In this blog post, we’re looking at what you need to know about corporate share structure when incorporating in Canada.
We’ll cover the basics of share structures, discuss common pitfalls, and share some tips on how to set up the best share structure for your business.
If you'd rather have Joe explain it, you can also check out this video 👇
What is a Share?
First thing’s first, what is a share?
A share represents a unit of ownership in a company. Holding a share means you own a fraction of the company, entitling you to a portion of its assets and profits.
Typically, the number of shares you own determines how much of the company you own.
Let’s say a company has 100 shares in total. If you own 1 share, you own 1% of the company.
If you own 50 shares, you own 50% of the company. It's a simple calculation based on the total number of shares and how many you hold.
Shares can have different characteristics, which we’ll get into next. But at its core, a share represents your piece of the company and your claim on its assets and profits.
Types of Shares
Next up let’s look at the most common types of shares you’ll see.
Shares can be classified in several ways, and these classifications determine how they function within the company.
Here are the main types you need to know:
Voting vs Non-voting Shares
Voting Shares give the owner the right to vote on company decisions, like electing the board of directors. If you want to have a say in how the company is run, you’ll want voting shares.
Non-voting Shares, on the other hand, do not give the owner voting rights. Non-voting shares are typically held by silent investors who are more interested in the financial returns than in controlling the company.
Common vs Preferred Shares
Common Shares are the standard shares of a company. Common shareholders can vote and receive dividends, but they are last in line to get paid if the company is dissolved.
Preferred Shares usually do not have voting rights but have a higher claim on assets and earnings than common shares. Preferred shareholders often have fixed dividend rates.
I’ll emphasize that the “preferred” nature of the shares means that dividends are paid to these shareholders before common shareholders get paid theirs. However, this is mostly important if a company is going through financial difficulties or is in the process of being dissolved.
Share Classes
You may also see various letters assigned to types of shares. These letters typically denote the various share classes.
Companies can issue different classes of shares, each with its own set of rules.
For example:
- Class A Common Voting Shares
- Class B Common Voting Shares
- Class C Common Non-voting Shares
- Class D Common Non-voting Shares
- Class E Preferred Shares
Each class can have different voting rights, dividend rights, and other characteristics, allowing for flexible ownership and control structures.
Authorized vs Issued Shares
Another important concept to understand is the difference between authorized and issued shares.
Authorized Shares are the maximum number of shares that a company can issue, as outlined in its Articles. It’s like a pool of potential shares that can be issued in the future. For example, a company might authorize 1,000 Class A shares but not issue all of them immediately.
Issued Shares are shares that have been distributed to shareholders.
When shares are issued, they come from the pool of authorized shares. For instance, if a company has authorized 1,000 Class A shares but has only issued 100, there are still 900 authorized shares available for future issuance.
Dilution Risk
A key point to remember is the risk of dilution. Dilution happens when more shares are issued, reducing the ownership percentage of existing shareholders.
For example, if you own 100 out of 1,000 shares and the company issues another 1,000 shares, your ownership drops from 10% to 5%.
Next, we’ll look at how share structure impacts your business, particularly in terms of legal ownership, accounting, and tax implications.
Share Structure and Business Impact
Understanding your share structure is vital for several reasons, especially when it comes to legal ownership and accounting and tax implications.
Legal Ownership
First, a quick note on the legal aspect.
Your share structure defines the legal owners of the company. It’s crucial to get this right to ensure that ownership and control are clear and undisputed.
As accountants, we’re not able to provide guidance on the legal side of things. That’s why we always suggest consulting with a lawyer to make sure everything is set up correctly and in compliance with the law.
Share Structure and Dividends
Where share classification often becomes important from a tax perspective is when the Company goes to pay out dividends.
Dividends from a corporation are paid out to a specified share class in proportion to the ownership structure of that share class. This is an important concept, so let’s look at a specific example.
A Common Dividend Scenario
Imagine you and your spouse each own 50 Class A common shares.
Over the year, you’ve withdrawn a total of $60,000 from the company and need to report this as dividend income.
Because dividends are issued to a specific share class and not to a specific shareholder, you would have to issue $60,000 of dividends, which are then split between you and your spouse based on ownership.
In this case, ownership is 50/50, so $30,000 of dividend income would be allocated to each of you.
