE – YEAR END WRAP UP
Whether you are incorporated or not, you must select a fiscal period-end which, usually, will remain forever the year-end date of the business. The first year-end may be for any duration you choose, to a maximum of fifty-three weeks. There are a number of considerations in choosing the first year-end, viz.:
- The profitability of the business
- Other income sources of the owners
- The business cycle of the activity
- The potential for one-time tax deferral
If you operate as a limited company, you must submit financial statements and a corporate tax return within six months of the year-end date. If corporate taxes are owing, they are due within three months of the year-end date; after this, arrears interest will be charged. Installment interest will also be charged (except in the first year) because the taxes owing are due in periodic installments during the fiscal year.
If you operate as an unincorporated venture, you must still prepare annual financial statements. However, the income will be taxed on your personal tax return for the calendar year in which your fiscal year ends. In this instance, the related income taxes are due by April 30th of the year following that calendar year. Again, installment interest may be levied if you don’t remit periodic tax installments during the year.
Tax planning is simplified for the unincorporated venture. The net income of the business accrues to the owner(s) directly, in the same manner discussed above. Tax planning is more complicated when there is a limited company. This form of organization creates a separate legal entity. The net income of the business belongs directly to the corporation, and only indirectly to the owners of the corporation. Therefore, no income accrues to the owners unless it is specifically provided for. This usually takes the following forms:
- Salaries, wages and bonuses
- Interest on shareholder loans
- Various taxable perquisites
Tax planning, then, in the incorporated situation is the combination of income taxable to the owners and to the corporation itself. Theoretically, there is some optimal combination that will result in the least combined income taxes. The optimal combination is specific to the situation; thus no hard rules can be given. The following considerations are relevant:
- The income of the business
- The other income of the owners
- The corporate tax rate
- The owners’ deductions and tax rates
- Pension planning for the owners
- Tax history of the corporation
- Opportunities for tax deferral
You are only required to prepare financial statements once a year. However, prudent management may suggest that statements be prepared more regularly — perhaps monthly or quarterly. Your lender may require copies of the annual statements. The statements are not required by law to be prepared by professionals. It is possible that your lender might require an audit; in this case, professional accountants must be engaged. Otherwise, accountants are engaged to undertake one of two less rigorous reviews of the records.
As tax law remains increasingly complex, you are well advised to seek professional assistance, from the decision to incorporate through to the preparation of annual financial statements and tax planning. Professional fees are generally recovered with the simplification of book-keeping procedures and the optimisation of income tax liabilities. Whether the statements are audited or not, having a professional associated with their preparation usually lends credence to the statements in the eyes of lenders and the Tax Department.
THIS IS A CHECKLIST FOR NEW BUSINESSES
1. Has insurance been considered for:
– business assets
– third party liability
– life insurance/key man insurance
– business interruption
– partner insurance
– disability insurance
– fidelity bonding
2. Has WCB coverage been considered ?
3. Is Creditel or Telecheque worth considering?
4. Is the premise lease ok?
5. Consider credit card processing?
6. Consider joining Retail Merchants Association?
1. Should the business consider a line of credit
2. Considered leasing?
3. Is a business plan required?
4. Using discounts well?
1. Should GL software be considered?
2. Owner aware of accountants’ review vs compilation vs audit?
3. Is a B.I.N. number required?
4. Aware of proper physical inventory count procedures?
5. Internal control an issue?
6. Cash flow budgeting appropriate ?
7. GST registered?
8. Has PST been considered?
3. Cellular phone
4. GST cash register
1. Is there a partnership agreement, with buyout provision?
2. Security – daily deposits
3. Graph sales trends?
4. Sales forecasting appropriate?
5. Ratio analysis to measure financial health?
6. Operating name protected ?
7. Create customer newsletter or website?