Changing a Corporation Back to a Sole Proprietorship in Canada

Can I change my corporation back to a sole proprietorship?

Not directly. A corporation is a separate legal person, so it cannot be converted into you. Going back means you start running the business in your own name and move out of the corporation whatever the business needs: equipment, vehicles, contracts, the client list and its goodwill. The CRA treats corporation to sole proprietorship as a change of legal status: in most cases the old accounts close and new ones open in your name.

The tax rule that drives the cost: there is no tax-free rollover out of a corporation. Property that moves from the corporation to you is generally treated as disposed of at fair market value (Income Tax Act, s. 69).

A small corporation with some cash and a laptop can be simple when its returns are filed and nothing is owed either way. These make a case need professional judgment:

• Just switching invoices: billing the same clients in your own name leaves the corporation's assets and cash inside it, and it keeps filing a T2. Whether its goodwill moved to you depends on the facts.
• Goodwill: clients, contracts and a name built inside the corporation have value but usually little tax cost.
• Depreciated vehicles and equipment: value above the undepreciated balance (undepreciated capital cost, or UCC) comes back into the corporation's income.
• Retained earnings: taking them all out in one year puts one large dividend on one personal return.
• Family members who hold shares: their part of the wind-up dividend can be taxed at the top rate as split income (s. 120.4).
• Other shareholders, money you owe the corporation, unfiled returns, or a business in Quebec.

Can I go back without closing the corporation?

Yes. You can stop using the corporation and keep it, keep it to hold cash or investments, or wind it up and dissolve it. Whichever you choose, moving the business assets out is still taxed as above; keeping the corporation only lets cash and retained earnings stay inside it.

All corporations, including inactive ones, must file a T2 for every tax year even with no tax payable, within six months of each year-end (CRA: T2 guide). For the registry filing, see Corporate annual returns. For distributing retained earnings, clearance certificates and final returns in full, see Closing a Canadian corporation.

Is there a tax-free rollover out of a corporation, like section 85 going in?

No. Section 85 lets you transfer property to a taxable Canadian corporation at an elected amount (s. 85(1)); it has no reverse version for a corporation transferring property to an individual. You and a corporation you control are related, so you do not deal at arm's length (s. 251). That brings in the fair market value rules.

For the reverse move, see Moving a business into a corporation.

What tax does the corporation pay when the business assets come out?

The corporation reports each asset as sold at fair market value on its T2 for the year of the transfer, which is the final T2 if it is dissolved. The tax depends on the asset.

A capital gain is included in income at the 50% inclusion rate. In a Canadian-controlled private corporation, a taxable capital gain is taxed as investment income, not at the small business rate (s. 123.3), and part of that tax is refunded when the corporation pays taxable dividends (s. 129). The non-taxable part is added to the corporation's capital dividend account (s. 89(1)); paying it out tax-free takes an election the corporation files on Form T2054 by the day the dividend becomes payable or, if earlier, is first paid (s. 83(2)); see Closing a Canadian corporation.

Unused losses belong to the corporation. They can reduce this income on its T2 (s. 111), but they cannot move to your personal return.

How much goodwill a one-person business has is a valuation question. Whether goodwill passes to you when you simply start serving the same clients in your own name depends on the facts, and official guidance does not settle it. Keep a written valuation as of the transfer date.

What tax do I pay when I receive the assets or cash?

On a wind-up or discontinuance of the corporation's business, the cash and asset value you receive above the paid-up capital returned to you is a deemed dividend (s. 84(2)). On a wind-up, your cost of each asset is its fair market value (s. 69(5)); for capital cost allowance, equipment, vehicles and goodwill start from the adjusted cost shown under your first sole proprietor year (s. 13(7)(e)).

Unless the corporation designates it an eligible dividend, you report the dividend grossed up by 15% and may claim the dividend tax credit (CRA: line 12000). A repayment of a genuine loan you made to the corporation is not a dividend. If you owe the corporation money, see Shareholder loans. The gain or loss on the shares themselves is covered in Closing a Canadian corporation.

If the corporation leaves its tax unpaid, including the tax on this transfer, the CRA can assess you for it at any time, up to the value you received above what you paid (s. 160; Excise Tax Act, s. 325).

Does GST/HST apply when the business moves to me?

Yes, if the corporation is registered for GST/HST, unless you and the corporation jointly elect on Form GST44 to have no GST/HST apply. The election needs you to acquire at least 90% of the property needed to carry on the business (CRA). If the corporation is registered, the election is available only if you are registered too (s. 167(1)(b)). The recipient (you) files it by the due date of its first GST/HST return covering tax that would otherwise arise on the transfer. It does not cover services the corporation provides or property it leases or licenses to you (Excise Tax Act, s. 167).

Without the election, a registered corporation charges GST/HST on the taxable assets it transfers, though not on the part of the price for goodwill when you take over all or substantially all of the business (s. 167.1); a small supplier that is not registered does not charge it (s. 166). If you are registered and use the assets mainly in the business, you can generally claim that tax back as an input tax credit (s. 169; s. 199(2)). Between you and your corporation, tax is generally on fair market value when the price is lower, unless you are a registrant acquiring the assets only for your commercial activities (s. 155). If the corporation closes its GST/HST account while still holding business property, the CRA treats it as having sold that property and collected tax (CRA: close your account).

You may not be a small supplier at first: while you control the corporation, its taxable sales from the previous four calendar quarters count with yours toward the $30,000 limit (s. 148(1); s. 127(2)). For the corporation's final returns, see Closing a GST/HST account.

In what order do I unwind?

Value first, register second, transfer on one date, then close the corporation's accounts. Each step depends on the one before.

