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Welcome to Part 2 of our series, Legal Fundamentals for Canadian Technology Startups. We're here to offer a pragmatic, legal roadmap for launching your Canadian tech startup. Be sure to check out Part 1 Exploring Business Structures for Canadian Tech Startups: Sole Proprietorship and Partnership if you haven't already.
What is a corporation?
In Canada, the term "LLC" (Limited Liability Company), commonly used in the United States, does not apply. Instead, the typical equivalent in Canada is a corporation. Many Canadian tech startups begin as sole proprietorships or partnerships before evolving into corporations. A corporation is a separate legal entity, distinct from its owners and managers. It can hold property, operate businesses, and incur contractual and legal obligations, possessing all the rights, powers, and privileges of a natural person. Owners and managers of a corporation are shielded from its debts and other obligations thanks to its limited liability. Moreover, a corporation enjoys perpetual existence, meaning it continues indefinitely until dissolution either by its owners or by court order.
Ownership of a corporation rests with its shareholders, which may include individuals, other corporations, partnerships, or trusts. Shares can be transferred between parties, subject to certain restrictions in specific circumstances. A corporation operates through its board of directors and officers. The directors, elected by shareholders, oversee the business and affairs of the corporation, appointing officers and delegating day-to-day management duties.
Where should you incorporate your Canadian Tech Startup?
In Canada, a corporation can be incorporated provincially or federally. Each province has its own legislation governing corporations, though these laws are more similar than not. The choice of where to incorporate depends on the jurisdiction where your corporation operates. In Alberta, for instance, one can opt for incorporation under the provincial Business Corporation’s Act RSA 2000, c B-9 (the "ABCA") or the federally regulated Canada Business Corporations Act (R.S.C., 1985, c. C-44) (the "CBCA").
Incorporation under the CBCA allows a corporation to establish its head office in any Canadian province and benefits from the perception that a federally regulated corporation enjoys greater international prestige. Moreover, the CBCA offers nationwide protection for the corporation's name.
Incorporating under Alberta's ABCA brings its own benefits. For example, the Alberta Corporate Tax Act RSA 2000, c A-15 offers the country's lowest corporate tax rates to businesses incorporated in Alberta, allowing for more substantial tax benefits (to be detailed in a forthcoming article). Alberta also boasts a favorable corporate environment, with the ABCA not imposing residency requirements on corporate directors like the CBCA does. Furthermore, the ABCA doesn't necessitate that corporations maintain a register disclosing information about individuals with significant control or ownership, unlike the CBCA.
For early-stage Canadian tech startups, incorporation under the ABCA is often more advantageous due to fewer regulations, reduced costs, and favorable tax treatment. Moreover, the ABCA is particularly beneficial for startups whose owners aren't Canadian residents. For these reasons, this article will focus on the incorporation process under the ABCA.
How do you incorporate your Canadian Tech Startup?
Incorporation in Alberta is achieved under the ABCA. Bear in mind that a corporation's existence is dependent on the governing statute. Section 5 of the ABCA states that one or more persons may incorporate a corporation by signing articles of incorporation and complying with Section 7. Section 7 requires that an incorporator send to the Registrar the articles of incorporation and documents required in Sections 12(3), 20 and 106. Section 20 requires that a corporation have a registered office within Alberta and Section 106 requires the corporation send a notice of the directors.
The Articles of incorporation are like a “birth certificate” for the corporation and contain valuable information about the corporation. Section 6(1) state that the articles of incorporation shall include the name of the corporation, the classes and maximum number of shares that the corporation is authorized to issue, whether there is a restriction to transfer shares of the corporation, the number of directors, including the minimum and maximum number of directors, and any restrictions on the businesses the corporation may carry on.
Name
The corporation's name must comply with Section 10 of the ABCA. One of the following terms should be included as part of the name: "Limited", "Limitée", "Incorporated", "Incorporée" or "Corporation", or the abbreviation "Ltd.", "Ltée", "Inc." or "Corp." placed at the end of the name. The corporation use that of another corporation, trust, association, partnership, sole proprietorship or individual in existence. A NUANS ("newly upgraded automated name search") report is required within 90 days before submitting the articles of incorporation to ensure no similar names exist.
