# Investing: Sole Proprietor vs Incorporation



## LionMG (Dec 21, 2012)

Hey guys,

I have a major decision to make this year, whether to incorporate or register as a sole proprietor. It all comes down to which is the best option to invest my income - that is what I'm mainly concerned about. I'll outline my situation, and any advice would be very much appreciated. I'll be going to an accountant, but I'd like to have as much information so I'm not going in blind.

I made $50,000 this year. I will likely double that this year and subsequent years. So for simplicity sake I estimate for the next 3-5 years I'll be making $90,000. That's before taxes.

I'm 25 and my goal is to retire very early. For the next 3-5 years I'll be making some sacrifices in terms of spending and investing as much money as possible, starting it compounding while I'm young. The goal is to save at least $30,000-$40,000 a year. My strategy will be a long-term dividend growth strategy where I can live off of only dividends. So I'll exclusively be buying dividend stocks and re-investing the dividends.

So with that in mind, does it make sense for me to incorporate and invest within the corporation, or register as sole proprietor and invest in my personal accounts? I think it comes down to a question of how investment dividends are handled in a corporation. I should point out I'm from Manitoba and the corporate small business tax rate is 11% total here. http://www.taxtips.ca/smallbusiness/corporatetax/corptaxrates2012.htm

I've read some conflicting reports that the investment dividends would be taxed at a high rate within the corporation - something about the income not being active business income. Which in my case I don't think it would be active (see information below about me having no expenses). There's also the high cost of first incorporating, and then requiring an accountant file an annual corporate tax return. On the flip side I wouldn't have to pay much CPP (or none), which I have no interest in considering my dividends will be enough for retirement!

Or with sole proprietorship I'd invest in my TFSA and RRSP which would generate tax-free dividends and be much less hassle. Then again since I'll hopefully be retiring early, the RRSP would useless to me I believe.

I should note that I have zero business expenses, or very few. My work is all online - I don't sell any physical goods, pay for advertising, or have any clients to meet for lunch. I work from home for now and don't pay rent. In other words I don't have a lot of deductions at all, and that won't be changing. In fact the only thing I claimed last year were my bus passes. Also my business is VERY simple and straight-forward. There aren't any sales to keep track of or any bookkeeping other than my monthly payments. I'm not sure if that information affects my choice for sole pro or incorporation or not, but just in case.

Some more relevant information:
- I won't need much income to live on the next 3-5 years. $25,000 per year maximum.
- I am single and would be the only shareholder in the corporation, no income splitting.
- I haven't invested anything at all yet. I'm in the process of opening a brokerage account. My RRSP room is only $3,500 (my income was very low before this year), and $25,500 room in TFSA.

Perhaps this would be my best strategy?
- Don't incorporate for year 2012. Pay the full personal taxes on my $50,000 income.
- Max my TFSA with that money right now before I incorporate.
- Don't bother with RRSP.
- Incorporate for this year (2013). Set it up so that I'm paid enough for personal expenses (around $25,000). Perhaps a bit more so I can max out my TFSA every year.
- Invest 2013 earnings and all future earnings in my corporation (dividend stocks as mentioned)

I'd love if someone could run the numbers for me comparing my two options. Let's say $90,000 income, and with either option I need $25,000 for personal expenses. The excess is invested in dividend stocks at an estimated 5% for this example.

One of my main concerns with incorporating is if after 3-5 years I decide on a change of direction in life such as returning to school. At that point I'd make a lot less income, but still have the high corporate expenses to worry about (accountant, corporate bank account).

Anyway this is getting long. Any help would be MUCH appreciated. Thanks.


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## sharbit (Apr 26, 2012)

First off regardless of what happens you'll need an accountant. So talk this over with that person.

