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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

Sole proprietor

Ownership: One person

Setup and registration:

  • Quick and easy registration
  • Low-cost setup
  • Minimal working capital required

Legal status and liability:

  • Business not a separate entity from owner
  • Owner personally liable for any debts

Tax treatment:

  • Taxed as personal income
  • Business expenses and losses can be written off from personal income

Capital considerations: Difficult to raise capital for expansion, etc.

Death of owner: End of company

Partnership

Ownership: Two or more people

Setup and registration:

  • Low-cost setup, shared between partners
  • Quick and easy registration
  • Legal partnership agreement recommended

Legal status and liability:

  • Business not a separate entity from owners/partners
  • Partners personally liable for any debts

Tax treatment:

  • Taxed at each partner’s personal income level
  • Business expenses and losses can be written off from personal income

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 registration comes with costs and complexity
  • Annual fees for accounting/legal
  • More oversight, with compliance and annual filing requirements

Legal status and liability:

  • Business is a separate legal entity
  • Owners have very limited liability for corporate debts

Tax treatment:

  • Business files its own tax return
  • Taxed at the corporate rate
  • Can be used to defer taxes or for income splitting

Capital considerations: Much easier to raise capital

Death of owner: Continuous existence; ownership is transferrable.




© 2019 Manulife. The persons and situations depicted are fictional and their resemblance to anyone living or dead is purely coincidental. This media is for information purposes only and is not intended to provide specific financial, tax, legal, accounting or other advice and should not be relied upon in that regard. Many of the issues discussed will vary by province. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. E & O E. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value. 

[1] 1 www.ic.gc.ca/eic/site/061.nsf/eng/h_03090.html

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