When starting a business, the business structure should be carefully considered as it will have consequences to the way your business is runned.
In Canada, there are essentially 3 common business structures:
- Sole proprietorship
Sole proprietorships are the simplest and most common business structure where a business is owned by one person. A sole proprietor makes all the decisions relating to the business. In the eyes of the law, a sole proprietor and their business are considered one of the same, which means the sole proprietor assumes all the risks, which also extends to personal property and assets. Self-employed individuals are considered sole proprietors.
The net income (or loss) from the business must be reported in a personal tax return (T1). Net income from the business will be added to all other personal income and taxed at the personal income tax rate. Net losses would be deducted from the total personal income, which may reduce the amount of tax to be paid.
There are 2 types of partnerships — general and limited.
The majority of partnerships are considered a general partnership. This is when a business has 2 or more owners where the owners have come together to pool their capital and resources to start and manage a business. Together, they will share in the profits and the losses. Partners are liable for each other’s actions. As the business itself does not file an income tax return or pay taxes, partners are considered self-employed and therefore must report their share of the net income or losses from the business on a personal tax return (T1). Like sole proprietors, each partner assumes the risk and could each be personally liable.
Limited partnership is a form of general partnership where there are general and limited partners involved. Limited partners contribute capital to the business and are not involved in the management of the company. Therefore, limited partners have limited liability to the business whereby they are not personally liable for the business.
Forming a corporation means that the business is considered a separate legal entity from the owner(s) of the business and shares representing percentage of ownership are distributed. Owners may receive a salary and dividends. The company can sell shares to raise capital for the business.
One of the main advantages to incorporating is the limited liability to the owners (shareholders). This means that if the business faces financial difficulties, the owner’s (shareholders) personal property and assets should be safeguarded.
Another advantage to corporations are the tax advantages such as income splitting, corporate tax rates are lower than personal tax rates, and you can decide on the timing of receiving income so that it can be timed to when you pay the least amount of tax.
A corporation will survive even if shareholders die or leave the company. Businesses can be incorporated provincially or federally.
Corporations must report all income or losses by filing a T2 Corporation Income Tax Return.
IFC’s Business Start Up will help you every step of the way in starting your own business. Contact us to learn more.