Congratulations! You’ve decided to start your own business. There’s probably a million different things running through your head right now. And before you order business cards and a World’s Best Boss mug for your desk, you’ll have to give some thought to business structure. We'll give you a quick overview of the differences between the three main business structures in Canada: sole proprietorship, partnership and corporation. Each has important and distinct characteristics that will have an impact on taxation and liability.
This is the most basic business structure. With a sole proprietorship, you are responsible for all profits, debts, obligations and taxes associated with your business.
Advantages of sole proprietorship
It's easy to set-up and dissolve, has low-start-up costs and fewer regulations than other structures. With this structure, you have only one tax return to file - any profit from the business is declared on your individual income tax return.
Disadvantages of sole proprietorship
As a sole proprietor, the Canada Revenue Agency views the business and owner/operator as being one and the same, which means if you're sued by a customer, your personal assets could be liable. You'll also be relying on your own credit rating and existing contacts to raise capital. Plus, your income is taxed at the personal rate, which means you could be placed in a higher tax bracket if you're making a decent amount of money.
A partnership is a non-incorporated business that is formed between two or more people. Like a sole proprietorship, a partnership has no legal structure. We recommend that partners have an agreement that stipulates how the business is structured with regards to revenue, profits, expenses and liabilities. This is beneficial come tax time, as each partner understands what percentage of income and expenses applies to them.
Advantages of a partnership
It's simple to form and dissolve and has low start-up costs. Each partner is responsible for filing their own income tax return and claiming their share of the partnership’s profits or losses. Since more than one person is involved in the business, there's a stronger potential to access capital as your network is wider.
Disadvantages of a partnership
Like a sole proprietorship, there is no legal difference between you and the business. You are financially responsible for the actions of the other partners and if your business is sued, you're liable. It also has limited life, and there's a possibility of disputes and conflicts when you're working with someone else.
A corporation is a formal business arrangement that brings into existence a legal entity separate from you. For this reason, being incorporated provides small business owners in Canada with the most tax and liability advantages.
Incorporating a business can be done federally or provincially. If you're going to stick to operating your business in one province, it makes sense to incorporate on the provincial level. If you want to operate in more than one province in the future, you'll need to get a license for every province you want to operate in. So think about federal incorporation if you want to operate across the country.
Advantages of incorporation
Because an incorporated business is a separate entity, you are not personally responsible for debts, obligations or other acts of the corporation (talk to your tax professional about exceptions). Corporations are also taxed at a lower rate. For Canadian-controlled private corporations claiming the Small Business Deduction, the net tax rate is 9% (2019).
If the business is not incorporated, your income is taxed at the personal income tax level. In 2019, personal income is taxed 15% on the first $47,630 of taxable income; 20.5% on the next $47,629 of taxable income; 26% on the next $52,408 of taxable income; 29% on the next $62,704 of taxable income; and 33% of taxable income over $210,371.
If you're earning more than you need to live, you can reinvest surplus profit into the business, allowing you to defer personal taxes on withdrawals. In addition, the business has extended life, there are opportunities for income splitting, along with more opportunities to raise capital. You can also use the lifetime capital gains exemption if you have capital gains arising from the disposition of certain properties (small business corporation shares and qualified farm and fishing properties) and meet certain conditions - the exemption could spare you from paying taxes on some or all of it.
Disadvantages of incorporation
While there are many advantages to incorporating a business, there are also higher start-up costs, you have to file a separate tax return, you won't have personal tax credits, closing the business is more difficult and liability may not be completely limited. Corporations also need to keep meticulous records and report their financial statements. If you think incorporation might be right for you, talk to a tax professional who will analyze your business and personal circumstances and make a recommendation.
Disclaimer: The material above is provided for educational and informational purposes only. Always consult a tax professional like FBC regarding your specific tax situation.