When you start a new business, your
first decision will be the type of business structure that is the
most appropriate for you. Sole Proprietorship, Partnership and Incorporation
all have their benefits and drawbacks. No one method is best in
every case, and consideration must be given as to which method will
be most appropriate in your situation. To analyze your options,
consider the following criteria: desirability of limited liability;
desirability of perpetual existence; number of proposed proprietors;
borrowing requirements; cost; and income tax.
1. Sole
Proprietorship
Whenever an individual carries on business for the individual’s
own account without involving the participation of other individuals
(except employees), the individual is operating as a sole proprietor’s
personal tax return.
Advantages:
1. Low start-up costs.
2. Greatest freedom from regulation. A sole proprietorship is not
required to be registered if the business is carried on under the
owner’s name. If the business uses a name other than the owner’s
or adds “ and Company” or other word, the Business Names
Act requires that the business name be registered before it is used.
The registration is then valid for five years and currently cost
$80.
Disadvantages: 1. Unlimited personal risk. All assets of the owner are
exposed to creditors of the business.
2. Lack of continuity.
3. More difficult to capital.
2. Partnership
A partnership consists of two or more persons carrying on business
with a view to profit. The individual partners must each report
their share of the partnership’s income (or loss) as their
own, whether or not they have taken any of the profits out of the
partnership. A partner is not taxed on draws but on his or her share
of the partnership’s income.
Advantages:
1. Ease of formation. A Partnership Agreement should be prepared.
2. Low start-up costs.
3. Limited outside regulation. The business name must be registered.
Disadvantages:
1. Unlimited personal risk. Each of the partners is personally liable
for the full amount of the debts of the partnership.
2. Lack of continuity. The death or voluntary retirement of a partner
dissolves the partnership. An individual interest in a partnership
is transferable only with the consent of the remaining partners.
3. More difficult to raise capital.
4. Responsibility for your partner’s actions. Unless otherwise
stipulated in a Partnership Agreement, each partner is authorized
to act on behalf of the partnership and bind it legally.
3. Incorporation A corporation is unique in that it is a distinct
legal entity separate from that of the people who own its shares.
Advantages:
1. Limited personal risk. The greatest advantage of incorporation
is the limited liability that it confers on shareholders with respect
to debts, obligations and liabilities of the corporation.
2. Ability to raise capital. The ability to issue various classes
of shares with preferences as to dividends, redemption or convertibility
and to utilize bonds or debentures greatly enhances a corporations
ability to obtain funds for expansion or development.
3. Possible tax advantages. Small Canadian controlled private corporations
are taxed at approximately half the regular rate on the first $200.000
of active business income in each year. A corporation also has additional
tax planning and income splitting arrangements available.
4. Continuous existence & Ownership is transferable. The death
or withdrawal of a shareholder does not affect the existence of
the corporation, which enjoys perpetual succession.
Disadvantages:
1. More closely regulated.
2. Most expensive form to organize. A corporation is created by
filing Articles of Incorporation with the Ministry of Consumer and
Commercial Relations. Presently, the Ministry charges $360 for the
filing in Ontario ($250 federally). If the corporation has more
than one owner, a shareholder’s agreement should be prepared.
3. More record keeping is necessary.
CONCLUSIONS
Depending on the type of business, your potential risk and liability,
the amount of funds required to be in invested and the amount of
return expected from operations, you will use one of the forgoing
forms of legal entity. Each has its own benefits and drawbacks and
is treated differently for legal and tax purposes.
