Incorporating a company has many benefits. But before incorporating, it is imperative for you as a business owner to devise a share ownership structure that suits your needs. This is because corporate share structure has legal, accounting and tax implications. A share determines three rights of a shareholder; the right to vote, the right to receive dividends, and the right to receive the company’s remaining assets on liquidation.
In this article, we will look at various aspects to consider when planning corporate share structures.
The Classification of Corporate Shares
There are various types of shares, and each type has different rights. As stated before, the significant difference in share types is voting, dividend, and preference in the estate during the dissolution of the company. There are two major types of shares:
Preference shares – They get preference over common shareholders in receiving dividends and estate. They get dividends at a fixed rate as decided at the time of the issue. They hold no voting rights in the company, which means they cannot influence management’s decisions. For a company, preferred shares are an excellent option to raise money at a fixed price while retaining decision-making rights. They are ideal for passive investors and inactive business partners.
Common shares – Common shares give their holders all three rights, but they get priority after preferred shareholders. Common shareholders generally have voting rights, but you can issue common non-voting shares as well. These shareholders are entitled to receive dividends when the company makes profits and when directors decide to pay dividends. They are also entitled to other corporate actions like share buyback and rights issues.
Common shares are used to raise capital, acquire a stake in the company, and influence the management’s decisions. These shareholders also have a right in the estate during liquidation but after preferred shareholders.
You can customize shareholders’ rights by issuing several classes of preferred and common shareholders, like Class A common voting shares, Class B common voting shares, Class C common non-voting shares, and Class D preferred shares. For instance, you can grant Class A shareholders some extra privileges in the rights issue or vote for new board member elections.
Things to Consider For a Corporate Share Structure
Now that you understand the relevance of each share type, you can create a corporate share structure depending on your requirement. A shareholder can be a company or an individual. Every shareholder of a particular class of shares will have the same rights depending on their number.
Hence, if you want to have more rights over others, you might be tempted to create a share structure with different classes. Therefore, you should consider your objective when planning the corporate share structure.
- If you intend to retain ownership of your business, you might consider preferred shares and common non-voting shares for raising capital. In addition, you may keep common voting shares within the family.
- The share structure can also set the course for future mergers and acquisitions and estate freezes.
- If you want to attract investors to raise capital, you might consider issuing more common voting or non-voting shares. Here you will pay dividends only when the company makes profits.
- Many companies also give employee stock options to directors, contractors, and other senior management. Again, you might want to consult your accountant and legal consultant to explore these options.
- The share structure also has tax implications like income splitting, dividends, and capital gains exemptions.
Tax Implication of a Share Structure
Let us understand in length how the share structure can impact your taxes. In Canada, dividend income is taxable. As a business owner, you can withdraw profits from the business in several ways, including salary and dividends.
Initially, many business owners split the income by giving dividends to adult family members not active in the business and have little income. This way, they could withdraw more and pay less tax. But the Canada Revenue Agency (CRA) reduced this benefit by implementing new rules on tax on split income (TOSI), with effect from January 1, 2018.
For instance, you and your spouse are co-owners, holding 100 common shares each. You withdraw $50,000 a year in dividend income. As per the rule, every share of a certain class has equal rights. Hence, you can split the dividend income into $25,000 for each owner.
Now, your spouse is not active and never was involved in the business. As per the new TOSI rules, the CRA will charge the highest tax rate to the inactive shareholder, nullifying the benefit of income split. You can resolve this issue by smartly planning your share structure.
You can create two share classes, with each type having different dividend rights but equal voting and ownership rights. For example, you can own Class A common voting shares entitled to dividends and withdraw $50,000 as dividend income. Your spouse can own Class B common voting shares which are not entitled to dividends.
This is just one scenario. There are many scenarios where a flexible share structure can have significant legal and accounting implications. Talk to an expert to find your ideal share structure.
Experts at Edelkoort Smethurst Schein CPAs LLP can help you plan and implement an effective corporate share structure that meets your business objectives. Our Chartered Professional Accountants are highly skilled and serve businesses throughout Burlington and the surrounding area. To speak with a knowledgeable member of our team, please contact us online or by telephone at 905-517-2297.