The first step for any entrepreneur when starting a business is to select the legal structure that best supports their goals. It is essential because the form of ownership that is chosen will determine how the business is organized, how the money that flows in and out is handled, and how it all gets taxed. Business structures are chosen for the most part to comply with tax and publicity regulations, which treat each type of structure differently. This article breaks down the four forms of business ownership, their advantages and disadvantages to help you understand which form of business ownership is best for you when starting your own business in Canada.
The following are four common forms of business ownership in Canada:
A sole proprietorship is informal and easily created and therefore is the most common form of business ownership chosen by new businesses. In a sole proprietorship, the business and the operator are one and the same in the eyes of authorities. With this type of structure, you are the sole owner, and fully responsible for all debts and obligations related to your business. All profits are yours to keep. Because you are personally liable, a creditor can make a claim against your personal assets as well as your business assets in order to satisfy any debts. Tax regulations treats a sole proprietorship business 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 possibilities for tax management on the part of the sole proprietor. If the business generates a loss, that loss can be applied to reduce income gained from other sources. This is why most part-time businesses are sole proprietorships. Sole proprietorships have a downside, however, in that the proprietor is personally liable for all functions and debts of the business.
A partnership is a non-incorporated business that is similar to a sole proprietorship, but instead of one owner, there are two or more. As with proprietorships, there is no separate legal structure in a partnership. There is no need to file a separate tax return for the partnership and each partner is taxed personally on their own share. However, partners will usually have some type of contractual agreement, often called a partnership agreement, that governs the sharing of revenues, expenses, and day-to-day responsibilities. This agreement is essential to clarify management accountability, ownership and profit distribution, as well as avoid disputes later on.
There are further distinctions in the types of partnerships that can be established, for example general and limited partnerships. In a general partnership, each partner is jointly liable for the debts of the partnership. In a limited partnership, there is a combination of general partners and limited partners. Limited partners can contribute capital but cannot be involved in the company’s day-to-day management. Their liability is therefore capped by the amount of capital they contribute whereas the general partner is liable for the full assets and liabilities of the partnership. In some provinces, limited partnerships are available only to groups of professionals such as lawyers, accountants or doctors.
Corporations are more complicated legal structures than 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 as employees of the corporation, or can be paid through dividend distributions. 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 legislation in the operator’s province, but some companies that operate in many provinces or internationally, or that require enhanced credibility, incorporate federally. This is more expensive and complicated. Corporations must keep meticulous records and report their financial situations to governing authorities yearly. Therefore, their financial statements are likely to be audited annually by qualified accountants. Because corporations are more costly to operate than sole proprietorships and partnerships, new businesses do not usually incorporate unless they plan to acquire capital through sale of shares, or desire greater credibility. Companies usually do not incorporate until they generate at least $50,000 in revenue annually, or expect to.
A co-operative is owned and controlled by an association of members. It can be set up as a for-profit or as a not-for-profit organization. This is the least common form of business, but can be appropriate in situations where a group of individuals or businesses decide to pool their resources and provide access to common needs, such as the delivery of products or services, the sale of products or services, employment, and more.