Business FAQ 1

The sole proprietorship business structures are for businesses that have only one business owner. This type of business structure is simple and inexpensive to set up. If the business is operated under the owner’s personal name, then no registration is needed. Registration is required only if operating under a trade name. The regulatory burden of the sole proprietorship is light with minimal paperwork and legal costs. Moreover, there are no employees, partners, or investors to contend with, which may be advantageous if your business earns less than $100,000 a year. The simplicity of the sole proprietorship makes a great deal of sense, particularly if don’t envision selling your business or passing on your business to heirs. A sole proprietorship is a pass-through tax entity. A pass-through entity is a special business structure that is used to reduce the effects of double taxation. That means that there is no tax paid at the sole proprietorship level. Instead, all profits flow to the sole proprietor directly. In summary, the advantages of a sole proprietorship include the following:

• Easy and inexpensive to register.
• Regulatory burden is generally light.
• You have direct control of decision making.
• Minimal working capital required for start-up.
• Some tax advantages if your business is not doing well.
• All profits go to you directly.

The disadvantage to the sole proprietorship is that the owner assumes personal liability for debts and does not have access to certain tax planning strategies, such as income splitting and the Lifetime Capital Gains Exemption. In summary, the disadvantages of a sole proprietorship include the following:

• Unlimited personal liability. Your personal assets are at risk.
• Income is taxable at your personal rate and, if your business is profitable, this could put you in a higher tax bracket.
• Pay tax on all of the business income you earn at a high tax rate; lose investment income.
• Lack of continuity for your business if you are unavailable; difficulty of transitioning business to next generation or selling business.
• Can be difficult to raise capital on your own.

The partnership business structure is for businesses that have two or more partners. Setting up a business as a partnership is more advanced and expensive than a sole proprietorship. The partners must file both a T1 Income Tax and Benefit Return to file personal income as well as a T5013, a Partnership Information Return. Partners in a general partnership agreement assume personal liability for debit and do not have access to certain tax planning strategies, such as income splitting. However, if the partnership is a professional one (e.g., dentists, doctors, accountants), the partners can set up a Limited Liability Partnership (LLP), which will limit the personal liability of the partners themselves.

Setting up a corporation is complex and expensive, however there are a number of benefits: The benefits of incorporation are limited liability, separate legal entity, perpetual existence, and free transferability. The most important advantage of setting up a business as a corporation is the income tax savings. Although there is double taxation, once on the corporate level and again on the shareholder level, once dividends are transferred to shareholders, less tax is still paid overall on income that is earned through a corporation, where the business is a Canadian Controlled Private Corporation (CCPC). Currently, a CCPC in Ontario is taxed at 11.5% on the first $500,000 of ABI in each year, which is 25.5% less than the combined average marginal personal tax rate. A corporation can also utilize tax savings strategies such as income splitting and the Lifetime Capital Gains Exemption. It should be noted, however, that a professional corporation, which is a corporation owned by members of certain professions, such as physicians, lawyers, accountants, and doctors, cannot income split with family members. Finally, a corporation protects the corporation’s owners from personal liability, thereby safeguarding the owner’s personal assets from corporate creditors and/or lawsuits. Sole proprietors are liable to the full extent of their personal assets for the liabilities of their businesses, whereas a shareholder’s liability to creditors of the corporation is limited to the amount of the shareholder’s investment. Directors are not liable at all (except where the director engages in fraud).

In the event a corporation becomes insolvent, the owner and shareholders are not liable for the debts or other obligations incurred by the corporation. Yes, the shareholders will lose their investment, but they will not be responsible for its debt.

Separate legal entity refers to a corporation’s operating as distinct from its shareholders, directors, and officers.  A corporation (like a person) can own property, enter into a contract, sue and be sued, and be convicted of a criminal offense (corporations pay fines in lieu of imprisonment.) A corporation exists as its own entity, regardless of what happens to the individuals involved in the business.

Perpetual existence refers to a corporation’s continued existence until it is liquidated, dissolved, or acquired by another entity. When a business is incorporated, the owners, officers, and shareholders (the organizers) can choose to give it an end date when the mission of the corporation has been fulfilled. More commonly, a corporation acts in perpetual existence; that is it will continue to exist, until the organizers decide to end it. Even if the executive team and employees were to quit, the business corporation as an entity would continue to exist, and new employees could take their place.

Free transferability refers to the shareholders’ ability to sell shares without the consent of the directors, officers, or other shareholders, unless otherwise restricted in the corporate constitution. That being said, shareholders in a new venture often will want to prevent unrestricted transfer of shares and thus may provide transfer restrictions or buy-sell and redemption agreements in the articles of incorporation, further limiting transferability. There are separate rules and restrictions governing the transfer of shares in a private versus a public corporation.

A Limited Liability partnership is a type of general partnership structure where each partner’s liabilities is limited to the amount they put into the business. LLP’s are only permitted in Ontario for the sole purpose of carrying on a profession, such as lawyers, physicians, and accountants.

With an LLP, the personal assets of the partners who are not negligent are not exposed to claims against errors, omissions, negligence, incompetence, or malpractice committed by other partners or by employees of the firm, just as in a corporation. Another advantage of an LLP are it offers a fluid governing structure, allowing for assets and funds to be moved in and out of the business with ease. A limited liability partnership also offers a simplified tax structure. As a pass-through tax entity, a special business structure that is used to reduce the effects of double taxation. That means that there is no tax paid at the partnership level. Instead, the partnership’s income is allocated among the partners, who pay income tax at the individual partner’s level. While this simplified structure avoids double taxation, it will be difficult for a high-earning partner to shield his income from a high tax rate. Finally, an LLP offers lower costs in maintenance in the long run; while there are higher start-up costs in the short term, in the long run, the costs will be lower as there are no annual tax filings or legal fees incurred on a regular basis.