In Ontario, there are many different ways to organize a business. The choice of what form of business entity you will choose depends on several different factors and their relative importance to you. From the cost of starting the business, to matters liability and taxation, the choices you make when establishing your business will impact every aspect of your venture going forward.
This article will concentrate on the most common methods of establishing a business, which are the Sole Proprietorship, the Partnership and the Corporation.
Sole Proprietorship
The sole proprietorship is the most basic form of carrying on a business. It is relatively simple and inexpensive to establish, and requires few legal formalities. As the name implies, a sole proprietorship is owned and operated by a single individual and excludes the participation of other individuals, except as employees.
All benefits of the sole proprietorship such as assets and profits accrue to the individual owner, and all obligations including losses and liabilities are likewise the responsibility of the sole proprietor. This preceding aspect of the sole proprietorship brings us to the primary disadvantage of this business vehicle – unlimited personal liability on the owner. Any obligations of the business are personal obligations of the owner of a sole proprietorship. Accordingly, all business and personal assets are at risk of being seized in satisfaction of liabilities of the business.
Income or losses of a sole proprietor will be calculated in the aggregate with any income or losses of the owner from other sources during the year. Accordingly, a sole proprietorship allows a business that is losing money to offset those losses against income received from other sources.
Partnership
A partnership is established when two or more persons carry on a business together with a view to profit. Like a sole proprietorship, a partnership is relatively simple and inexpensive to set up and there are few required legal formalities required to create. Also like a sole proprietorship, the partnership is not a separate entity from the partners. Accordingly, liability attaches to the individual or corporate partner and is unlimited. The exception to this is if a limited partnership or limited liability partnership is established.
An essential component to a partnership is that each partner must rely on the other partner for all business decisions that need to be made. One partner’s actions binds all the partners. From major capital purchases to selection of employees, the decision making process in a partnership is essential to the operation of the business. It is always prudent in a partnership to have a formal understanding of the terms of business and to build protections for the various partners in case of disagreement or dissolution of the partnership. This is generally accomplished through the drafting of a partnership agreement with the assistance of your lawyer.
Taxation of a partnership is similar to a sole proprietorship in that it is the individuals and not the entity that is taxed. Income flows to the individual partners who pay income tax on all income earned from the partnership in addition to other income earned by the individual. In a similar vein, losses incurred by the partnership can be used to offset income earned from other sources.
Corporation
The most frequently used business entity to carry on commercial activities is a corporation with a share capital. Distinct from the business structures already mentioned, a corporation is a legal entity separate from its owners. The corporation is able to carry on business, own property, possesses rights and can incur liabilities all of which are not those of the shareholders.
The corporation is created under provincial or federal statute by registration of the Articles of Incorporation. Once created, it continues to exist in perpetuity and can only be dissolved by resolution of a special majority of shareholders.
One of the most beneficial aspects of a corporation is protection it affords to its owners. Shareholders only have limited liability. The shareholders are said to have limited liability because their liability in connection with the property or business owned by the corporation is limited to the value of the assets they have transferred to the corporation in exchange for shares in the corporation. Liabilities of the corporation do not extend to the individual shareholder unless the shareholder has guaranteed to pay its debts.
Because a corporation is a legal entity separate from its shareholders, a corporation’s income is determined and subject to tax separately from that of its owners, the shareholders. A corporation’s net income is subject to tax each year. If any of the corporation’s after-tax income is to be paid to its shareholders, this is accomplished by the directors declaring a dividend to the holders of the corporation’s shares.
Which Method is Best
No one method is best for every case. When deciding what business vehicle is appropriate in your particular situation, you must consider a number of criteria and their respective importance to you including liability, the number and relationship of proprietors, borrowing requirements of your organization, costs, flexibility requirements, income tax and several other important issues.