Winding Down a Corporation to a Proprietorship
By: Nizam Shajani, CPA, CA, MBA, Partner
When circumstances change such that operating a corporation no longer maintain those advantages and a sole proprietorship would be more beneficial – tax considerations should be accounted for in this wind down. The same factors that were considered when contemplating a corporation structure may be used to decide the benefits of winding down an existing one. Generally, these include simplification and loss or minimal income generations verses limited liability and various tax advantages.
Lower administration costs of no longer requiring a separate corporate tax return or annual filings with registries and maintaining a corporate minute book may be enough to sway your decision to wind down the company. Financial statements are also no longer required as the income statement is now included on the proprietor’s personal tax return.
There are other considerations. There is loss of limited liability for owners which can be a real factor if the business has large accounts payable to vendors and creditors that cannot be paid. The owners are now personally liable and no longer considered a separate entity from the business.
Obligations that are not transferred to the individuals would result in a void. As such, the directors of the corporation could face liability if they do not discharge all the corporation’s obligations. The corporation may also have security agreements with lenders that prevent or restrict the transfer of assets without consent being granted. Lenders should therefore be considered in this process.
Property that is transferred from the corporation to the individual may require a transfer title of assets from the corporation to the proprietor which can be costly. There may also be a coverage gap for insurance on property that has transferred and should be addressed.
If a company has employees, a wind up could trigger termination and renewal of employment contracts, a change in the status of employer CPP contributions, potential payout of vacation pay and severance obligations (under the Employment Standards Code (Alberta)) and the transfer of employee benefit plans.
As an added benefit, losses from the business would be deducted against other sources of income of the proprietor in future years, such as investment income or employment income. However, any future profits of the business are subjected to much higher rates of tax in the hands of the proprietor than if earned by a corporation.
The wind down process does have some immediate legal procedures and compliance reporting requirements (ie. voluntary or formal dissolution) that have a legal cost that would not otherwise be incurred.
The dissolution of the corporation and wind down is a taxable event. Before proceeding, some careful tax planning should be undertaken with your accountant to quantify the expected tax costs and savings that result because of winding down a corporation to a proprietorship. This includes gains from the transfer of assets from the corporation to the individual,
Tax may be payable by the corporation on any unrealized gains on assets that are distributed to the owner even though there is no cash received from which tax can be paid. Tax may also be payable by the individual. There can be taxable dividends in the hands of the owners to the extent assets are distributed directly to them from the corporation. GST/HST should also be considered on the transfer of this property. GST/HST may need to be billed, collected and remitted even though the proprietor will be entitled to claim an Input Tax Credit.
The corporations various tax account balances should also be considered to achieve tax efficiencies and minimize tax burdens. There may be unclaimed losses from prior years, General Rate Income Pool amounts and Capital Dividend Account balances that will be stranded in the corporation following the dissolution.
An additional consideration is that there is no Capital Cost Allowance (CCA) claim available to the corporation in the year of disposition and the proprietor will be subject to only the half-year CCA limitation in that year. The timing of the wind down may affect overall taxes from one entity to the other.
With much to consider, a successful wind down would result in simplification and cost savings. Consulting your accountant would be a prudent first step.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.