As for corporate tax a somewhat simplified answer; investments within a corporation are taxed at a different rate to prevent rich people and their dog from incorporating simply to avoid paying tax. That 12% tax rate is on "active income" aka you have to actually do something. The theoretical target tax rate for investment income gets taxed at 46 2/3 i think. However there are tax credits on this such that you will pay no tax on dividends once they are distributed (what you paid gets refunded) and I think arround 30% for all other income. I don't have the numbers in front of me but hopefully you get the idea. So IMO, the likely optimal strategy for a legitimate business is to retain cash in the corp that you earn but pay out all investment income immediately. This may not be realistic for your situation though, theres lots of details about your situation that I dont know and I'm not actually an accountant.

There's also rules such as the "Personal Services Corporation" which i recommend you read up on. If you mess up and find yourself voilating these rules you'll likely be paying 60% tax. The basic idea is to prevent the case of the "incorporated employee" where your doing a job on behalf of another company and the line between employee or contractor is blurry. There's a checklist on the CRA site. Maybe get a friend to do it for you to remove any bias.

Finally I'd rethink your position on RRSP. With retiring early an RRSP would be incredibly useful. If you have lots of income now and no income then; this is the perfect case for tax minimization and differral for when you make withdrawls and is structured in a far better way then a corp. Beond tax there are legal benifits to an RRSP should your business not work out. Though, if the income is business income as a sole propriotor I dont remember if you accumulate room or not; it would make sense that you do.

A corporate bank account cost depends on how much you have in it and what you do with it. Mine costed about 150 last year. I do my own accounting and tax but I have friends that don't and they pay about 2000/yr. If the corp is idle I would think it would be less.

Good luck!


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## MoneyGal (Apr 24, 2009)

I don't understand why this is a decision you believe you must make this year. 

Also: I am not sure why you have written off RRSPs as useless. Income of $90K before tax means you can shelter approximately $25K per year from tax of any kind (in RRSP and TFSA contributions, assuming $80K in taxable income) -- and likely more if you have no TFSA or RRSPs now. (In the case of the RRSP, tax is deferred until the contributed funds are withdrawn). 

You say you need $25K to live on, and assuming you have $80K of after-tax income, that's $55K available to invest each year. But if you can shelter $25K per year from tax, the differential you are comparing is $55K in a corporate account (exposed to tax each year, plus ongoing costs of incorporation) versus $25K in RRSP/TFSA and $30K in an unregistered investment account. 

So, in this quick rundown (which I am typing out so you can put your own numbers in if you like), you need to compare the total costs of keeping $55K/year in a taxable corporate account versus $30K per year in a taxable unregistered investment account. 

Compare the frictional costs (tax, corporation costs) of $55K in the corporate account versus $30K in an unregistered personal account (or whatever numbers you feel are more appropriate). If the funds in the corp account are taxed as investment income, not active business income (which they will be) you will see that there is no advantage to incorporating (or if you can demonstrate there is an after-tax benefit to incorporating given these numbers, I'd be interested to see your calculations).


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## Homerhomer (Oct 18, 2010)

LionMG said:


> Or with sole proprietorship I'd invest in my TFSA and RRSP which would generate tax-free dividends and be much less hassle. Then again since I'll hopefully be retiring early, the RRSP would useless to me I believe.
> .


If you retire early it may be a perfect scenario to cash out RRSP tax free or at much lower rate than the tax savings when you contributed to RRSP, win win situation.

Based on your post I really don't think there is a good reason to incorporate, dividends in the corporation are taxed as investment income, infact you will need to declare dividends to shareholders in order to avoid paying refundable tax inside the corporation, if you don't want to pay CPP you will need to declare dividend income instead of earned, in turn you will not create any rrsp room. You are IMO underestimating the value of CPP.

I would suggest not incorporating, maximizing rrsp and tfsa, create cpp down the road, draw rrsp when you have no other income when you retire young. If you increase your income drastically the advise may change, once you maximize rrsp and tfsa, it then may make sense to invest after tax income in the corporation.


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## LionMG (Dec 21, 2012)

Thanks for the replies!

