If you are starting a business, choosing between different business structures such as sole proprietorship, partnerships, corporation can be difficult if you do not know the advantages or disadvantages that come with each structure.
Whether you are buying an existing business or creating one, you should have a firm grasp of the basic characteristics of the various structures. Below are details on 4 types of business structures in Canada to consider. The process for setting up a certain type of business, some taxation and finance issues you need to keep in mind, legal aspects to be aware of and characteristics of each structure.
A Sole Proprietorship is the most common type of all business structures that is the easiest and most cost effective to set up and puts you in control as the owner. As sole proprietor, you get full control over company management and decisions.
Aside from a well laid out business plan, there are some things to have in place as you start your business as a sole proprietor.
Unless you want to operate your business under your own name, you will first need to come up with a name for your business and perform a name search to ensure it is available. You can either order a NUANS report or retain an independent registration name search to perform one for you. Once your name search passes, you will then need to register the name with the Ontario Ministry of Consumer and Business Services. This can be done online for $60 CAD and will have to be renewed every 5 years.
A business name registration will entitle and provide you with a business license and number that is used by the Canada Revenue Agency (CRA) to identify your company. You may also need to determine which CRA programs you need to join as a business. These programs assist you with business transactions, such as payroll and GST/HST. You will also need proof of registration to open up a business account.
Lastly, you will need to set your business up with the appropriate provincial and municipal permits as needed, such as liquor licenses, parking permits and so on. It is the business owner’s responsibility to ensure the business complies with existing bylaws.
Taxation And Finances
Your business is typically financed by personal assets, line of credit or loans. Thus, you may find raising startup capital difficult since investors will typically want a percentage of the business in return for their investment.
As a sole proprietor, you will only need to file one annual income tax return, reporting your business income on Form T2125, which is included with the general T1 form. The T2125 form is where you report all your business deductions. There are restrictions and conditions for business tax deductions. For instance, if you run your business from your home, you can deduct expenses used for your business including rent, utilities, and repairs attributable to the business. The household cost you can deduct is calculated based on the amount of time and space used for your business. You can deduct current expenses like office supplies, for example, but not furniture which are capital expenses. Travel expenses are deductible for up to 50% and there is also a capital cost allowance to cover the costs of wear and tear and replacing obsolete equipment.
Note that as a business owner, you may also be put into a higher tax bracket as your business revenue is considered personal income. Likewise, you can deduct your losses from your personal income, and be put into a lower tax bracket.
However, this does not mean all your finances should be recorded and run the same way. You will need separate books and good financial practices. You will likely need a business credit card and bank account. The penalty for not reporting all your income can be steep at having to pay 10% on the income you did not report.
There is no legal distinction between you as the owner and the business. Proprietors are considered self employed, not employees. While all profits and assets pass to you as the owner, so do its losses. If a creditor makes a claim against your business, your personal assets can be targeted to satisfy your debts. Yet, this also means that, as sole proprietor, you can transfer your business by selling your assets.
You may have also heard of the term, DBA or “Doing Business As”. In itself, this is not a structured business, but a designation. This enables your business to operate under a name that differs from your personal name, your partner’s’ name or the name registered of your corporation.
Partnerships are business structures that are formed and owned by two or more people.This allows you all to share in the business’ management, profits or losses. Start-up costs are shared equally with you and your partner. Like a sole proprietorship, it is fairly easy and inexpensive to set up a partnership.
Setup and Process
There are no formal filing requirements for general partnerships other than registering the business name within the province you intend to operate. This involves the same process as registering a name for a sole proprietorship, complete with name search and registration that will need to be renewed every five years. Once set up, if you need to hire new employees and such, you will have to register for the usual business tax accounts through the CRA just as you would setting up a sole proprietorship.
To safeguard against any future conflicts, you and your partners should consider drafting up a partnership agreement that outlines the rules and regulations that will govern how you and your partner decide on matters. This can cover a wide range of aspects: asset ownership, budgets, distribution of income, account management, signing authorities, insurance policies, procedures for dispute resolutions and so on.
