Understanding Canada’s Different Business Structures and What’s Right for your Business

Written by Deepa Tailor, Founder and Managing Director of Tailor Law Professional Corporation

Choosing a business structure is one of the most important decisions you will make as an entrepreneur. The right business structure for your business will largely depend on what your business is, the liability associated with running your business and who your target market is.

There are three primary business structures available to entrepreneurs in most industries: the sole proprietorship, the partnership and the corporation.

When would I want to operate as a sole proprietor?

A sole proprietorship is the most common business structure for new businesses because it is inexpensive and easy to create.

A sole proprietorship is a business structure where there is no distinction between the business and the owner that operates that business. Because there is no separate legal entity for the business, sole proprietors enter into contracts using their own name.

Pros:

• The money and responsibilities of the business are also those of the owner. Any income earned will be attributed to the individual for income tax purposes.
• This business structure is only available when there is one person who owns the business and is a good option for business owners who are looking to set up their businesses quickly.

Cons:

• The owner is exposed to unlimited personal liability. If your business is unable to pay a debt or has otherwise incurred liability, creditors can enforce a judgement against the personal assets of the owner such as their home, car or personal bank accounts.

To create a sole proprietorship, you need to register your business in the province or territory where you will be carrying out your business and obtain a master business license. You will also have to obtain a federal business number and set up your tax accounts.

When would I want to operate as a partnership?

Similar to sole proprietorships, partnerships are not a separate legal entity from the owners of the business, and there is no distinction between the business entity and the owners. Like sole proprietorships, partners are personally responsible for the obligations of the business.

Pros:

• This business entity is inexpensive to set up and any income earned will be attributed to the individual partners of the business for income tax purposes.
• It is ideal for businesses that do not regularly enter into contracts on behalf of the business where the risk of liability is low.

Cons:

• Individual partners are personally liable for the debt obligations of the business, including those obligations entered into solely by one of the other partners in the business. Simply put, if your partner enters into a contractual obligation on behalf of the business and the business is unable to fulfill its obligations under that contract, creditors can enforce a judgement against your personal assets regardless of whether you personally signed the contract.

When would I want to incorporate my business?

Limiting your personal liability is one of the main benefits of incorporating your business. When you incorporate, the business becomes a separate legal entity from yourself as the business owner. You can enter into contracts in the name of the corporation instead of taking that liability on personally.

Unless you have signed a form of personal guarantee in relation to a contract, the liability for claims from creditors or employees of the business belongs to the corporation. The reality, however, is that most financial institutions require a personal guarantee before a loan is extended to you for your business. This eliminates one of the primary advantages of incorporating. Similarly, if you are a director of the corporation, you can be personally liable for unpaid HST and payroll taxes to the Canada Revenue Agency.

Incorporating your business has its tax advantages.  If your business is a Canadian Controlled Private Corporation (“CCPC”), the business can take advantage of the small business deduction and pay a lower rate of federal tax on the first $500,000 of active business income compared to businesses that have not incorporated. Corporations can also utilize income splitting and distribute dividends to shareholders. As a shareholder, you do not have to be actively involved in the management of the corporation in order to receive the dividend.  This allows for higher income earning individuals to distribute dividends to lower income earning family members who are shareholders of the business to reduce personal income tax liability.

What about limited liability partnerships and professional corporations?

Limited liability partnerships and professional corporations are available to certain regulated professions where the governing legislation for that profession allows practice through that type of business structure.

Generally, you will see lawyers and accountants adopt these business structures because it allows you to render services while reducing the amount of professional liability you are exposing yourself and your business to. If you are a regulated professional looking to start your practice, look to your governing legislation to see which business structures are available to you and the restrictions you need to abide by.

Ultimately, the correct business structure for your business will depend on your specific situation. If you are operating your business by yourself, starting off as a sole proprietor and then incorporating your business may be a good option for you. If there is more than one owner of the business, consider incorporating to reduce the amount of personal liability you are exposing yourself to.

Seek legal advice for guidance specific to your business. 

Author Bio

Deepa Tailor is the founder and Managing Director of Mississauga-based, Tailor Law Professional Corporation and a general law practitioner, with vast expertise in a wide variety of cases. Prior to starting her firm, she articled at a full service national Canadian law firm and worked as commercial counsel for a multi-national corporation. Deepa also serves on the board of directors for Many Feathers, a non-profit which focuses on creating local community spaces focused on food security in urban and rural settings across Canada.