What is an LLC in Canada?
You might have heard the buzz about setting up an LLC before you start your business. Unfortunately, Canada doesn’t offer LLCs like their American counterparts do. LLCs are a type of US entity, there is no such thing as a Canadian LLC. Even though only the US offers LLCs, Canadians can still join the club and set up an LLC. But the real question is whether a Canadian should bother with an LLC? And if not, what other options do we have? The answer is that Canadians should not set up LLCs and there are better options. If you’re interested in learning about what options you should consider, contact us at Tax Heroes.
What is an LLC and What are the Benefits?
An LLC stands for a ‘limited liability company’. It is a type of business entity in the US that is like a corporation because it offers personal asset protection for legal purposes but offers the tax benefits of a partnership or ‘flow-through structure’ in the US. Generally, corporations are seen as their own entity for tax purposes and are subject to a separate corporate tax. If someone want to withdraw their money from a corporation, the corporation would have to pay a dividend to that person, which would be subject to personal tax. This creates two layers of tax for someone that owns a corporation, corporate tax and personal tax. With an LLC in the US, you get the legal benefits for a corporation with the personal asset protection, while also letting the person get taxed directly (no corporate tax) to avoid the two layers of tax.
If LLCs are So Good, Should I Set One Up?
Because of the legal and tax benefits, it is now the most commonly used business structure in the US. Many books, podcasts, and advisors will tell you to open an LLC. However, that is because most of the advice is coming from Americans. Tax advice from the US is not always practical for Canadians.
Generally, LLCs should not be set up by Canadians. Despite LLCs not being offered in Canada, Canada still has to classify it with a similar Canadian structure for tax purposes. As such, Canada recognizes LLCs as corporations and may tax the LLC as a corporation since it is controlled by Canadians.
If you’re only doing business in Canada, it just becomes an unnecessary way of creating a corporation where you can create a Canadian corporation instead. If you do business in the US, the US may tax the owner of the LLC. Canada will still tax the LLC since its owners are Canadians. You may be subject to tax by both countries. Being taxed by two separate countries is common for Canadians and Canadian businesses doing business in another country. To avoid double tax, Canada will generally offer a foreign tax credit for any US tax paid to offset some of the Canadian tax. The issue here is Canada will offer the foreign tax credit to the LLC as the LLC is subject to Canadian tax. However, the US will be taxing the owner directly. As such, the LLC will not be paying any tax and cannot use the US tax paid by its owner as a foreign tax credit. This leads to double tax.
If I Shouldn’t Set Up an LLC in Canada, What Structure Should I Use?
If you are only doing business in Canada, you can use:
Sole proprietorship - Despite its fancy term, this is just another way of saying doing business as an individual without any formal entity. This often makes the most sense if you are just starting out, aren’t worried about personal protection of your assets in the event you get sued or go bankrupt, and need all the money you earn (as opposed to investing whatever you don’t need).
Canadian Corporation - This is a more complicated structure but can help you defer a lot of tax if you don’t need all the money you earn. It can also give you personal protection of your assets.
If you are doing business in the U.S., the structure can depend on what exactly you’re doing in the U.S. Some potential structures you could use are:
Sole proprietorship
Canadian Corporation
US Corporation
If you’re interested in doing business in Canada or the US and have questions regarding what structure you should use, contact us at Tax Heroes, we’re happy to offer a free consultation.
