Thinking of Starting A Business? What Structure Should I Use?

You have made up your mind to take the plunge into entrepreneurship, but this is just the beginning.  One of the first decisions that you need to make is the choice of the structure of your new business venture.  

You need to decide between setting up a sole proprietorship, partnership or incorporation.  Which one of these structures is the fit for your business?

I ask you first to put the darts, dartboard and blindfold away for now (a reference to those of you who still remember playing games before computers and smart phones), and lets take a bit of a dive into the business structures available to you. 

Each structure has advantages and disadvantages that must be examined and evaluated based on your particular situation and goals.  So what are your choices?

The Business Structure Choices

Sole Proprietorship 

A business that is not incorporated, and owned by one individual. The net income earned by the business is taxed in the hands of the owner personally at the applicable graduated personal income tax rates. The net income / loss of the business is included in the personal income tax return of the owner along with all other sources of income earned by the owner in the calendar year.

Partnership 

A business that is not incorporated similar to a sole proprietorship with one key distinction; there are at least two owners of the business. The net income earned by the business is taxed in the hands of owners based on their percentage ownership. For individuals who are owners, their portion of the net income is taxed personally at the applicable graduated personal income tax rates. The individual owner’s proportion of the net income / loss of the business is included in the personal income tax return of the owner along with all other sources of income earned by the owner in the calendar year.

Corporation 

A business that is a separate legal entity.  Corporations can be incorporated federally or provincially. The owners or shareholders of the corporation are issued shares of the corporation which represents their ownership percentage of the entity. Since the business is a separate legal entity, it is required to file annually tax returns (Corporate Income Tax Returns) separate from the shareholders of the corporation. The shareholders of the corporation include amounts received by the corporation in their income for tax purposes that represent remuneration (e.g. salaries and wages, director’s fees), dividends or interest payments in the calendar year.

Advantages and Disadvantages

There are advantages to each structure. The advantages of Sole Proprietorships and Partnerships represent the disadvantages to Incorporation, and the advantages of Incorporation represent the disadvantages of Sole Proprietorships and Partnerships.

Advantages of Sole Proprietorships and Partnerships

• Simple and low cost to setup and maintain;
• Losses can be utilized against other sources of income to reduce the taxpayers overall taxes.

Advantages of Incorporation

• Limited liability, generally the liability of the owners of the corporation is limited to their investment in the business (Note that there are of course limits to limited liability);
• Low tax rates.
• The ability to shelter capital gains on the sale of the business.

Well which business structure should you use?

The corporation structure becomes more and more attractive as the net income of the business increases, due to the many tax advantages available through incorporation.  Also the corporate structure provides some protection against business creditors through limited liability.  The choice of the business structure that best meets your needs will depend on the projected income earned in your business and the associated tax implications, your administrative budget, and your assessment of the risk associated with limited liability.

It is advisable to seek professional advice to understand the tax laws that impact your particular situation, and to guide you through the complexities of Canadian Income taxes.

AWFS Consulting Inc. offers professional tax, business advisory, and accounting services to clients. The company’s mission is to offer financial leadership and support to clients in this ever-changing economic environment by empowering clients with financial knowledge.