From a legal standpoint, there are many similarities between a partnership and a proprietorship. For instance, there is no legal distinction between the business and the owners, and there is a joint liability. This means that if you have outstanding debt, your own assets can be used to pay it off. The owners in a partnership can be sued as a group. Moreover, you are held financially responsible for decisions made by your partner such as broken contracts, unpaid debts and mismanaged funds.
Note, though, that there are options to limit your liability depending on the type of partnership structure you choose. Thus, before you set up a partnership, consult with an OMQ lawyer to explore a structure that works strategically with all individuals involved.
Taxation And Finances
Finance-wise, startup capital may be easier to raise for partnerships. Partners can pool their financial resources together and thus, the amount of start up capital can be substantially greater than that raised by a sole proprietor.
Partners are considered self-employed, much like the owner of a sole proprietorship is considered self-employed. A partnership is not a tax-paying entity and thus, they have only one level of taxation in Canada. The same restrictions and allowances that apply to sole proprietors also apply to partnerships. Each partner files a personal income tax return and reports their share of the partnership’s net income or loss. One advantage of this tax structure is that if the income from your partnership is low or loses money, it can reduce your own personal income tax.
Types Of Partnerships
There are different types of partnerships you can establish: general, limited, and limited liability. Any partner in a General Partnership can act on behalf of the entire business without the knowledge or permission of the other partners.
In a Limited Partnership, all partners enjoy limited liability according to each partner’s contribution. The partners are not responsible for more than the amount they invested. Limited partners only contribute financially and do not actively manage the business. Only one of the partners will be the general partner and have unlimited liability.
In a Limited Liability Partnership (LLP) the partners are not liable for any debts that arise as a result of negligence by other partners. This is usually a partnership for professionals, such as lawyers and accountants.
A general corporation is considered a separate legal entity on its own, separate from its owners and shareholders. As a corporation, your business can be taxed, held liable, and also make a profit. You can tell if a business is incorporated by the name. Incorporated businesses include a designation such as Inc., Ltd, Limited, Unlimited, or Corporation.
A corporation is formally structured with shareholders, directors, and employees. Because corporations need to vote on company issues, this is one of the most ideal business structures for bigger companies looking to go public, raise venture capital or invest its profits. This type of business comes with a more complex legal structure and hence is more expensive to set up than a sole proprietorship.
To incorporate your business, you need to complete Articles of Incorporation, a NUANS search report, a fee to the Minister of Finance, a covering letter with your contact information and any other supporting documents required.
You can submit your application online through one of the Service Providers under contract with the Ministry of Government and Consumer Services. For submitting in person, you can visit your nearest Land Registry/ServiceOntario office in Ontario. Or if you would like to submit by mail you can send it to the Central Production and Verification Services Branch.
Once incorporated you will need to set up your corporation. This means keeping a corporate minutes book, organizing your corporation and issuing shares, setting up bank accounts, obtaining necessary licenses or permits, and hiring employees.
From a legal standpoint, corporations have limited liability. This is because incorporating a business creates a new legal entity. This entity, your corporation, will operate under Canadian law as an individual person would. This means that your company can have assets, it can apply for loans, it can enter into contracts, and it can sue other parties. The corporation’s money and assets belong to the corporation. Because a corporation is a separate legal entity, its shareholders are not responsible for the company’s debts.
Legally, the corporate business structures are sometimes seen as “corporate shields” as they protects the owner’s personal assets from the business’ liabilities. However, if you are sued, it is possible for courts to bypass the corporation’s limited liability status and “pierce the corporate veil”, holding shareholders or directors personally liable for any actions or debts of the corporation. If this happens, seek legal counsel with OMQ corporate lawyers first.
Types of Corporations
There are different types of corporations to consider. For instance, you can establish a For Profit or Not for Profit corporation. Professions, such as dentists, accountants, lawyers, and doctors, can operate as a Professional Corporation (authorized and sanctioned by the governing professional body). A CCPC is a Canadian-Controlled Private Corporation that is controlled by Canadian residents. You can establish a Public Corporation or a Private Corporation.