It would seem I'm very misinformed in regards to RRSP. I was under the assumption I couldn't withdraw from the RRSP until a certain age without triggering a penalty, unless it's for a house or education. To confirm... I can withdraw from a RRSP at any time, including the dividends without penalty (other than reducing my contribution room)? Whatever I take out would simply be taxed at my personal marginal rate for that year no matter when I withdraw? Does withdrawing dividends affect my contribution room? For example if I have a down year in sales, or decide to return to school and have low income... let's say $20,000 for the example, and I have $125,000 in my RRSP earning dividends. So say I need to withdraw a quarterly dividend (estimated $2,500) from my RRSP to help pay for an expense. How would that be taxed? 

The reason I was considering incorporation is this information I received from someone very helpful who spoke at length with me:

Assuming (income after expenses) Profit is $60000 in 2011 - SP vs. Corp

Sole Proprietorship - $60000 in profit is your personal income. Assuming you have no other income this is you total income. I've assumed a 24 year old living in Manitoba with no tax credits, no EI or CPP paid in 2011. You can put in your own numbers and see how much different your income really would be. Again why Sole Proprietorship is easy and you can do you own books and taxes. Anyway, I put in $60000 under line "Self-employment (include business income/loss from rentals)". Based on this with no pre-tax paid (CPP, EI, Income tax) you would owe $17946 in taxes or 32% of your income in taxes.

Corporation - $60000 in corporate profits.
Corporate tax rate is 11% = 60,000 * .11 = $6600 in corporate taxes.
Assuming you paid out all profits (after tax) to yourself as dividends = $60,000 - $6,6000 in dividends = $53,400. If you take out $53,400 in Self-employment income and put $51,000 into 'Cdn non-eligible dividends" then your personal tax payable is $7131.
So total tax payable is Corporate tax of $6600 + personal tax payable of $7131 = $13731. This is assuming you pull out all profits from the corporation but technically, you could only take out what you "need" as dividend income, so say you take out $30000. Your personal tax payable is only $2615, leaving $27385 in your pocket and $21000 in your corporation. Also, keep in mind that any interest, dividend or capital gains earned inside your corporation or on the $21000 left in the corporation above it only taxed at a rate of 11%.

I then pointed him to this thread which basically has opinions that there is no point of incorporating for the purpose of passive investments: http://forums.redflagdeals.com/investing-money-within-my-corporation-939489/2/

He then replied with: 

I read over the thread in detail and I agree/understand where the lengthy post, you described, is coming from and I don't disagree with the assessment, however, in your case you are not looking at hundreds of thousands of $ in your corporation earning passive income (investment income). Your corporate "profit" available to invest for income (passive income) won't be a large some of money after you remove expenses, your income and pay yourself a quarterly dividend. Even with $100,000 in available profit to re-invest as passive income which say earns approximately 8% return, it is only $8000. I'm sure any tax accountant could quantify a portion of this amount as active investment so you have no real risk here. If you had a $1,000,000 to invest, then that might be a different story. As one poster mentioned, post #8, there is a happy medium between salary/dividend income and only what is left that you can't justify as active income would become passive and taxed at a separate rate. Based on the information you provided me, it won't be enough to be concerned about.



MoneyGal said:


> I don't understand why this is a decision you believe you must make this year.


 Well it affects my long-term investment goal and what I should do with my initial chunk of money. I also reached over $30,000 in sales for the first time so I have to register for GST. Am I not required to either register as a sole proprietor or incorporate? 



MoneyGal said:


> and assuming you have $80K of after-tax income


 How did you come up with the $80K after taxes from $90K before tax? Would I not owe a ton more than $10k taxes on $90k of personal income? (Keeping in mind I wouldn't have many deductions at all). 

Also... as sole proprietor, I'd have to pay both halves of the CPP. Around $4000 a year. 

Does the fact that I shelter a lot more income (even though dividends might be taxed at a high rate) in the corporation outweigh the benefits of taking it all personally and investing in RRSP? Could the corporation not essentially act as an RRSP, stockpiling the income only taxed at 11%, earning dividends while I take out just what I need with a small salary + corporate dividends to insure I'm taxed personally at a low rate. I'd pay myself enough to max out my TFSA each year. Then when I retire early the funds would drain slowly from my corporation to myself in salary + dividends, and by that point my TFSA would be at around $200,000 or more with some luck, supplementing my income with tax-free dividends. 