This setup might seem straightforward, but the fact that you both own the same class of shares limits your flexibility when paying dividends.
Any dividends must be paid to Class A shareholders, which means you will always have to pay out 50/50 between you and your spouse.
This can also create negative tax consequences if your spouse is not active in the company. Check out our video linked below for more details on how to pay family members from your Canadian corporation.
Recommendation
The preceding scenario is fairly easy to avoid with a bit of planning. If you are about to incorporate and haven’t set up shares, you may want to consider authorizing and issuing separate classes of shares for different types of owners to allow flexibility in how dividends are paid.
If you have already incorporated and issued just one class of shares between all shareholders, you may want to seek legal assistance to reorganize your shares so that separate classes are held between owners.
There are additional considerations when determining your share structure, but this is probably the most common pitfall that we see corporate business owners fall into. Check in with your accountant before making share structure decisions. Sometimes a 5-minute chat can save you a heap of trouble and cash.
And if you need to learn more about dividends and how they work, check out our article on how to pay yourself from your corporation.
Common Share Structure Scenarios
Now that we’ve looked at types of shares and various share structures, here are some examples of common share structures.
But remember, these are quite generic, so we recommend speaking to both an accountant and a lawyer before incorporating.
Scenario 1: Single Owner
For a single owner, the simplest structure is often the best.
In this example, you would set up the corporate share structure so that you own 100% of the company with any number of issued Class A shares. This means you have full control and receive all the profits.
We often get questions about including a spouse in ownership of the company. And in the past, we often recommended including a spouse in the share structure to take advantage of income splitting through dividends.
However, recent changes in tax laws have limited this opportunity.
Now, to pay dividends to a spouse without facing high tax rates, both spouses need to be active in the business or have made a significant investment.
This tax concept is called “Tax on split income” or “TOSI”. If you plan on having a spouse owning the company with you, check out our Tax On Split Income article to learn all about tax on split income
Scenario 2: Corporation with Multiple Owners
Next up, a useful way to set up the share structure for a company with multiple owners. To avoid the potential tax pitfalls of a single share class, a more flexible structure can be used.
Separate Share Classes: In this scenario, you could still have Class A shares for voting, but introduce Class B and Class C shares for dividends. Each owner can hold different classes of dividend-paying shares.
Let’s say you and your business partner each own 50% of the company.
You both have 50 Class A shares for voting, but you also issue 50 Class B shares to yourself and 50 Class C shares to your partner for dividends.
This way, if you have a high income one year and prefer not to take dividends, you can pay dividends only to your partner with Class C shares. Then, in a future year when your tax situation is more favorable, you can receive dividends from your Class B shares.
This setup allows you to pay dividends to each owner based on their individual tax situations and needs.
By setting up separate share classes, you gain the flexibility to manage dividends more effectively and optimize your tax situation. This is particularly useful for companies with multiple owners who have varying financial needs and tax circumstances.
Remember, these scenarios are just examples. The best share structure for your business will depend on your specific situation. Always consult with your accountant and legal advisor to determine the optimal setup for your company.
Recommendations
With all of this in mind, here are my overall recommendations around corporate share structure.
Plan Ahead
Planning your share structure before incorporating is crucial. A well-thought-out share structure can save you a lot of headaches down the line and provide the flexibility you need as your business grows.
By considering your future needs and potential changes in ownership, you can set up a share structure that supports your business goals from the start.
Get Legal Assistance
If you’re planning on incorporating, it’s a good idea to reach out to a lawyer for help.
Or if you’ve already incorporated and find that your current share structure isn’t meeting your needs, seeking legal assistance to reorganize your shares can be a smart move.
A lawyer can help you navigate the complexities of share restructuring and ensure that everything is done correctly and in compliance with the law. This can help you avoid potential legal issues and make the most of your share structure.
Save Tax by Consulting an Accountant
Proper share structure planning can also lead to significant tax savings. By setting up different classes of shares and planning your dividend distributions carefully, you can optimize your tax situation.
This is especially important for businesses with multiple owners who have varying financial needs and tax circumstances.
Consulting with an accountant can help you identify the best share structure for maximizing your tax benefits.
If you’re looking for guidance or need a hand with your share structure, we’re here to help. Just reach out through our contact form, and we’ll be happy to chat.
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