A recent Ontario Superior Court of Justice decision is a good example of how the courts can grant relief to minority shareholders of a family business where there has been unfair conduct denying reasonable expectations.
The relevant facts of Tannenbaum v. Tanjo Investments Ltd. are quite simple. There were seven shareholders in a family business. One shareholder (the Applicant in the case) owned 1/3rd of the shares. The other shareholders each owned 1/7th of the shares. The Company paid dividends equally to each shareholder regardless of the fact that the Applicant owned three times the shares of the others. The Applicant applied to court under the oppression remedy.
The Court ruled that the reasonable expectation of a shareholder is to receive dividends proportional to their holdings. As a result the company was Ordered to compensate the Applicant accordingly.
Connolly Nichols Allan & Snelling is an Ottawa law firm. We are Ottawa Lawyers who regularly represent minority shareholders in family business disputes. We have succeeded in using the oppression remedy to enable our clients to assert their rights to their just entitlements time and again.
To read the full reasons in Tannenbaum v. Tanjo Investments Ltd. click here: http://www.canlii.org/en/on/onsc/doc/2009/2009canlii48526/2009canlii48526.html
Frequently Asked Questions
I am the sole proprietor of a profitable construction business that I want to expand. I’m nervous about the risk associated with the business and its expansion. Should I incorporate?
We would strongly recommend incorporation. Incorporation provides you with limited liability to protect your personal assets from creditors, and tax advantages that will help you grow your business and your wealth.
Limited Liability
A corporation is a legal entity distinct from its shareholders. The obligations, debts and liabilities of the business are those of the corporation and not of its shareholders. The protection from creditors is a significant advantage, particularly for businesses that are inherently risky. As the sole proprietor you are currently liable for every debt, liability, obligation and claim against your business. In your construction business, an inadvertent error or mistake by a sub-contractor, or simply the failure of the project caused by others, could result in huge liabilities for which you are personally exposed to creditors, risking loss of your house, savings and other assets. Incorporation of your business creates a significant barrier of protection. (Note: there are statutory and other limited exceptions to the protection provided by a corporation)
Income Taxes
Active business income earned by a corporation is taxed at a much lower tax rate, approximately 15.5% in Ontario on income up to the small business limit of $500,000. This presents two wealth planning opportunities. Firstly, a growing business requires working capital. As a sole proprietorship, growing working capital is hard because profits are taxed at your personal marginal rate of taxation which may be in excess of 50%. By incorporating, you can grow your working capital, and thus expand your construction business, at a much faster rate because of the low rate of corporate tax. Secondly, by leaving profits in the Corporation in excess of your personal needs, you can grow your retirement savings in the corporation at a much faster rate. (In subsequent publications, we will talk about how to creditor-proof these savings).
Tax Splitting
A corporation provides for legal tax splitting with members of your family, if they are made shareholders of your corporation. The shares of your corporation may be structured so that you remain in control of the corporation notwithstanding shares issued to family members.
I want to become an entrepreneur and start a business. Should I incorporate now, or start as a sole proprietorship and delay incorporation to a later date?
The advisability of incorporation is dependent on the particular facts and personal preferences of the entrepreneur. The role of the Lawyer and other professional advisors is to help draw out the relevant facts and explore personal preferences to assist the entrepreneur in making the decision that is right for her. Some of the relevant factors include:
Risk. Is the proposed business inherently risky? The shield of limited liability that an incorporated entity provides to the entrepreneur is an important benefit (note that the shield from liability is not absolute);
Tax. A valuable attribute of an incorporated entity is the relatively low tax rate (approx. 16%) payable on the first $500,000 of net income. This allows a profitable incorporated entity to grow much quicker using internally generated working capital than a similarly sole proprietorship where a marginal tax rate in excess of 50% of profits may be payable. An exception is where the sole proprietor has other sources of income and it is anticipated that the new business will suffer losses in the start-up year(s) – it may be possible to set off the losses against the other income and thus reduce the overall tax burden;
Costs. Incorporation of the business at an early stage is less expensive than incorporation once the business is up and running. Once the business (sole proprietorship) is up and running it is generally necessary to use a “rollover” transaction to transfer the business from the sole proprietorship to the corporation.
Separate Existence. An incorporated entity has a legal existence separate and apart from the entrepreneur. This provides for a number of real and perceived benefits including (generally): broader alternatives for raising capital; easier salability of the business and possible availability of lifetime capital gains exemption to avoid tax on sale, continuous existence past the life of the entrepreneur, public perception of greater substance, and easier separation of personal and business dealings.
My husband and I are the sole shareholders and directors of an incorporated retail business. We have been quite successful and are generating cash excess to business requirements. We do not want to pay the cash out to ourselves now, and pay high rates of tax, but at the same time this cash is a significant part of a retirement fund. We have no creditors, other than trade creditors payable in the ordinary course. How do we protect this cash for our retirement?
You are asking a good question. In the event of an unexpected economic downturn or legal claim against your active business corporation, the excess cash generated in the business could be exposed to potential creditors. Once the liability is crystalized, it may be too late to take action that will protect the cash. You have also correctly identified that the simplest solution –payment of the cash out to yourselves – attracts undesirable tax consequences.
A cost efficient solution is the creation of a holding corporation. The holding corporation structure, when designed properly, allows excess money from your active business corporation to be paid by dividend to the holding corporation, tax free. The holding corporation is a separate legal entity, and is generally insulated from claims against your active business corporation.
Care is required that the desired tax treatment is achieved in the structuring of the holding corporation. There are other financial planning considerations, such as ensuring the availability of the lifetime capital gains exemption, which must be addressed by the new structure. This type of corporate structuring may also be implemented as part of a broader strategy for business succession and included as part of your estate planning.