That sounds pretty messy though. To be honest I don't really want to incorporate. It sounds like a ton of stress, and I'm happy just having my personal bank accounts to worry about.

But if I can save a lot more money and retire quicker by incorporating... I need to consider it fully.

Thanks to anyone who's reading these long posts and replying.


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## Homerhomer (Oct 18, 2010)

You can withdraw rrsp any time, you are taxed at your tax rate, if you have no income at the age of 37, you withdraw $10,000 rrsp, the bank will withold tax, however it will all be refunded to you upon filing your personal tax returns.

Your investment income will not be taxed at 11%, I don't know who is trying to tell you that but that's simply not correct.

Let's say you have a bank account, over time you accumulate $100,000 dollars in it and earn some interest, as this is your operating bank account you can claim this income as active income, it's part of running the business, however if you use the excess funds to buy stocks and other investments there is no way in hell CRA will accept it as active income, it just won't happen.

Yes, CPP is a cost to you, over $4000 per year if you max it out, but reading your other post about travelling and possibly retiring in other parts of the world, if you live until 85 or longer, that CPP from the age of 67 will go a loooooong way, I think that many poeple over estimate how much they will be able to save and earn from investments, IMO CPP is an important part of planning for retirement. if you truly retire early you can draw your rrsp before you reach 67, and then live off tfsa and cpp, and even GIS if you live in Canada, you will not have CPP/RRSP option if you draw dividends from corporation.

For corporation you are also looking at $1000 (sometimes little less, sometimes alot more) in annual expenses, something that you don't need to have if you only file personal tax returns.

8% of annual income from investments is also pretty hefty estimate.

At your income level I think incorporating makes little sense, unless you see a signinicant increase in profits in the near future, once you then maximize rrsp and tfsa you can invest higher after tax profit inside the corporation than you would do in the margin account personally.


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## MoneyGal (Apr 24, 2009)

Couple of comments back: 

I should probably have used another figure than $80K, but there isn't a "right" figure; my comments were supposed to spur discussion. 

You should probably create a couple of scenarios using Excel or another spreadsheet program, keeping all the variables the same ($90K income, $25K living expenses). 

Scenario 1: You ean $90K as a sole proprietor but make no TFSA or RRSP contributions. 

Scenario 2: You earn $90K as a sole proprietor but make maximum TFSA and RRSP contributions. 

Scenario 3: You incorporate and withdraw $25K (or whatever incorporation scenarios you want to run). 

My main point is that the existing tax-deferral and tax-sheltering mechanisms (RRSP and TFSA) provide a benefit which is at least equivalent to the benefits of lower taxation of corporate income at the income levels you are talking about. That's what you'd see if you compared scenarios 2 and 3; your knowledgeable friend did not include a scenario in which you make RRSP and TFSA contributions. 

As for your RRSP questions: generally speaking you can withdraw money from an RRSP at any time. There is no "penalty," but you will be assessed the tax you owe on that income and there is a mandatory withholding amount which will be levied at the time of withdrawal and then squared up when you file your taxes.

I think part of your confusion (if that is not too strong a word) is that I'm not sure you are sure about what problem you are trying to solve. It seems as though you've landed on incorporation as a solution and now you are comparing various alternatives to incorporation. (Like someone said, "corporations pay way less tax than individuals! You should incorporate!") Instead, I think the question you want to be asking is, "For a given level of income and expenditures, what is the optimal business structure to minimize taxes?" (if that is your main goal, which it sounds like it is). 

If you ask the question that way, I really doubt you will land on incorporation as the answer. 

Specific comments on the scenarios laid out by your knowledgeable friend:

1. His writing is a little difficult to follow, but passive income left in a corporation is *not* taxed at preferential rates. For non-active income of a corporation such as investment income or capital gains, the corporation effectively pays tax at the same rate as an individual. Accordingly there is no material tax deferral possible on passive income.

