Select The Right Structure For Your Business

by Tax Guy - Burlington Accountant on November 4, 2010 Print This Post Print This Post

If you own or are thinking of starting a business you may be considering incorporating your business.

The structure of your business is important and the appropriate help you plan for the future growth of your business.

There Are 3 Different Business

There are three main forms of business structure in Canada: A sole proprietorship, partnership, and the corporation.

The Sole Proprietor

Sole proprietorship is the simplest and easiest form of business structure.

There is no separation of the owner and the business. Business income is taxed in the hands of the owner and is included on the personal tax return of the owner. Other features of the sole proprietorship include:

  • Easy to establish: In many provinces you only need to register your business name and obtain a business license from your city or municipality.
  • Lack of permanence: Because the owner is the business the owner is truly self-employed. If the owner passes away, the assets are passed to family but any debts may not be transferred.
  • Liability: The owner of the business is fully liable for any debts and legal actions against business. If the business becomes insolvent or if the business is sued, the personal wealth of the owner is at risk.
  • Income tax: Your business income is included with your other income for tax purposes. If you are already earning a high income, your business income may be heavily taxed.
  • Loss realization: If your business will operate at a loss in the first couple of years, you will be able to directly deduct those losses against your other income.

The Partnership

The partnership shares many similarities to the sole proprietorship with the exception being that there is more than one owner.

In the partnership, the owners share a proportional interest in the income, expenses and assets of the business and report the income and losses on their personal income tax returns.

The Partnership Agreement

Whenever you enter into a partnership, it is advisable to have a partnership agreement drawn up.

The partnership agreement puts in writing who does what, how the interests are allocated, what to do in the event of a dispute and how the partnership will be dissolved.

Without a partnership agreement some provincial laws establish certain terms for partnerships. However, if certain conditions are not covered by law can cause problems in the event there is a dispute.

The Limited Partnership

Limited partnerships permit the partnership to bring in new limited partners, however the limited partners must not be involved in the management of the partnership to ensure they are insulated should the firm be sued of become insolvent. In the limited partnership structure, the general or principal partners have unlimited liability like the sole proprietor.

Each partner brings skills and experience to the business to benefit all of the partners. On the other hand, decision making in a partnership is made jointly.

The Corporation

A corporation is a separate legal entity and therefore separates the owners from their business. The shareholders become the owners of the corporation and are responsible for appointing the directors who are responsible for hiring managers. For many small corporations, the shareholder is both director and key manager.

The corporation issues shares to its shareholders to raise funds to begin operations and it can pay dividends to its shareholders or a salary to its owners. The issuance of shares provides a mechanism to obtain funding to establish or expand a business by offering a portion of the business of a range of investors without imposing repayment terms on the.

Advantages Of The Corporation

The benefits of incorporation include:

  • Limited liability: The corporation is considered a separate legal entity separate from its owners which insulates the owners of the business from legal liability, hence the term limited liability company (or Ltd.). If the business is well established and has lots of assets for collateral, then the liability of the shareholders is their investment in the business.
  • Income tax advantages: Canadian controlled private corporations are subject to a low rate of income tax on the first $500,000 of active business income (13% to 19% depending on your province). Structured right, the corproation can help you pay less tax.

If certain conditions are met, the shareholders may qualify for an exemption of tax on the first $750,000 of capital gain on the sale or disposition of their shares.

Disadvantages Of The Corporation

There are downsides to incorporation to be considered:

  • Formal establishment: The corporation is established through the drafting of the articles of incorporation and registering the firm with the federal or provincial government. This process can be costly to establish and imposes administrative requirements on the owners.
  • Administrative requirements: The corporation is required to make annual filings to the provincial for federal government. This imposes an administrative burden on the business and may add some additional costs.
  • Separate income tax: The corporation is required to file its own annual income tax return. This is in addition to your own personal tax return.
  • Trapped losses: Losses incurred by the corporation are retained and cannot be deducted from the owners’ income until the shares are sold.
  • Some liability: Many financial institutions require personal guarantees for the corporations’ debts. In addition, the directors of the corporation will be liable for remitting source deductions and GST.

The corporate structure can be complex and may not provide a tax advantage to the owners. Incorporation is best when a business is profitable, there is and intend to pass the business on to other family members, or there is a liability concern.

We Can Help You Can Pay Less Tax

Call us today at (289) 288-1206 to email us to arrange your appointment. We provide professional income tax preparation and planning to help you keep more of your hard earned money.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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{ 1 comment }

Phil Hogan January 9, 2011 at 1:10 am

This is one of the best comparisons of possible business structures I’ve seen on the net.

I get this question all the time….”should I incorporate my business??”

I’ll be pointing some of my callers to this post for sure.

Thanks again for the great info.


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