Maybe you have a great business idea or maybe you want to use your skills to start consulting. There's just one obstacle - you're not sure what your options are around how to set up your new business.
The good news is that you have a few different business structures to consider. Here are four legal business structures in Canada, and each has a very different function. So, which one is best for you?
We'll help you compare the options so you can decide what works best for you!
The 4 legal Canadian business structures
1. Sole proprietorship
A sole proprietorship is the simplest and most common business structure in Canada. It is relatively easy to set up and administer. As the only owner and the recipient of all profits from your business, the Canada Revenue Agency (CRA) allows you to file your business taxes as part of your personal income tax return filing. This allows you to claim business expenses and to pay income tax on the net income from your business.
When setting up a sole proprietorship, you can choose to operate under your name or choose a business name. If you decide to operate under your own name as a sole proprietor, all you need to do is bill your customers under your name. But if you register a business, you'll need to open a separate bank account in your business name. Regardless of business structure, you may be required to register for GST or HST and any relevant business licenses in your province/territory or municipality.
Sole proprietorships are a good fit for many people who have very small businesses or are doing freelance or consulting work either part-time or full-time. A sole proprietorship keeps your accounting and income taxes relatively straightforward and requires a lot less paperwork to register your business and get started, but still allows you to claim start-up costs and certain other business expenses as tax deductions. Since you are the sole owner, you also retain full decision-making capacity for anything related to your business.
Sole proprietorships involve some risks. For example, if someone is injured on your property or if you harm someone in any way, you might personally need to compensate them. Also, you will be unable to build business credit and borrow money, and are personally responsible for any loans or debts. In addition, your business profit will be taxed at your personal income tax rate, which could potentially be higher than a business not structured as a sole proprietorship.
If you are going into business with one or more partners, a partnership could be the right legal structure for you. There are three types of partnerships available to businesses in Canada: a general partnership, a limited partnership, and a limited liability partnership (LLP).
A general partnership is a good fit for when two or more people want to start a business together and share the profits and liabilities of the business. To do so, the partners can enter into a partnership agreement to outline the terms of the partnership. In a general partnership, like in a sole proprietorship, all partners are fully personally liable for the debts and obligations of the organization. Depending on where you form the partnership and do business you may need to register the partnership or any trade name under which you operate.
A limited partnership is a good fit for businesses that have partners who want to invest but won’t be involved in the day to day operations of the business. Unlike a general partnership where you can choose to have a partnership agreement, a limited partnership must have an agreement. A limited partnership can be a good way to attract investors. Limited partnerships must be registered in their province of formation.
The third type of partnership is a limited liability partnership (LLP). This gives the partners involved certain protection from liabilities of the others and is often used for organizations like the practices of a group of accountants, lawyers, and other types of professional partnerships.
Generally, a partnership does not pay income tax on its income and does not file an income tax return. Instead, each partner files an income tax return to report their share of the partnership income or loss.
A corporation is more involved at the set-up stage than a sole proprietorship and some partnerships, and offers many benefits. The main benefit of a corporation is that it is a separate legal entity from you which in many instances can shield you from certain liability.
Your corporation also exists as a separate business entity, which means that it will continue existing after its owner’s death. That could make it easier to someday sell your business or to pass it along to family in your will.
Incorporating allows you to protect your personal assets, build up business credit, hire and pay staff easier, and take advantage of all sorts of programs.
A corporation is taxed as a separate legal entity from its shareholders. Generally, the business profit of a corporation is taxed at the applicable Federal and provincial income tax rates. The integration of personal and corporate income tax is complicated and is beyond the scope of this article. Please consult with your tax advisor.
Starting a corporation will take extra work to set up since you need to register your corporation and renew annually. You also need to file separate corporate taxes, which are more involved than a personal tax return and often cost more to hire an accountant to do because they involve additional financial statements. There are also greater record keeping requirements for a corporation than a sole proprietorship.
Co-operatives are a great option for a business if you are starting a company where you want a number of members to own it and democratically control it. Some common examples of co-operatives are co-op banks, co-op housing complexes, day care co-ops, and worker co-operatives.
The rules in each province or territory will be different, but to start a co-op, you need to hold a meeting to choose a name and elect a board and then submit an application to register as a co-operative either federally or provincially. Members need to decide together on the organization's structure and policies.
One challenge around starting a co-op is figuring out where your business start-up funding will come from. Because business credit takes time to build, most entrepreneurs who are starting a corporation have to initially use their personal credit as a guarantee to qualify for a loan. While there is risk, the upside if you're the owner of a corporation could be significant. That's not the case with a co-op where they upside is shared amongst all members while the risk of co-signing a loan might be carried by one member. That can make it more challenging for co-ops to get loans and access credit.
Choose your business structure wisely
Changing your business structure after running your business for a few years can be complicated. While it's relatively easy for a Canadian business to move from a sole proprietorship to a corporation, if you decide you want the benefits of a corporation or your business grows in size and complexity, doing the opposite can be tricky. It could involve the need to consult professionals for financial and legal advice like lawyers and accountants. If you decide to incorporate, make sure that you choose the right jurisdiction in which to incorporate as changes might be complicated.
As you decide what business structure is right for you, consult with business owners in your industry to discover how they decided to structure their businesses and if they're happy with their choice. Also consult with professional legal, accounting, and tax advisors
Making the right choice when you first start your business will save you considerable time.