Which form of business would be good for you? Sole proprietorship, partnership, or corporation
In Canada, the legal structure of your business matters: partnership, sole proprietorship, or incorporation. In this post, we’ll explore the 3 main business ownership structures in Canada, including the advantages and disadvantages of each one. This will help you understand which form of business is best for you.
Basic Business Ownership Structures in Canada
Your business ownership structure determines several things including startup costs, liability, tax rates, and estate planning.
If you’re just starting your business, understanding each type of business structure can make a big difference in your costs. If your business has been around for a while, the ownership structure you started with may no longer be the best one for you now.
Let’s take a closer look at the key characteristics of the main business ownership structures in Canada.
A sole proprietorship is a business with one person (the owner-operator) who bears all the responsibilities and legal rights associated with the business. It’s the most common structure used by new businesses, largely because it’s easy and inexpensive to set up.
A sole proprietorship can be the name of the sole proprietor or any name you choose for your business.
The law sees the business (the sole proprietorship) and the operator (the sole proprietor) as the same legal entity. The law considers the income of a sole proprietorship self-employment income. The business owner claims the income on their personal income tax forms.
Advantages of Sole Proprietorship
The ease of setting up a sole proprietorship is a big advantage. In Alberta, starting a sole proprietorship is as simple as choosing a business name (if you don’t want to use your own name), and registering it with a provincial registry. If you’ll make more than $30,000 in a year, you also need to register for a GST number.
Tax simplicity is another advantage of sole proprietorship. As sole proprietor, the Canada Revenue Agency (CRA) only requires you to submit your annual personal income tax forms, declaring business income as personal income. You can deduct business losses and expenses from personal income, which reduces your tax payable.
For many sole proprietors, the greatest advantage is that you own 100% of the business. This means you get to make all the decisions and run your business your own way.
Disadvantages of Sole Proprietorship
A sole proprietorship sounds good, doesn’t it? But it’s still not the best business structure for everyone. There are some disadvantages.
Perhaps the biggest downside of a sole proprietorship is that the sole proprietor is personally liable for all functions and debts of the business. Remember that the law sees a sole proprietorship and its owner-operator as a single entity. So if your business incurs debt, you are personally responsible for it. Claims can be made against your personal assets to pay off the debt.
It can be more challenging to raise money to help grow the business as a sole proprietorship. Also, if the sole proprietor lacks skill and knowledge to run the business well, management will be weak and stunt the growth of the business. The last notable disadvantage is that it’s more difficult to transfer ownership of a sole proprietorship in the event of the sole proprietor’s death.
A partnership is like a sole proprietorship, but there are two or more proprietors (owner-operators). The partners typically have a contractual agreement that dictates the percentage of ownership, revenue shares, responsibilities and authority of each partner.
There is no legal limit on how many partners a partnership can involve.
As with a sole proprietorship, the law considers the partners in a partnership the same entity as the business. This means the partners claim their business income as self-employment income on their personal tax forms.
Advantages of Partnership
Most of the advantages of the partnership business structure are the same as a sole proprietorship. A partnership is relatively easy and inexpensive to set up. And partners can use business expenses and losses to reduce personal income for tax purposes.
Another advantage of a partnership is the division of responsibility. Some business owners might prefer to share the costs and management of the business with someone else. Decision-making can benefit from the input of more than one person.
A partnership can be an opportunity for mentorship. And, when partners have complementary strengths and skills, a partnership can be significantly fulfilling all around.
Disadvantages of Partnership
The shared responsibilities of a partnership can become a disadvantage, too. It can be more challenging to move forward if the partners can’t reach a consensus.
As with a sole proprietorship, in a partnership, all partners are subject to unlimited liability. This means that their own personal assets can be claimed to pay for any business debts. This personal liability remains even after death or retirement if the business incurred the debt before the death of the partner.
Partners can also be held responsible for any wrongful act by other partners acting on behalf of the business.
A contractual agreement is highly recommended for your partnership. This can prevent complications about income, expenses, taxes, decision-making, responsibilities, authority, and processes in your business. The lawyers at Osuji & Smith can help you draft a partnership agreement.
A corporation is a separate legal entity that can buy, sell, and own property independently of its shareholders. Any number of people can form a corporation. The CRA requires the corporation to pay corporate income tax, which is separate from the shareholders’ personal income tax.
Advantages of Incorporation
Because a corporation is a separate legal entity, there is some distance between the business and its shareholders. This is the key advantage for the owners (who are usually paid as employees) because it removes the personal liability and offers tax deference opportunities, income splitting, capital gains exemptions, and other financial benefits.
There’s stability and continuity that comes with incorporation. Even if the owners change, the business entity remains the same.
Another advantage of incorporation is that there are more funding options which can make it easier to grow the business.
Disadvantages of Incorporation
Incorporating a business is more complex and costly than a sole proprietorship or partnership. For most businesses, setting up a corporation is done at the provincial level, but for businesses operating across Canada or internationally, federal incorporation is sometimes necessary.
The government requires corporations to submit annual financial reports. Qualified accountants must audit these statements. This means higher accounting fees.
How to Choose the Right Business Ownership Structure
Every business is unique. The business ownership structure you choose will affect your taxes (both corporate and personal) and how you manage your business, including administrative costs and legal implications. The corporate commercial and business lawyers at Osuji & Smith can advise you and help you choose the best form of business for you.