In the first three parts of this series, I explored the pros and cons and key considerations involved in starting or buying a business. This article moves on to explore one of the more common questions I receive from my clients; whether they should incorporate their business. Before we begin examining whether to incorporate, let’s take a quick look at the four most common business structures, as they each impact the answer.
Sole Proprietorship – perhaps the most common small business structure. As a sole proprietor, you are the business owner, and in most cases, the operator, whether you operate under you own name or a trade name that you have registered. You are legally responsible for the activities of your business as well as the reporting and paying of federal and provincial tax on your own personal tax return.
Partnerships – are comprised of two or more individuals or corporations, or a combination of the two, carrying out a business. The parties to a partnership share in the assets, liabilities and profits of the business. There are sub-forms of partnerships such as general partnerships, limited liability partnerships (LLP), and limited partnerships (LP), which all deliver various forms and levels of financial liability. However, in all such partnerships, business profits are allocated to the individual partners, hence taxes are paid at that individual partner level, not at the partnership level.
Joint arrangements (also called joint ventures) – these entities are normally set up by two or more individuals or corporations for a specific purpose. Often, the parties to a joint venture pool their resources for this one specific purpose which usually has a relatively short timeline. Typically you see this business structure in real estate development or in the natural resource sector. Like partnerships, profits are allocated to the individual parties and tax is paid at the individual level. Unlike partnerships, amortization of capital assets is taken at the discretion of the individual parties, whereas in a partnership it is taken at the partnership level and allocated without discretion to the partners.
Incorporated business (referred to as a corporation) – these structures are unlike the above three, as this structure is a complete and separate legal entity apart from its shareholders (owners). All assets, liabilities, and profits stay at the corporate level. Furthermore, a corporation in some situations provides a layer of liability protection between a third party and the shareholder. Taxation occurs at the corporate level and not at the shareholder level. A corporation continues as a legal entity until it is ceased to be registered as a legally incorporated entity with the Provincial registrar.
When assessing the type of business structure that will work best for a new business, one should consider:
Consider discussing the optimal business structure with your accountant and lawyer early on in the process to avoid having to make costly changes later on. In next month’s article, I will explore in greater detail the process and benefits of incorporating your business.
Jonathon (Tug) McGraw, BCOMM, CPA, CA
BDO Canada LLP
Jonathan can be reached at: firstname.lastname@example.org