Partnership, sole proprietorship or corporation?
Understanding the basic business ownership structures in Canada.
If you’re a small business owner or are thinking about starting your own business, you’re in good company. Small businesses account for 97.9 per cent of all businesses with employees in Canada and are also the largest private sector employer, providing jobs for almost 70 per cent of the private sector labour force.[1]
While the sky’s the limit for what kind of business you own, there are just three main ownership structures for your business: sole proprietorship, partnership or corporation. Even if you already own a business, the structure that worked for you at the start may not be the one you need now. Understanding what structure is right for your business can help determine a number of things – such as who is responsible for taxes, business decisions and legal matters. Here is a brief overview of each structure to help you get started.
Sole proprietorship
Most small businesses in Canada are sole proprietorships, owned and controlled by one person who has all the legal rights and responsibilities associated with their business. You make all the decisions and reap all the profits, but you also bear all the responsibility if something goes wrong. A sole proprietorship is not considered a separate legal entity from the owner, so if your business incurs debts, claims can be made against your personal income and assets to pay them.
This structure is best suited to a small or a start-up business. Registration is quick and easy and start-up costs are low. From a tax perspective, owners are able to deduct business expenses from their income, which reduces the amount of tax payable. If your business isn’t doing well, you can deduct losses directly from your income. However, if your business becomes profitable, it could put you in a higher tax bracket, significantly increasing your tax burden. In that case, it might be time to shift to a corporation.
Partnership
A partnership is established when two or more people pool their financial, managerial or technical resources to operate a business. Each partner has a share in the management of the business, its assets and profits (or losses) – according to the partnership agreement in place. There is no legal separation between the business and the partners, so business debt claims can be made against the personal assets of each partner. Because partners are held responsible for business decisions made by the other partner(s), it is highly recommended that you put a partnership agreement in place that outlines the authority and responsibility of each partner, as well as how the income will be allocated.
A partnership is best suited to a small or a start-up business and it’s fairly easy and inexpensive to form one. Income from a partnership is allocated to the partners and taxed as personal income on each partner’s own tax return. As with a sole proprietorship, if the business has losses, the losses flow through to the partners and offset other income on their personal tax returns, lowering their taxable income.
Corporation
Unlike the other two structures, a corporation is a separate legal entity, independent from the business owner(s), and required to file its own tax return. Any number of people can form a corporation, an entity that can buy, own and sell property – and also become involved in legal action. The big difference with a corporate structure is the liability, because the corporate entity bears the legal liability rather than the owner(s). Setting up a corporation is usually complex and more costly than a partnership or sole proprietorship.
When a corporation earns income, it pays tax at the corporate level, often at a significantly lower rate than that of individuals. However, when a shareholder draws income out of the corporation, it is taxed at the personal level. Business owners can use the corporation to defer taxes, take advantage of income splitting and capital gains exemptions, and plan for retirement by limiting the amount of salary they draw.
Finding the right business fit
Every business is different, so speak to your advisor today to better understand all the financial, tax and legal implications of each business structure. Your advisor can refer you to a team of specialists that can help structure your business in the way that makes the most sense.
BUSINESS STRUCTURES AT A GLANCE
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Sole proprietor Ownership: One person Setup and registration:
Legal status and liability:
Tax treatment:
Capital considerations: Difficult to raise capital for expansion, etc. Death of owner: End of company |
Partnership Ownership: Two or more people Setup and registration:
Legal status and liability:
Tax treatment:
Capital considerations: Difficult to raise capital for expansion, etc. Death of owner: End of company, unless provision has been made in the partnership agreement. |
Corporation Ownership: Any number of people Setup and registration:
Legal status and liability:
Tax treatment:
Capital considerations: Much easier to raise capital Death of owner: Continuous existence; ownership is transferrable. |
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[1] 1 www.ic.gc.ca/eic/site/061.nsf/eng/h_03090.html