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Considerations when deciding the legal structure of your business

February 10, 2022   ·   0 Comments

One of the first considerations when starting a new business is determining how you are going to structure your enterprise.

In Ontario, there are three ways that a business can be registered — a sole proprietorship, a partnership, or a corporation.

Each offers its own unique advantages and there is no “one size fits all” option. Here, we discuss the three types of ownership and the advantages and disadvantages of each. 

Sole Proprietorship

A sole proprietorship is considered the simplest ownership structure and the easiest and least expensive to set up.

This structure is best suited for small enterprises as all the benefits and liabilities of the business flow through to the individual — there is no distinction between the business and its owner.

The profits of the business are considered personal income for the owner and are therefore taxed at the tax rate of the individual.

Sole proprietors also enjoy some tax advantages, such as the ability to deduct losses and expenses from their personal income.

While there are a great number of benefits to this business structure, it is important to understand that because there is no legal distinction between the owner and the business, the owner is personally liable for any financial, tax or legal issues that arise. A creditor could claim personal assets as well as those of the business for unpaid debts.

In most circumstances licensing and business name registration will need to be completed; however, if you chose to operate strictly under your legal name (i.e. John Smith), registration is not required.

Sole proprietorship is the most straightforward way to structure your business, requires the least amount of paperwork, and you can be up and running immediately.

As your business grows, you can change the structure to better address your needs at that time.

Partnership

The second form of ownership is a partnership.

A partnership exists when two or more individuals or corporations carry on business together with the intention of earning a profit from their venture.

For tax purposes, a partnership is not recognized as a distinct entity and the profits and losses of the partnership flow through, on a proportionate basis, to the partners.

The partners must pay tax on profits within their personal tax returns. There are three distinct types of partnership structures: 

1. A general partnership may be formed where each partner is liable for the debts and obligations of the partnership on an unlimited basis. 
2. A limited partnership is composed of at least one general partner and any number of limited partners. General partners manage the affairs of the partnership and are liable to an unlimited extent to creditors of the partnership. The liability of the limited partners is limited to the amount of capital contributed and limited partners must not participate in the management of the partnership. 
3. A limited liability partnership is available only to groups of professionals such as lawyers, accountants, and doctors. This structure gives the partners more liability protection than they would have as general partners as only the assets of the partner whose actions caused the liability are at risk.

Corporation

The final structure for a business is a corporation.

An incorporated business is more complicated, expensive, and time consuming to establish and maintain, but it offers several key advantages.

A corporation is a legal entity distinct from its shareholders and may be created either federally or provincially. When federally incorporated, the company will also need to obtain additional extra-provincial registrations in each province in which it operates.

Shareholders of a corporation do not own the business or assets of the corporation and are not personally responsible for its liabilities. Owners keep their personal assets separate from the assets of the corporation, so if the company is in debt, it’s less likely that the owner will be personally liable.

As it is a distinct legal entity, changes in management can occur without affecting the corporation’s existence. Shares can be bought or sold to allow the owner to easily exit the business.

With regard to taxation, a corporation must pay taxes on its income. As a result, an owner will be required to file two tax returns each year: one for personal income and a separate one for the corporation’s income.

Corporate losses cannot be deducted from personal income as they can be with a sole proprietorship or partnership.   

It is highly recommended that you work with both a legal professional as well as an accountant to assist you in choosing a business structure that is right for you. The team at the Orangeville and Area Small Business Enterprise Centre (SBEC) is available to provide free guidance and assistance with business registration. Contact the SBEC  today to get started.

Mark Jamieson is the co-ordinator of the Orangeville & Area SBEC and can be reached at mjamieson@orangeville.ca, 519-941-0440 Ext. 2270 or via cell phone at 519-942-6334.

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