To determine which legal structure is best for your business, you need to understand all the options. There are three main business structures in Canada: (1) Sole proprietorship; (2) Partnership; and (3) Corporation. This article will explain each type of business structure and give you an idea of which one is right for your business.
A sole proprietorship is the simplest and most common business structure among small businesses. Sole proprietorships are owned by one person and do not require much paperwork. If you operate your business under your legal name, you do not need to register your business. You only need to register with the CRA if your sales exceed $30,000 a year.
A unique feature of sole proprietorships is that the business and the owner are treated as one entity for tax purposes. All the profits from a sole proprietorship are treated as the owner’s income source. This is beneficial because even if the business generates a loss, rather than a profit, the loss will reduce the sole proprietor’s total income, reducing the total taxes to be paid.
There are also significant disadvantages to sole proprietorships. First, sole proprietors are subject to unlimited personal liability for the functions and debts of their business. This means their personal assets are always at risk. Second, if the business does very well and makes a large profit, the sole proprietor will likely be placed in a higher tax bracket and will have to pay more taxes. Third, selling a sole proprietorship can be difficult.
A partnership is very similar to a sole proprietorship but consists of two or more business partners and are more costly. Individuals entering a partnership will likely sign a partnership agreement to govern their relationship and set out the terms for sharing profit, expenses, and tasks. There are different types of partnerships, such as: general partnerships, limited partnerships, and limited liability partnerships (LLPs).
A general partnership is a business agreement where partners share debts and other liabilities. Partners can also be personally liable which allows creditors to go after their personal assets.
A limited partnership has one general partner who manages the business and is liable for its debts. All other partners are limited partners, and as the name suggests, have limited liability – they can only lose their investment in the limited partnership. Limited partnerships are a good choice for people who just want to be passive investors in a company.
An LLP is an agreement available for professionals such as accountants, lawyers, and doctors in which partners cannot be held liable for another partner’s debts.
A corporation is a separate legal entity and is owned by shareholders. Corporations are different from sole proprietorships and partnerships because the corporation is legally distinct from its owners. Because corporations are separate legal entities, they can own property, borrow money, invest, have a separate bank account, etc. This means that contrary to the other business structures, the owners of a corporation are not personally liable for the liabilities and debts of the business – their personal assets are protected.
There are several benefits to incorporation, including:
- Limited liability protection for owners;
- Easy transferring and selling ownership – the owners can simply sell their shares;
- Tax benefits (such as lower rates than other structures);
- Ability to easily raise capital by selling more shares; and
- Increasing the credibility of the business, which makes it easier to receive loans and supply.
Corporations can be incorporated provincially or federally. Federal incorporation is more advantageous if you plan to expand your business across other provinces or countries, while provincial incorporation is preferred for small local businesses.
Corporations, although very advantageous for entrepreneurs, are more costly and complicated than partnerships and sole proprietorships. Corporations must keep detailed records of their financial situations, file tax returns, and have their financial statements audited by accountants each year.
However, if you plan to grow and develop your businesses while protecting your personal assets, incorporation is likely the right structure for you.
Contact Us for more information or to get started with incorporating your business.