Selecting the Optimal Structure for Your Business

The structure of your business can most easily be thought of as the legal identity of your business, or in other words, how your business will be viewed with respect to several legal issues including personal liability and tax. There are three common structures available to Canadian businesses: sole proprietorships, partnerships, and corporations.

Sole Proprietorships

A sole proprietorship is the most basic business structure: whenever an individual operates a business on their own and for their own account, a sole proprietorship exists. A sole proprietorship is relatively inexpensive to set-up and has few legal formalities. All income and assets arising from the business accrue exclusively to the owner/sole proprietor.

However, all losses and liabilities are also the sole proprietor’s responsibility. As a consequence, business and personal assets may be seized in satisfaction of the sole proprietor’s business obligations, although it may be possible to limit personal liability exposure by contract or through insurance.

Income or losses from a sole proprietorship are included within the sole proprietor’s income or losses from other sources during the year, all of which are subject to taxation at the marginal tax rates applicable to individuals. This may allow for some tax planning flexibility: a sole proprietor may offset their other income with business losses from the sole proprietorship, which may be carried forward or back to a particular taxation year.

Partnerships

A partnership arises where two or more persons, whether individuals or corporations, are carrying on business together with a view to profit. Like sole proprietorships, partnerships are relatively inexpensive to set up and may require few legal formalities for creation.

There are three types of partnerships: general partnerships, limited partnerships, and limited liability partnerships.

In a general partnership, the liability of each partner for the debts and other obligations of the partnership is unlimited, and each partner is jointly liable along with their co-partners for all debts and obligations of the firm.

For tax purposes, income or loss is determined at the partnership level before being allocated to the partners. The allocation to each partner is then included in calculating their individual income. This means that, generally, income and loss flow through the partnership to the partners and retain their characteristics as to source and nature.

Corporations

A corporation is a legal entity, separate and distinct from its owners, that can own property, carry on business, possess rights, and incur liabilities. Shareholders own the corporation but not the property of the corporation – however, shareholders may be entitled to some portion of the company’s asset where the corporation is dissolved.

Generally, a shareholder’s liability is limited to the value of the assets they have transferred to the corporation in exchange for their shares.

A corporation’s income is determined and subject to corporate tax. In other words, a shareholder does not treat the net income or loss of a corporation as the shareholder’s own income or loss. However, if after-tax income of a corporation is paid to its shareholders by way of dividend, this generally constitutes taxable income for the shareholders.

A business owner will have to decide whether to incorporate provincially or federally.

Federal incorporation provides greater protection to the company name by allowing operation of the business throughout Canada under one name. An Ontario corporation’s name is only protected in Ontario and cannot be registered in a province where a business is already operating under the same name.

Jurisdiction of incorporation may also affect costs for initiating and renewing the corporation. Incorporating federally may have a slightly lower initial cost but complying with federal filing requirements may erase any initial savings.

The optimal place of incorporation may ultimately depend on where the business intends to operate (ex. provincially, nationally, or internationally).

Choosing Your Business Structure

A prominent factor in selecting the right business is exposure to liability. Sole proprietors and most partners are liable to the full extent of their personal assets for the liabilities of their businesses. A shareholder, on the other hand, is generally only liability up to the amount of their investment. Therefore, if your business faces a substantial uninsurable risk, a corporation is likely the best vehicle to limit liability.

Other considerations include the business’s perpetual existence (which is available to a corporation), tax and estate planning of the owner, administrative costs, and flexibility of the structure.

Want to know more? Ask us!

Slingshot can help you choose the optimal structure for your business, so you can focus on getting to work.