1. Value the business. Get a dated fair market value for each asset and the goodwill.
2. Work out the tax both ways. The corporation's recapture and gains, your dividend, and whether keeping the corporation dormant costs less.
3. Register in your own name before the transfer date: business number, GST/HST and payroll accounts if needed.
4. Settle the corporation's side. Collect its receivables, pay its bills and file any missing returns.
5. Transfer on one date. Move assets, assign or re-sign contracts and leases, sign Form GST44 if it applies, and tell clients to pay you. A sale or a dividend in kind can happen on that date. A wind-up distribution waits: the CRA says to begin distributing only after it issues a clearance certificate (Form TX19), which needs the notice of assessment for the final T2, so steps 6 and 7 come first. Whoever distributes without one can be personally liable for the corporation's unpaid tax up to the value distributed (s. 159; CRA: T2 guide).
6. Finish the corporation's payroll and GST/HST. File the final returns and close those accounts. Directors can be personally liable for payroll deductions and GST/HST the corporation did not remit, and the CRA can pursue them for up to two years after they stop being directors (s. 227.1; Excise Tax Act, s. 323).
7. File the corporation's T2 for the year of the transfer, within six months of its year-end.
8. Dissolve, if you are not keeping it. A federal corporation can be dissolved only after its property is distributed and its liabilities are discharged, and Corporations Canada charges no fee for the certificate (Corporations Canada). A provincial corporation follows its own registry.

Closing a Canadian corporation covers clearance and steps 6 to 8.

What do I register to restart as a sole proprietor?

A business number and program accounts in your own name if you need a GST/HST, payroll or other program account (CRA: do you need a business number), plus a business name if your province requires one. In most cases the corporation's accounts close and you register new ones; the CRA asks you to call its business enquiries line for a corporation-to-sole-proprietorship change (CRA: change of legal status).

How is my first sole proprietor year reported?

On form T2125 with your personal return, from the day you start running the business. Self-employed individuals generally use a December 31 year-end, and a first fiscal period can be shorter than twelve months (CRA: fiscal period).

Capital cost allowance on the assets you took over starts from the value used on the corporation's return, adjusted because you and the corporation do not deal at arm's length (s. 13(7); CRA: non-arm's length transactions).

For instalments and self-employed pension contributions, see How self-employed income is taxed.

When is it cheaper to keep the corporation dormant?

Keeping it can cost less when most of the value is retained earnings: it can pay dividends over several years instead of one. Dissolving can cost less when little is left inside, because a kept corporation files a T2 and a registry return every year.

Example

These examples are illustrative, in Canadian dollars.

A designer with almost nothing inside

The corporation has C$5,000 of cash after paying its bills and a laptop worth C$800. The laptop cost C$1,500, is the only asset in its class and has an undepreciated balance of C$800, so its transfer creates no recapture. Paid-up capital is C$100. On the wind-up, the designer receives C$5,800 of cash and property; C$5,700 is a deemed dividend, which the designer reports grossed up, with the dividend tax credit. The corporation files its final T2 and is dissolved. The designer starts a T2125 the next day. For capital cost allowance, the laptop's capital cost is C$1,500, with C$700 treated as already claimed, so claims start from C$800.

A contractor with a work truck

The corporation's work truck, not a passenger vehicle, cost C$45,000, has an undepreciated balance of C$20,000 and is worth C$30,000. It is the only asset in its class. Moving it to the contractor gives the corporation C$10,000 of recapture. There is no capital gain because C$30,000 is below the C$45,000 cost. If the contractor pays C$30,000, he has no income from the purchase; the C$30,000 then sits in the corporation and is taxed as a dividend when paid out. If the corporation is registered for GST/HST, it also charges GST/HST on the C$30,000, unless the truck moves with the rest of the business under a Form GST44 election; if he is registered and uses the truck mainly in the business, he can claim that tax back as an input tax credit. If the truck is distributed on a wind-up instead, its C$30,000 value counts toward his deemed dividend. Either way, his capital cost is C$45,000, with C$15,000 treated as already claimed, so his claims start from C$30,000.

A consultant with retained earnings

The corporation holds C$60,000 of after-tax profit and no goodwill or equipment of value. The consultant restarts as a sole proprietor and keeps the corporation dormant.

• Year 1: the corporation pays a C$20,000 dividend and files its T2 and annual return.
• Year 2: another C$20,000 dividend; the same filings.
• Year 3: a final C$20,000 on wind-up; the corporation files its final T2 and is dissolved.

Paying all C$60,000 in year 1 would put the whole amount on one personal return, on top of the new business income. Spreading helps when that income leaves room in lower brackets, and each extra year costs a T2 and an annual return.

Different for you?

• The corporation holds retained earnings, goodwill or depreciated vehicles and equipment: model the corporate and personal tax before anything moves, with corporate tax help.
• You are not sure going back is worth it: see Sole proprietorship or corporation.
• You are ready to wind up and dissolve: see Closing a Canadian corporation.
• The corporation never filed its T2s: see Dormant corporation that never filed before moving anything, and get corporate tax help.
• The registry dissolved the corporation by mistake: see Reviving a dissolved corporation.
• The corporation owns real estate: moving it out is also a disposition at fair market value; see Rental property in a corporation and get corporate tax help.
• The business is in Quebec: Quebec administers its own corporate income tax (CRA), so the corporation has Quebec returns to close too; see How to incorporate in Quebec and get corporate tax help.
• The business is in Alberta: Alberta also administers its own corporate income tax: a corporation with a permanent establishment there files an Alberta return (AT1) for each year, including its last (Alberta); get corporate tax help.
• You work through the corporation for a client who would otherwise be your employer: it may be a personal services business, whose income gets no small business deduction (s. 125(7)). See Personal services business.
• You would rather sell the business to someone else: see Selling your business.
• You may incorporate again later: see the sole proprietor to corporation checklist.