Remember, a corporate name differs from a trademark. Registering the name as a corporation under the ABCA doesn't offer the same protections as a registered trademark under the Trademarks Act. See our series on trademarks on the process for registering a trademark.
Registered Office
The corporation's registered office address, where it can receive legal documents and maintain corporate records, must be included in the articles. Per Section 20(1), a post office box cannot serve as the registered office address.
Share Capital
As stipulated by Section 26(1), every corporation is mandated to have at least one class of shares. The articles define the number and class of shares a corporation is authorized to issue. Three rights are typically embedded in one or more classes of shares: the right to vote at shareholder meetings, the right to receive dividends as declared by the board of directors, and the right to partake in the residual value of the corporation’s assets upon its liquidation.
If a corporation has more than one class of shares, the typical share classes include:
Common shares: This class includes the three rights previously discussed.
Non-voting common shares: These shares hold the same rights, privileges, restrictions, and conditions as common shares, excluding the right to vote.
Preferred or special shares: These shares have a fixed liquidation preference and must be paid before any common shares. They may also include other rights attached to common shares.
Frequently, incorporators introduce a class of "blank cheque" preferred shares. These are authorized but unissued preferred shares that can be issued in series. The rights, privileges, restrictions, and conditions of these shares can be determined by a corporation's board of directors per Section 29 of the ABCA. "Blank cheque" preferred shares can be used to raise additional funds or as an anti-takeover defense by enabling the board to create a new series of preferred shares with specific voting, conversion, or control rights.
The exact share structure depends on various factors like financing needs and strategies, control of the corporation, investor expectations, exit strategy, tax issues, and possible employee incentive programs. A qualified lawyer's advice on structuring your share capital is crucial to your business success.
Restrictions on Share Transfers
The articles also outline any restrictions on the issue, transfer, or ownership of shares. Transfer restrictions are essential for various reasons, including controlling the business ownership and leveraging commonly used prospectus exemptions. More on share issuances and transfers will be covered in a subsequent article.
Directors
The articles must state the full legal name and address of the first director(s) and specify whether there is a fixed number of directors or a range (minimum and maximum number). If a range is chosen, the actual number of directors at any given time must fall within that range. Every corporation must have at least one director.
Restrictions on the Business of the Corporation
Restrictions on a corporation's business are common in professional corporations for doctors or lawyers but are not frequent in Canadian legal tech startups.
Filing the Articles of Incorporation
Filing an incorporation can be done through a registry agent or authorized service provider and must include:
Articles of Incorporation
Notice of English/French Name Equivalency (optional)
Notice of Address
Notice of Directors
Notice of Agent for Service for an Alberta or Extra-Provincial Corporation
NUANS report
Valid ID
Fee payment
Once the Director under the ABCA issues a certificate of incorporation, the corporation is officially incorporated as of the date indicated on the certificate.
Directors and Officers
Directors manage the overall business and affairs of the corporation, and the board appoints officers to handle day-to-day matters. A private corporation must have at least one director. According to Section 105(1) of the ABCA, a director must be at least 18 years of age, must not be bankrupt, must be an individual, and must be of sound mind pursuant to various legislations. Unlike the CBCA, the ABCA does not require director(s) to be Alberta residents.
Individuals can become a director of a corporation through the articles of incorporation, election by shareholders, or appointment by the board of directors to fill a vacancy. A director may resign, become disqualified, or be removed from office by the shareholders.
Officers manage the daily operations of a corporation and can be appointed by the directors.
