If you’re considering or in the process of setting up a new Canadian Business, chances are you’ve come across the various types of shares and ownership structures. Below we’ll provide some clarity on their differences to help you make a more informed decision regarding your business set-up.
Here at McNabb Lucuk LLP, we are happy to discuss the individual factors that pertain to your situation to help guide you in making the right decision for you, your family, and your business.
- Common or Preferred: Common and Preferred share designations determine how dividends are allocated to the share. Preferred shares will often have payment terms outlined whereas common shares are declared by the shareholders at their discretion.
- Voting or Non-Voting: One of the major distinctions between shares is Voting, meaning their allocation is proportionate to their control in decision making in the business, and Non-Voting, which are often provided to “silent investors”.
- Classes : Share classes, denoted by a letter starting, is how a selection of shares, as characterized by their classifications from above, are differentiated and listed. Examples:
- Class A Common Voting Shares
- Class B Preferred Non-Voting Shares
- Authorized Shares: During the setup of a business, the owner(s) may choose to create a type of share but not allocate them to any shareholders. These would be considered Authorized Shares, and they are available to allocate to owners through sale or assignment.
- Issued Shares: Once a share is assigned to an owner or shareholder, it is considered an Issued Share. Only Authorized Shares can be issued.
Impacts of Share Structure on Your Personal Income
The creation of shares impacts the legal ownership of a business as well as the accounting and taxation of dividends issued and received by the shareholders.
For the purposes of taxation, share classification becomes important when dividends are declared. When a corporation declares a dividend, it is paid out to a specified share class in proportion to the ownership structure of that share class.
A common example, which can often cause concerns at taxation time, is a husband and wife who equally own a business. For this scenario, we will assume they both own 25 Class A common shares.
The business owners withdrew $50,000 in one year from the business and would be required to declare it as dividend income at tax time. As the dividends are issued to the class of share and not the individual, both the husband and wife would declare a $25,000 dividend or a 50/50 split.
In this example, if the husband or wife was employed or owned another business where they received additional income or dividends, the 50/50 split may put that individual into a higher tax bracket. If this shareholder can not prove that they are active in the operation of the business, they may also suffer a negative tax consequence by paying the highest rate possible on the dividend.
Improving Your Share Structure
If you have not set up your share structure, authorizing more classes of shares than you initially need can build in important flexibility for future growth and share allocation. In the example above, the high tax rate on the non-active shareholder could be avoided while still retaining the same ownership division by issuing 25 class B voting shares to one shareholder and 25 class c common voting shares to the other. The business could then declare dividends for the class of shares held by the active shareholder only to decrease the tax owed.
If your business is already incorporated with the share structure set-up, you can still authorize additional classes of shares but you may wish to seek legal guidance to reorganize how the new share classes are held between shareholders.
Contact your accountant or reach out to McNabb Lucuk LLP by phone at 780-539-3400, or email [email protected] or [email protected] before you file your articles of incorporation – it could save you time, money, and confusion with shareholders.