Sole proprietor to corporation: a step-by-step tax checklist

Set the date and pick the registration route

This checklist assumes you have already decided to incorporate. If you are still weighing the choice, start with the guide and estimator on whether to incorporate. What follows is the order of work once the answer is yes, and the order matters because several later steps are measured from the day the corporation starts operating the business.

Choose a start date for the corporation’s operations and write it down. It is usually close to the incorporation date, but the two are not always the same, and the sole proprietorship’s last day of trading should line up with it so that no sales or expenses fall between the two entities. Decide at the same time whether you will incorporate federally or in Ontario. The federal government notes that a federal corporation can carry on business anywhere in Canada and gets stronger name protection, while some owners prefer provincial incorporation. Either way, the registration is the legal step. The tax steps below are separate and are not done for you by the incorporation filing.

Register the corporation with the CRA

A corporation is a separate legal entity, so it needs its own business number. The CRA says you need a business number when you incorporate, and that you can only have one business number for the same legal entity. When you incorporate federally, or in Ontario, you receive a business number and a corporation income tax program account as part of that process, so you do not register for that account separately. The CRA also lists changes to legal ownership or business structure as situations that can require a new business number, which is why your existing sole proprietor number should not be assumed to carry over.

Other program accounts are separate. If the corporation will sell taxable goods or services and is not a small supplier, it will generally need its own GST/HST account. If you will pay yourself or anyone else a salary, it needs a payroll deductions account before the first pay date. The CRA’s registration page lists what you will be asked for, including the incorporation date, jurisdiction and certificate number, for GST/HST the fiscal year-end and reporting period, and for payroll the number of employees, expected salaries and pay frequency. Having those ready avoids a second round of registration. The registration checker tool can help you test the GST/HST question.

Decide how the business assets move across

Equipment, inventory, receivables, vehicles and goodwill that you own personally do not become the corporation’s property just because you incorporated. Each asset has to be sold or transferred in, and the tax result depends on how. If you transfer at fair market value, you may report income or a capital gain for the difference between that value and your tax cost. If you qualify, section 85 of the Income Tax Act lets you and the corporation jointly elect a lower amount for each property so that the tax is deferred. Eligible property is limited, so ask your accountant whether each asset qualifies before you assume it does.

The rules for the election are specific. The consideration you receive has to include at least one share of the corporation, or the election is not valid. The election is made on Form T2057, with a separate agreed amount for each property, although a whole class of depreciable property can be reported in total with supporting schedules kept on file. The CRA’s circular says the deadline is the earliest date on which any party to the election must file a return for the year of the transfer. That circular is dated 1996, so confirm current practice with a professional rather than relying on it alone. Late elections are possible but can carry a penalty.

Keep the working papers behind every value: appraisals, invoices, a list of equipment with original cost and undepreciated balance, and your basis for any goodwill figure. Goodwill is now treated as depreciable property in Class 14.1, so the allocation affects the corporation’s future deductions.

Handle GST/HST on the transfer

Moving a business into a corporation is a sale for GST/HST purposes, so the question of whether tax is payable on the transfer needs an answer. Under the joint election on Form GST44, no GST/HST is payable on the sale of a business or part of a business if the buyer acquires at least 90% of the property needed to carry on the business. The election cannot be used if you sell only individual assets, or if the seller is a registrant and the buyer is not. That second rule is why the order of registration matters: if you are registered and the corporation is not, the election is not available.

The buyer files the form by the due date of the GST/HST return for the first reporting period in which tax would otherwise have been payable. Even with the election, GST/HST can still apply to taxable services, to leases and licences, and to a taxable sale of real property to a buyer who is not registered. Then deal with your own account. Your sole proprietor GST/HST account can be closed once you stop making taxable supplies in that name, with a final return and a cancellation date. Ask your accountant whether to close it or keep it open for a short period to finish collecting and reporting.

Set up payroll, books and the first T2

Starting on the corporation’s first day, keep its money separate. Open a business bank account in its name, move any credit cards and loans only with the lender’s agreement, and record the assets you transferred as a purchase, usually in exchange for shares or an owner’s loan. Document what you were paid and how. A balance left owing to you in the corporation’s books is a shareholder loan, and it should match the transfer agreement. Bring the opening balances to your bookkeeper so the first month starts clean.

Income you earned personally before the transfer date is still reported on your personal return, along with the final sole proprietorship results, while income after that date belongs to the corporation. The corporation’s first return is due within six months of the end of its first tax year, which is generally its fiscal period, and you choose that year-end, so decide it with your accountant. Pay yourself through payroll or dividends according to a plan, not by withdrawing whatever is in the account; the guide on salary versus dividends covers the trade-offs.