2. His main argument in response to your posting of a redflagdeals forum thread (which I have not read) seems to be that because you are not sheltering a lot of money in the corporation (as retained earnings earning passive investment income), you will not be subject to a lot of tax. However, this is not a useful comparison to make. The useful comparison is not "how much tax will I pay on the retained income compared to someone sheltering $1M in their corporation?" but "how much tax will I pay on the retained income compared to what I would pay if I earned the income personally?" to which the answer will be, "there is no material difference." 

Final comments, now on CPP:

First, you understand that CPP contributions made by you as a self-employed individual are tax-deductible for the "employers' share", while the "employee share" is tax-creditable. So, the after-tax cost of CPP contributions is not the "face" cost of $4K (or whatever). 

Secondly, you are getting a benefit for those contributions - guaranteed income in retirement. (In fact, many many incorporated professionals spend a lot of time optimizing salary + dividend withdrawals to maximize CPP contributions.) You aren't just "paying a tax" - you get a benefit at the other end. Compare this, for example, to the frictional costs of paying for a corporate income tax return each and every year, which provides you with no personal benefit of any kind.


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## LionMG (Dec 21, 2012)

Very interesting indeed! I'd certainly prefer not to incorporate (I prefer things simple and want to spend more of my time researching actual investments!) so this is all awesome information to know. 

Another thing I forgot to mention is that I'm paid in US dollars, and I had originally planned to invest in a lot of US dividend payers within my RRSP, thereby avoiding the taxes including 15% withholding. I won't be able to do that with the incorporation option.

Definitely leaning toward sole proprietorship now, but I'll have to do some more research and consult an accountant to be absolutely sure.

Is there any essential information I should know about sole proprietorship? As in hidden gems that I won't be able to find myself easily.

Will the income I've earned in 2012 and doing my tax return for soon be considered to be with me as a sole proprietor, even though I won't be registering until now?

I like this forum. :biggrin:


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## Spudd (Oct 11, 2011)

For sole proprietor you don't need to register formally anything. Just do your taxes as a sole proprietor, and put your own name as the business name.


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## MoneyGal (Apr 24, 2009)

Yay crowdsourcing!

It isn't exactly a "hidden gem," but this sole proprietorship landing page on the CRA website has a LOT of useful information: http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/menu-eng.html

The first "guide" (under the "Forms and Publications" link) is a useful read for you.


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## LionMG (Dec 21, 2012)

Thanks again guys - you've saved me a lot of money and headache. I was quite close to starting the incorporation process including meeting with a lawyer. Great for someone young and inexperienced like myself to be led in the right direction. 

Now to turn my attention to planning my investment strategy within my TFSA and RRSP! Much more fun. :biggrin:


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## CanadaBlue (Aug 16, 2015)

LionMG said:


> Thanks again guys - you've saved me a lot of money and headache. I was quite close to starting the incorporation process including meeting with a lawyer. Great for someone young and inexperienced like myself to be led in the right direction.
> 
> Now to turn my attention to planning my investment strategy within my TFSA and RRSP! Much more fun. :biggrin:


Hi,
I know its an old thread, but what did you ended up with, Investing as A sole Proprietorship or Incorporation.
I was thinking of investing under incorporation, I was earlier investing under my Person Accounts and now in past couple years account value has grown
so I was thinking of investing under Incorporation so that I can write off few expenses and also withdraw some amount as a salary.Please advise.
how has been your experience in past two years.
Thanjs


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## Financialplannerdude (Apr 30, 2015)

The Blunt Bean Counter has written quite a few very posts on this very subject. On the right scroll down and look for "Tax Topics and Tax Planning"


http://www.thebluntbeancounter.com/


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## agent99 (Sep 11, 2013)

Spudd said:


> For sole proprietor you don't need to register formally anything. Just do your taxes as a sole proprietor, and put your own name as the business name.


Would GST/HST be payable? Need to register for that, but otherwise using own name is OK as sole proprietor.


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## emmaj855 (Aug 31, 2015)

Agree.



