Corporation or Sole Proprietorship? (CAN)
You are about to enter into a new business, or perhaps you're expanding your current operations. One of the most important questions you should consider is “Do I need to Incorporate?”. Generally, your business will be 1 of 2 structures – a Proprietorship or a Corporation. (You can also form a partnership, but for the most part this will be treated in same way as a Proprietorship.)
A sole proprietorship is an unincorporated business entity entirely owned by an individual resident of Canada. Examples of a typical proprietorship would include:
• A bookkeeper, operating from their home part-time to earn extra income.
• A handyman, operating from their home part-time to earn extra income.
A proprietorship is likely the most common form of business structure in Canada.
Income from a proprietorship is reported on the individual’s tax return (T1 Schedule 2125) and is generally not subject to many additional provincial or federal rules, with the exception of proper financial reporting on the tax returns. The Sole Proprietorship is the simplest form of operating a business. Only one person is responsible for decision making and therefore earns all of the profits or incurs all of the losses of the business, however, the same individual also incurs all of the risk and obligations associated with running a business.
A Canadian Controlled Private Corporation (CCPC), also known as a Corporation or Company, will have Ltd, Inc. etc. following their company name. A corporation is an entirely separate legal entity and is treated as having its own legal personality. This means it is distinct and separated from its owners (Shareholders) and the individuals responsible for running the Corporation (Officers and Directors).
To qualify as a CCPC, the shareholders of the Corporation must be Canadian Residents.
Each structure has its own advantages and disadvantages, and you should discuss your unique situation with Accounting and Legal Professionals before you make any decisions in this regard.
There are several advantages and disadvantages to forming either a corporation or a sole proprietorship.
We'll highlight a few of them:
Advantages & Disadvantages of a Corporation
Limitation of liability – Although you will always be liable to pay government taxes and bank loans, you may not be personally liable for other debts such as trade payables, lawsuits etc.
Lower Tax Rate – Generally, corporations are taxed at a lower rate than proprietorships.
Income Splitting – If your corporation is structured properly, it is possible to transfer income to other members of your family (if they're set as shareholders)
Capital Gains – You can take advantage of the Capital Gains Exemption if you decide to sell your business at some point in the future. (For more info on Capital Gains Exemption, see this article )
Fees – Corporations incur higher fees for legal and accounting services.
Borrowing – Banks and other credit lending institutions could still require a personal guarantee from the corporation's Directors.
Double Taxation – Dividends from the corporation may be subject to double taxation. In other words, in addition to paying taxes on corporate profits, you'll still be taxed on the personal income you take out of the company.
Reporting Requirements – Corporations typically have more reporting requirements with CRA and other legal entities.
Advantages & Disadvantages of a Sole Proprietorship
Relatively simple to establish – Generally, you can operate a business in your name with no registration requirements.
Lower administrative costs – Possibly simpler to manage without double taxation and tax compliance costs.
Reduce tax liability – Business losses may be used to offset income from other employment sources.
Unlimited liability – The business owner is personally liable for all actions of the business.
Fiscal Periods – Proprietorships must use Calendar Year for reporting their year end.
Harder to Sell – Proprietorships are typically harder to sell, since the business is the actual owner.
As you can see, there are many things to consider in choosing the best structure for your needs. Do not rely on your neighbour's advice to incorporate, talk to a professional first. Incorporating can cost you significant amounts of money in accounting fees, legal fees and more, although often time the benefits far outweigh the cost of administration.