When setting up a business, there are a variety of business structures that are available. So which is best for your needs? Below is a general overview of three basic business structures.
In a Sole-Proprietorship a business has a single owner who is solely responsible for all the liabilities a company owes to third-parties (eg. financial institutions). This business structure is the simplest way of organizing your business as it only requires a business owner to
- Obtain a tax number; and
- Open a bank account.
From a legal and tax standpoint, there is no distinction between the business and the individual who owns the business. As a result, there is single ownership of the assets and liabilities of the business and there are low administrative costs and few formalities associated with operating the business. The lower level of complexity of a sole-proprietorship allows business owners to use simple accounting software to track their revenue and expenses. Further, if a business owner chooses to retain an accountant for their accounting requirements, then there are likely to be lower fees associated with the work. The legal structure of a sole-proprietorship is such that no public reporting is necessary, and the sole proprietor only needs basic financial knowledge to run the company and satisfy banks, vendors, CRA etc.
From a tax standpoint, the sole proprietorship’s earnings before tax (EBT) form the taxable income of the sole proprietor. The sole proprietor’s income is taxed at the personal tax rates of the individual, hence this type of business structure is limited when it comes to deducting expenses and sheltering its income.
Finally, as mentioned, the liabilities of the sole proprietorship are also considered to be the liabilities of the individual owning the business. As a result, the business owner is fully responsible for all of the company’s dealings. This can lead to a situation where, if the business were to be sued, then the business and personal assets of the sole proprietor can be seized to settle claims.
A Corporation is a separate legal entity that can own assets, incur debt, sue, be sued, enter into contracts, and hold property in its own name. A Corporation is formed when one or more individuals incorporate a business. It can be incorporated provincially or federally.
A Corporation is considered to have potential “immortality” in that it is an impersonal entity that can in theory exist forever. This means that despite certain changes in the Corporation’s composition (eg. An owner dying, shareholders changing etc.), the Corporation would not dissolve.
A defining feature of a Corporation is the limited liability associated with it. Under all Canadian statutes providing for the incorporation of companies, the members who form the corporation and become its shareholders are only required to contribute towards the debts of the Corporation the amount that they have agreed to pay for their shares in the Corporation. Limited liability is a substantial advantage in that if the Corporation is sued, the owners’ personal assets cannot be seized to settle the claims. Further, the ownership percentage of the owners of a Corporation is dependent on how many shares the shareholders hold.
A strong advantage for Corporations within our current taxation scheme is that they have few limits on the expenses they can deduct for taxation purposes. Corporations pay tax on earnings before tax at established rates. Net income that is distributed to owners is then taxed again at their personal rates. Further, some Corporations receive preferential income tax treatment and Corporations often provide more flexibility in deferring taxes and in allowing the division of business income.
However, incorporating and maintaining a corporation can be a relatively costly endeavour. For example, a corporation is required to file its own income taxes as well as abide by its annual filing requirements. The initial cost of incorporation and organization required to maintain related documents can also be a hurdle to consider. Further, in the multiple owner structure of a Corporation the shared decision making can increase accountability, but can also lead to slower decision making.
A General Partnership is a business established by two or more owners. General Partnerships are fairly simple and inexpensive to form as there are few formal legal requirements. All the General Partnership needs is a:
- Registered tax number for applicable taxes; and
- Bank account.
Typically the owners (the “Partners”) work out a partnership agreement that outlines their respective powers, ownership share and capital contribution, profit distribution, and operating procedures for the business. By default, all Partners are able to share in the management of the company, in the absence of a partnership agreement that states otherwise.
A General Partnership includes joint ownership with some formalities and moderate administration expenses. The Partners of the Company essentially pool their funds to raise capital. A disadvantage of a General Partnership is that decision making can become cumbersome, as important decisions require voting among partners. However, the partnership agreement may provide that smaller, less important decisions may be made individually as long as the other Partners are informed.
Revenues, expenses and cash flow management are typically tracked internally with additional support from outside accountants. There are no public reporting requirements for General Partnerships, but general financial information would be required to run the company and satisfy banks, vendors, CRA etc.
From a taxation perspective, each Partner is taxed individually on his or her share of the partnership income. Hence, there is no need for a tax return from the General Partnership itself. In terms of disadvantages, there are greater limits to what expenses can be deducted and the taxable income of the individual Partners is subject to their personal tax rates.
Legally, each Partner is liable for all assets and liabilities of the General Partnership. As a result, if the company is sued, then each Partner’s personal assets can be seized to settle the claims.
* Much of this general information can be found on the Business Development Bank of Canada website
If you have questions about how to best structure your business, contact Cohen Buchan Edwards LLP at 604.273.6411 to speak to one of our lawyers.