Directors and officers may be subject to personal liability due to their roles within the corporation. According to Section 122(1) of the ABCA, directors and officers have a duty to act honestly and in good faith, with the corporation's best interests in mind, and must exercise care, diligence, and skill. In addition, different Canadian statutes impose personal liability for:
Unpaid employee wages and vacation pay
Failure to remit employee income tax, employment insurance, and Canada pension plan source deductions
Failure to collect sales tax
Offenses under environmental protection legislation
Payment of dividends if the corporation is insolvent
Misrepresentation in certain public company disclosure documents
After Incorporation of your Canadian Tech Startup
Once the articles of incorporation are filed and a certificate issued, the corporation must be organized, and directors must prepare certain corporate records.
Bylaws are regulations made by the directors governing the corporation's internal affairs, addressing matters not included in the articles or corporate statute. Bylaws generally outline the identification process for contract signatories, the protocol for calling directors’ meetings, the quorum for these meetings, and the rules for shareholder meetings, among other things. These bylaws, once adopted by directors, must be confirmed at the next shareholders' meeting to remain in effect. Directors can modify the bylaws subject to shareholder ratification.
Pursuant to 105(5) of the ABCA, a person is a director when elected or appointed at a meeting and does not refuse to act as a director, or when not present at the meeting, consents to act as a director before the meeting or within ten days after the meeting.
Most corporations keep certain corporate records in a minute book,. The minute book can be understood as the “photo album” or the "family history" of the corporation and includes the
articles of incorporation and any amendments
bylaws
shareholder agreements
minutes of directors and shareholder meetings
resolutions of directors and officers
registers of directors, officers, securities, and transfers of securities
share ledgers, and
debt obligations.
Tax Perspective
Corporate tax is a distinct discipline, and this article can only provide a brief overview of the topic. Because the corporation is a separate legal entity, it pays its tax separately from shareholders. A shareholder cannot include the corporation’s income or loss in their personal income. When the corporation's income is distributed to shareholders, it must be in the form of a dividend from the corporation's after-tax income. Dividends to individual shareholders constitute taxable income, even though the corporation has already paid tax on them. Integration mechanisms (such as the gross-up and dividend tax credit or refundable corporate taxes) help eliminate or reduce the element of double-taxation that would result from the imposition of tax at both the corporate and shareholder levels. When a shareholder sells their shares, it's generally taxed as a capital gain. Under certain conditions, this gain may be tax-exempt up to a limit.
Alberta’s corporate tax rates, the lowest in Canada, stand at 8%, plus the federal rate of 15%, equating to a combined rate of 23%. There are further tax deductions available to Canadian Controlled Private Corporations (the “CCPC”) on the first $500,000 of active business income and additional tax advantages like the Scientific Research and Experimental Development Program (the "SR&ED") (a future article will consider the CCPC and SR&ED in depth).
Corporations also have the advantage of compensating employees and independent contractors with equity, an important tool for Canadian tech startups to attract, incentivize, and retain key personnel. There are many forms of equity-based compensation available to corporations, including stock options, restricted share units, deferred share units, and stock issuances. Future articles will explore the tax consequences arising from these types of equity-based compensation.
Conclusion
Navigating the world of incorporation in Alberta may appear complex, but it can offer many benefits for Canadian tech startups, especially given Alberta's favourable corporate tax rates and flexible regulatory environment. It's essential to understand the responsibilities that come with incorporating, such as establishing a registered office, formulating a share structure, adhering to the stipulations concerning directors and officers, and maintaining comprehensive corporate records. Also crucial is an understanding of the tax implications for both the corporation and shareholders.
While this article has aimed to provide a broad overview, it is always wise to engage a legal professional when incorporating a business to ensure all legal and financial aspects are properly addressed, thus laying a solid foundation for the future success of your tech startup. Stay tuned for more in-depth articles on corporate tax deductions, equity-based compensation, and other relevant topics for your Canadian tech startups.
At Andrew Roy Legal, we provide a range of advice relating to corporate and commercial law. We offer flat fees to provide you and your business with certainty. Contact us today to learn more about how we can assist you.
This article is intended for informational purposes only and should not be considered as legal advice and does not establish an attorney-client relationship. Consulting with a qualified legal professional is recommended for specific legal concerns and requirements related to your business.
© 2023 Andrew Roy
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