I don’t know of any logging contractor that doesn’t operate through a limited company. On the other hand, some truck owner-operators and other equipment operators sometimes operate through limited companies, and sometimes as sole proprietors.

Often, people misunderstand what a company is, and the legal implications of operating through a company.

In Canada, we tend to use the British word “company” and the U.S. term “corporation” interchangeably. They mean the same thing. A company is a legal person (although not a natural person) capable of owning assets, of owing money, of suing, and of being sued. Importantly (but often forgotten) is the fact that a company is a legal person separate from the individuals that own it and run it.

The theory behind the company is that the shareholders’ liability is limited—the most that a shareholder could ever lose would be his or her investment in the company, but no more. A shareholder’s personal assets (other than that shareholder’s investment in the company) could never be touched by the company’s creditors. This concept of limited liability explains why many company names end with the word “Limited”. That same limited liability does not exist for a proprietorship, nor for an ordinary partnership.

Limited liability may be good in theory, but not necessarily good in practice. When assets are accumulated in a company, and that company becomes an individual’s or family’s sole source of income and most valuable asset, it is little consolation when the company fails (because, for example, a contract went very wrong, or a large receivable became uncollectable, or there was a large uninsured liability claim against the company) for the shareholders to say “oh well, all that I have lost is my investment in the company.”

Limited liability is a bit of a myth. Government has gone a long way to overcome limited liability. A company’s directors will be personally liable for the company’s GST, its unremitted employee source deductions, certain unpaid wages owed to its employees, and its WCB premiums, among other things.

In terms of family-held companies, banks and other lenders (like equipment financiers) will almost always ask for personal guarantees from the owners. Some trade creditors, like fuel suppliers and heavy equipment repair shops, also ask for personal guarantees.

So, yes, there is still some limited liability when operating through a company, but it isn’t much. Basically, there is protection against claims from the company’s suppliers and other parties that it contracts with, where there are no personal guarantees. And, there will be some protection where there is a negligence claim brought against the company, for which there is insufficient insurance. (But, if it is the act of the company’s owner that gives rise to the negligence claim, one can expect that both the company and the owner will be sued.)

Why, then, are companies so popular? The main reason, in my view, is tax reduction. Personal tax rates are considered “progressive”. The first $10,000 earned by an individual is tax free. The 11,000th dollar earned costs 20 cents in tax. The 130,000th dollar earned costs 43.7 cents. There are several tax brackets between those figures.

Companies, on the other hand, tend to pay a lower rate of tax than individuals.

Operating through a limited company, then, offers a tool for tax minimization. One common technique is to have the company shares owned by various family members, with the result being that there is income splitting between those members. So, for example, if an option exists between the company paying a $100,000 management salary to just one family member, or a $50,000 salary each to two family members, there are net savings by selecting the latter. (This depends, of course, on what other sources of income exist for these individuals.)

As well, companies can be used for the accumulation of wealth, in a fashion not unlike the RRSP system. If a company earns a $100,000 in a year, but its owners only need $50,000 to live on, the remaining $50,000 can stay in the company. The lower corporate tax rate applies in the year that this money is earned, and it is only in later years, when the money leaves the company and is paid out to the company’s owners, that issues of personal tax arise.

I wish to make it clear that this is a gross oversimplification of the very sophisticated tax rules that exist. Please consult with a tax accountant for detailed advice on the subject.

John Drayton is a Kamloops lawyer with Gibraltar Law Group who practices in the areas of forestry and motor transport law.