To incorporate your business federally, you must go through Corporations Canada. You will still have to incorporate your business provincially, as well. You will need your articles of incorporation, Initial Registered Office Address and First Board of Director form completed, and a NUANS name search report for your proposed company name. Though this option requires more money and effort, it allows you to operate your business nationally with the same name.
Incorporating your business provincially is done through a provincial registrar and is especially important to research because your business may or may not have to follow certain rules and agreements set up between other provinces.
Taxation and Finances
Where finance is involved, corporations generally have better opportunities and access to grants and funding. As a corporation, you have the options of issuing bonds and shares to investors to help raise capital. You also have to file an annual return to Corporations Canada within 60 days following your corporation’s anniversary date.
Because corporations are a legal entity, they can be taxed. However, corporations benefit from lower tax rates than the general individual tax rates. Corporations must file annually, submitting a T2 corporate tax form to the CRA.
One of the main benefits of incorporating a company is the reduction in taxes that could give you a number of advantages. For instance, Canadian-Controlled Private Corporations benefit the most from tax deductions as a corporation. They can take advantage of the small business tax deduction, enhanced investment tax credits, capital gains exemptions for shareholders. They can also claim research and development tax credits if eligible. Before you file your taxes as a corporation, you should consult with a lawyer and an accountant first.
A Co-Operative is one of those business structures that are ideal for a group of people who want to pool resources, knowledge, finances and skills together to provide a service whether it be for selling products or providing access to resources.
A co-operative is an incorporated business structure where the company is owned and controlled by an association of members. Rather than being structured to maximize profits, a co-op is structured to meet the expectations of their members. Because co-operatives are a democratically run business structure, there is a longer decision-making process as each member must vote on company decisions.
Types of Co-Operatives
There are different types of co-operatives with different purposes and goals.
- Worker co-operatives are focused on the commitment of employees. In this type of co-operative, the members and owners of the enterprise are also the employees.
- Service co-operatives provide products or services to their members. These businesses can serve the needs of their members with services such as housing, electricity, healthcare, childcare, and funeral services.
- Producer co-operatives process and market the goods and services that are produced by their members. They also supply services needed for members to carry out professional activities as independent entrepreneurs, farmers, etc.
- Multi-stakeholder co-operatives serve the needs of different stakeholders who share an interest in the company such as employees, clients and other investors and organizations.
Co-operatives are set up and established like other business structures. To start a co-operative, you need a cover letter including contact information for the person filing the application. A completed and signed copy of Articles of Incorporation, a Notice of Registered Office or Notice of Change of Address of Registered Office form, and a signed and completed copy of a Notice of Directors or Notice of Change of Directors form. You will also need a NUANs Name Search Report for the co-operative’s proposed name. You will also need a statutory declaration included along with a filing fee.
Taxation And Finances
As a co-operative, your business can be a for-profit or not-for-profit organization. A for-profit co‑operative’s income is taxable. Taxation and finances are the type of business structures that share the surplus (funds and earnings after paying expenses, but before taxes) among members based on how they use the organization, not on the number of shares. Dividends are deductible from a co‑op’s taxable income. For tax purposes, co-operatives need to file a T2 corporation tax return annually. Depending on the nature of your co-op services, you may have to pay municipal property taxes and federal and provincial income taxes.
As a member of a co-operative business, you have limited liability and risk losing only the amount of your investment. If you leave a co-op, you are entitled to get your investment back. However, you may be liable to the co-op’s creditors in certain circumstances. For instance, if you received any of the co-op’s property before paying off your creditors, you may be liable to them for the amount you received. Also, if the number of members in your co-op falls below five (or three if you are in a worker co-op) for longer than a six month period, you and the other members are responsible for any liabilities of the business.
Choosing the structure of your business requires careful consideration. There are many disadvantages and benefits to each structure. If you are looking to open your business, be sure to consult a lawyer at OMQ Law to find out just exactly how each business structure will affect you.