How to choose the right structure for your business
When starting a company, it’s essential to select the business structure that best supports your goals. Most of the time, business structures are chosen to comply with tax law, which treats each type of structure differently.
What are the types of structures?
There are three types of legal structures for a business:
- sole proprietorship
- partnership (which is a form of proprietorship)
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Here’s a summary of the pros and cons of the three business structures.
|Legal status||Does not exist as a separate legal entity. Proprietorship = ownership||Does not exist as a separate legal entity. Partnership = partners as owners||Corporation is treated as a separate legal entity from its owner. Corporation = shareholder ownership|
|Control||Owner has total control.||Partners’ agreement determines control between partners.||Directors and shareholders.|
|Profits||Profits are paid to the owner.||To partners according to a partnership agreement.||Earned by the corporation. Dividends may be paid to shareholders and/or retained in the corporation.|
|Debts||The owner is responsible (unlimited liability).||Partners are individually and collectively responsible.||Paid by the corporation.|
|Taxation||The owner is taxed as an individual on the income of the business as if he or she was employed.||Partners are taxed individually according to their share of the income.||The corporation pays corporate taxes separately from taxes paid by directors and shareholders.|
|Assets||Business assets are wholly owned by the proprietor.||Partners jointly own business assets and/or ownership is governed by partnership agreement.||Business assets are owned by the corporation. There is no specific claim on the corporate assets by shareholders.|
As you can see, each legal structure has distinct characteristics. But what does this specifically mean for each one?
1. Sole proprietorship
A sole proprietorship is informal and easily created, which is why it is the most common structure chosen by new businesses.
In this structure, the business and the operator are one and the same in the eyes of legal and tax authorities. Tax law treats a sole proprietorship as an income source for the proprietor and therefore requires that the business’s financial details be listed in a separate section of the personal income tax form.
In a sole proprietorship, the business’s money and responsibilities are the proprietor’s, and vice versa.
This presents some tax management options for the proprietor. If the business generates a loss, that loss can be applied to reduce income gained from other sources. That is why most part-time businesses are sole proprietorships.
However, sole proprietorships have a downside in that the proprietor is personally liable for all functions and debts of the business.
A partnership is similar, but instead of one proprietor there are two or more.
As with a sole proprietorship, there is no legal structure for a partnership. However, this partnership is usually entered into with some type of contractual agreement that governs, in percentage terms, the sharing of revenues, expenses and tasks.
When preparing their taxes, the partners apply those same percentages to their income and expenses.
Corporations are more complicated legal structures compared to sole proprietorships or partnerships.
Incorporation is a process in which a separate legal entity, owned by its shareholders, is formed.
Incorporation creates formal ownership shares, which produces a taxation and legal distance between the company and the shareholders. This in turn has tax advantages for the owners, who are usually paid salaries as employees of the corporation.
Incorporation provides some liability protection for the corporation’s debts and offers some measure of protection for a company’s name. Company officers and shareholders may come and go, but the corporation exists until it is wound down.
Incorporation is most often done under a charter in the operator’s home province, but some companies that operate in many provinces or internationally, or that require enhanced credibility, incorporate federally, which is more costly and complicated.
Corporations must keep meticulous records and report their financial situations to competent authorities yearly. Therefore, their financial statements must be audited annually by chartered accountants.
Incorporation is simpler and cheaper than you might think
Many entrepreneurs are not interested in the idea of incorporating, at least not in the early stages of building a business.
“Starting a business takes a lot of time and energy. There’s a lot of information to sort through, and entrepreneurs often put off questions about incorporating until later. Many don’t yet understand the benefits of incorporating,” says Stefanie Ricchio, a chartered professional accountant (CPA) and founder of the consulting firm The Modern Accountant.
Laura Didyk, BDC’s Vice President, Client Diversity echoes these comments. “Incorporating is often seen as an administrative burden for self-employed people starting a business, especially women. It’s common to think that the quickest and easiest way is to use your own name.”
“However, it’s not so time-consuming and complicated,” assures Yasmine Chaouni, a manager with Corporations Canada. “If the company structure is not too complex, you can do it in less than 20 minutes,” she says.
The issue of cost, often perceived as high, is also a misconception and should not be an obstacle to incorporating. “Obviously, it depends on whether you want or need legal and accounting advice, but you can initially incorporate a business for as little as $200 under federal jurisdiction, with subsequent fees for extra-provincial registration, which vary depending on the provinces where the business intends to carry on business” adds Chaouni.
4 steps to incorporate a business in Canada
Entrepreneurs who want to incorporate can do so directly online on Corporations Canada website. Here are the four steps to incorporate in Canada.
- Choose and register the corporation name (company name or number).
- Create articles of incorporation—basic incorporation involves pre-determined articles of incorporation that can be modified later if necessary.
- Establish the initial address of the head office and board of directors. Choose an address where you can be sure you will receive any documents that are sent there, as legally it will be assumed that they have been received by the organization. You must also decide who will sit on your board of directors.
- Pay the fees.