Spudd said:


> For sole proprietor you don't need to register formally anything. Just do your taxes as a sole proprietor, and put your own name as the business name.


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## Eclectic12 (Oct 20, 2010)

LionMG said:


> ... It would seem I'm very misinformed in regards to RRSP.
> I was under the assumption I couldn't withdraw from the RRSP until a certain age without triggering a penalty, unless it's for a house or education.
> 
> To confirm... I can withdraw from a RRSP at any time, including the dividends without penalty (other than reducing my contribution room)? Whatever I take out would simply be taxed at my personal marginal rate for that year no matter when I withdraw? ...
> Does withdrawing dividends affect my contribution room?


That would more likely be a locked-in retirement accounts (LIRA). It's like an RRSP but usually has money that an employer has put towards one's retirement. 

For example, I chose when leaving my first job, I took the proceeds from the defined benefit pension. It had both employer and employee contributions so some had to go into a LIRA, where age 55 is I believe the earliest I can without. Since then, there are certain criteria that allows earlier withdrawals but I haven't needed it.


For the RRSP itself, as others have pointed out, there is no restriction on when a withdrawal happens. There is a withholding tax that has it's percentage set by how much is being withdrawn. This is similar to an employer withholding taxes on income. At the end of the year, when one files one's tax return - if not enough was withheld for the final income reported, more will be charged. If too much was withheld, then a refund of the excess will occur.
http://www.taxtips.ca/rrsp/withholdingtax.htm

Dividends, cash, stock (a withdrawal "in-kind") are all withdrawals for the RRSP. The value withdrawn is added to one's income for that year.
So $100 from dividends from a stock, $100 from a GIC or ten shares trading at $10 (i.e. $10 x 10) ... it all gets reported as $100 income. 

Some choose to setup a RRIF to start withdrawals from the RRSP as the money coming out of it, up to the minimum withdrawal amount is not subject to the withholding tax (but may mean a tax bill when one's tax return is filed).

http://www.taxtips.ca/rrsp/withholdingtax.htm




LionMG said:


> ... For example if I have a down year in sales, or decide to return to school and have low income... let's say $20,000 for the example, and I have $125,000 in my RRSP earning dividends. So say I need to withdraw a quarterly dividend (estimated $2,500) from my RRSP to help pay for an expense. How would that be taxed?


The first and second RRSP withdrawal will likely have 10% withholding tax taken from them (net would be $2250, cash in hand).

Before computers were talking to each other so much, the 3rd + withdrawals would also be the same. Some has posted on CMF that their bank bumped up the withholding tax to 20%, even if it was the first withdrawal from that particular financial institution.

I haven't reached that stage yet so I can't say for sure.

When one files the end of the year tax return, there's a spot for reporting the RRSP withdrawal as income (i.e. 4 x $2500 = $10K) and the withholding tax. It is similar to reporting $50K of income from an employer where say $6K of income tax was withheld by the employer.

Income becomes the total of the $20K regular income plus the $10K withdrawn from the RRSP and the income taxes paid becomes the total of any income tax on the $20K plus the withholding tax on the RRSP withdrawal.

http://canadianfinanceblog.com/withholding-tax-on-rrsp-withdrawals/


Cheers


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## Eclectic12 (Oct 20, 2010)

MoneyGal said:


> Couple of comments back: ...
> I think part of your confusion (if that is not too strong a word) is that I'm not sure you are sure about what problem you are trying to solve. It seems as though you've landed on incorporation as a solution and now you are comparing various alternatives to incorporation. (Like someone said, "corporations pay way less tax than individuals! You should incorporate!") Instead, I think the question you want to be asking is, "For a given level of income and expenditures, what is the optimal business structure to minimize taxes?" (if that is your main goal, which it sounds like it is).


+1 ... the articles I've read talk about needing to reach a certain level before the on-going costs of the extra reporting etc. become worthwhile. The guy I recall complaining about not incorporating earlier was complaining that he stayed a sole proprietor longer than he should have ... not that he should have incorporated starting day one.


Cheers


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