Which Business Structure is Best For You?

Which Business Structure is Best For You?

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Which Business Structure is Best For You? –

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.

Sole-Proprietorship

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

  1. Obtain a tax number; and
  2. 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.

Corporation

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.

General Partnership

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:

  1. Registered tax number for applicable taxes; and
  2. 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

https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/pages/sole-proprietorship.aspx

https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/pages/corporation.aspx

https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/pages/general-partnership.aspx

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.

Areas of Practice

Business Law




Directors’ Duties and Liabilities

Which Business Structure is Best For You?

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Which Business Structure is Best For You? –

Being the director of a corporation sounds like a cushy job, but not so fast. A director has a stringent set of rules to abide by.

The BC Business Corporations Act sets out all the duties that a director has. Particularly, a director must act honestly and in good faith with a view to the best interests of the corporation and exercise the care, diligence, and skill that a reasonably prudent individual would exercise in comparable circumstances.

Honesty

Directors must respect the trust and confidence they have been given in managing the assets of the corporation. Further, they must be truthful and open and are prohibited from realizing any secret profits or non-approved conflict of interest.

Good Faith and In the Best Interests of the Corporation

The duty of good faith can be generally referred to as the duty of loyalty or fiduciary duty. Whether a director has exercised this duty of good faith is determined on a case by case basis.

Diligence

The duty of diligence puts the onus on a director to make those inquiries that a person of ordinary care in that position or in managing his or her own affairs would make. Some examples of situations where these duties of directors come into play are as follows:

  1. Attending meetings à A director does not have to attend all directors’ meetings but should try to do so, because they may be held liable for any prohibited matters that occur while they were absent.
  2. Relying on other directors à Generally, directors are not responsible for the misdeeds or decisions of any of their co-directors if they have not participated in the acts resulting in the damage and is not negligent.
  3. Relying on officers and professionals à Directors are allowed to rely on the expertise and knowledge of officers of the corporation or skilled professionals (eg. lawyers, accountants etc.) to assist them in making decisions, but should still be cautious of the information prior to accepting it.

Skill

Directors must respect the trust and confidence they have been given in managing the assets of the corporation and must exercise the care, diligence, and skill that a reasonably prudent individual would exercise in comparable circumstances. Further, they must avoid using their position for their personal benefit and must avoid any conflicts of interest with the corporation. Finally, directors must maintain the confidentiality of any information they obtain by virtue of their position and they must serve the corporation selflessly, honestly and loyally.

Duties Are Owed to Corporation

The long standing principle has been that directors owe a fiduciary duty only to the Corporation and not anyone else. However, recent case law has carved out exceptions where directors may be held liable to other groups such as shareholders, creditors, employees, the government and the public, among other groups.

Conflicts of Interest

As mentioned previously, directors are to avoid conflicts of interest wherever possible. However, courts consider what a reasonable person, in considering a particular situation, would think gives rise to a real sensible possibility of conflict, not what one could imagine could arise out of a situation. Essentially, the courts are not willing to look at every possible situation which could arise out of a situation as a potential conflict.

Further, directors have an obligation to disclose to shareholders any profits or gains realized from a contract or transaction with the corporation if it is material to the corporation. The Business Corporations Act has codified this requirement, by setting out a general test which requires assessing whether

  1. A contract or transaction which creates a conflict is “material” to the corporation; and
  2. The director has a “material interest” in the contract or transaction.

If answers to both parts of the test, are a “yes” then a director should disclose the interest to the shareholders of the corporation.

From a practical perspective, an assessment of whether a director is in a conflict of interest, whether they have addressed the conflict of interest, and whether they have made sufficient disclosure to interested parties is a fact based exercise. Directors would be prudent to remain as transparent as possible when dealing with any potential conflicts of interest.

For inquiries on this topic, please contact one of the lawyers from our Business Law Group at 604.273.6411.

Areas of Practice

Business Law