When starting a business in Canada, one of the fundamental decisions you’ll face is choosing the appropriate business structure. The choice between establishing a corporation and operating as a sole proprietorship is pivotal, as it impacts various aspects of your business operations, legal obligations, and financial management.
Sole Proprietorship
A sole proprietorship is the simplest form of business organization. It is owned and operated by a single individual. There is no legal distinction between the owner and the business, meaning the owner personally assumes all liabilities and obligations of the business it runs.
In a sole proprietorship, the owner has unlimited personal liability for the business’s debts and obligations. This means that personal assets, such as a home or savings, can be used to settle business debts or legal claims. When considering a high risk business (which could be as simple as a restaurant that could face liability for slip and falls or food poisoning), it is best to opt for a corporate vehicle so as to avoid this liability from running to you personally and attaching to all of your personal assets.
With respect to taxation, income from a sole proprietorship is taxed as personal income and no separate tax return need be filed. Instead, the individual files a T2125 Schedule to their ordinary T1 Income Tax Return in which the net income from the business is added to the owner’s other sources of personal income and taxed at their individual marginal rate. This can be a benefit for sole proprietors who do not have to pay an accountant to prepare a file a separate T2 Income Tax Return for corporations. Sole proprietors, just like corporations, may be eligible for certain tax deductions and credits.
Operating as a sole proprietorship involves minimal regulatory requirements. There is no need for formal incorporation documents or regular filings, and annual reporting requirements are simpler. Registration is only required to the extent the sole proprietor operated under a name other than their own name. For example, if Sarah Smith wishes to provide consulting services under the name Sarah Smith, no registration is necessary. However if Sarah wishes to provide services under the name Curious Consultants, than this trade-name will need to be registered with the Ontario Business Registry. With respect to GST/HST, the sole proprietor must register only if their annual worldwide sales exceed $30,000 per annum.
A sole proprietorship lacks continuity beyond the life of the owner. The business does not continue if the owner retires, becomes incapacitated, or passes away. For this reason, transferring ownership of a sole proprietorship can be complex and often involves dissolving the business and setting up a new entity.
Raising capital for a sole proprietorship can be more challenging since there is no equity to apportion to any other person other than the sole proprietor. If the proprietor wishes to take on investments from third parties, then he or she must incorporate a company.
Corporation
A corporation is a separate legal entity distinct from its owners. It can be either a private corporation or a public corporation. Incorporating a business creates a new legal entity that has its own rights and responsibilities, distinct from those of its shareholders. The corporation can enter into contracts, sue, and be sued independently of its shareholders.
A corporation provides limited liability protection to its shareholders. Shareholders’ liability is generally limited to the amount of their investment in the corporation. Personal assets of the shareholders, officers or directors are typically protected from business liabilities, although there are exceptions in cases of fraud or personal guarantees.
Corporations are taxed separately from their owners. Corporate income is subject to corporate tax rates, which can be lower than personal tax rates, especially on the first $500,000 of active business income in Canada which will attract an internal tax rate of 12.2%. Corporations must file an annual corporate tax return and pay taxes on their profits. Distributions to shareholders, in the form of dividends, are taxed again at the personal level, but this is often offset by the dividend tax credit.
Corporations face more stringent regulatory requirements. They must be incorporated under either federal or provincial law, which involves filing incorporation documents and paying fees each year. Corporations are required to maintain corporate records, hold annual meetings, and file annual corporate returns each year in addition to its tax return. They must also comply with corporate governance rules and regulations.
A corporation enjoys perpetual existence, meaning it continues to exist independently of changes in ownership or management. Shares in a corporation can be transferred, and the business can continue even if shareholders or directors change. This provides greater flexibility for business continuity and succession planning.
Corporations can issue shares to raise capital and attract investors. They have access to a wider range of financing options, including equity investments, venture capital, and public offerings (for public corporations). This structure can be advantageous for scaling and expanding the business.
Benefits and Burdens – Sole Proprietorship
Benefits
- Simplicity: Easy and inexpensive to start with minimal regulatory requirements. No registration is needed
- Direct Control: The owner has complete control over business decisions and profits.
- Tax Simplicity: Income is taxed once on the owner’s personal tax return, avoiding double taxation and additional accounting costs
- Fewer Formalities: No requirement for annual reports, board meetings, or extensive record-keeping.
- Direct Access to Profits: All profits go directly to the owner without the need for distribution.
Burdens
- Unlimited Liability: The owner is personally liable for all debts, obligations, and legal actions against the business.
- Limited Access to Capital: More challenging to raise funds, as there is no ability to issue stock and loans may be harder to secure.
- Limited Lifespan: The business is directly tied to the owner, so it may cease to exist upon their death or retirement.
- Tax Burden: Income is taxed at personal rates, which may be higher than corporate rates for certain levels of profit.
- Growth Limitations: The size and growth potential of the business are often limited by the owner’s resources and capabilities.
Benefits and Burdens – Corporation
Benefits
- Limited Liability: Owners (shareholders) are protected from personal liability for the company’s debts and obligations.
- Access to Capital: Easier to raise large amounts of capital through the sale of stock.
- Perpetual Existence: The corporation can continue to exist even if ownership or management changes.
- Tax Advantages: Internal corporate tax rate for revenue within a corporation is 12.2% for net income below $500,000 and 26.5% for income above this, which is much lower than individual marginal rates of a sole proprietorship
- Transferability of Ownership: Shares can be easily sold or transferred, enabling smoother business succession.
Burdens
- Cost! A corporation is expensive to set up and costly to maintain each year in professional fees for ongoing compliance (both accounting and legal)
- Complex Formation: More complicated and expensive to set up due to legal requirements and paperwork.
- Double Taxation: Profits may be taxed twice—once at the corporate level and again when distributed as dividends to shareholders.
- Increased Regulation: Subject to more government regulations, oversight, and mandatory disclosures.
- Rigid Structure: More formalities such as regular meetings, keeping detailed records, and bylaws are required.
- Costly Operations: Higher legal, accounting, and operational costs compared to simpler business forms.
Conclusion
Choosing between a corporation and a sole proprietorship involves weighing factors such as liability, taxation, administrative burdens, and the desired continuity of the business. Sole proprietorships offer simplicity and direct control but come with unlimited personal liability. Corporations provide liability protection, potential tax advantages, and greater opportunities for raising capital, but they require more administrative effort and compliance.
Before making a decision, it’s advisable to consult with a legal or financial professional who can provide personalized advice based on your specific business goals and circumstances. Understanding these differences will help you choose the most suitable structure for your business and set a solid foundation for future growth and success. If you would like to discuss running your business through a sole proprietorship versus a corporation, contact us to speak with one of our lawyers.
Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and private M&A law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law.
© Kalfa Law Firm , 2024
The above provides information of a general nature only. This does not constitute legal or accounting advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
