When starting a company, it’s essential to select the business structure that best supports your goals. Most of the time, business structures are chosen to comply with tax law, which treats each type of structure differently.
There are three types of legal structures for a business:
Each one has distinct characteristics
1. Sole proprietorship
A sole proprietorship is informal and easily created, which is why it is the most common structure chosen by new businesses. In this structure, the business and the operator are one and the same in the eyes of legal and tax authorities. Tax law treats a sole proprietorship as an income source for the proprietor and therefore requires that the business’s financial details be listed in a separate section of the personal income tax form.
In a sole proprietorship, the business’s money and responsibilities are the proprietor’s, and vice versa. This presents some possibilities for tax management on the part of the sole proprietor. If the business generates a loss, that loss can be applied to reduce income gained from other sources. That is why most part-time businesses are sole proprietorships. However, sole proprietorships have a downside in that the proprietor is personally liable for all functions and debts of the business.
A partnership is similar, but instead of one proprietor there are two or more. As with a sole proprietorship, there is no legal structure for a partnership. However, partners usually have some type of contractual agreement that governs, in percentage terms, the sharing of revenues, expenses and tasks. When preparing their taxes, the partners apply those same percentages to their income and expenses.
Corporations are more complicated legal structures compared to sole proprietorships or partnerships. Incorporation is a process in which a separate legal entity, owned by its shareholders, is formed. Incorporation creates formal ownership shares, which produces a taxation and legal distance between the company and the shareholders. This in turn has tax advantages for the owners, who are usually paid as employees of the corporation.
Incorporation provides some liability protection for the corporation’s debts and offers some measure of protection for a company’s name. Company officers and shareholders may come and go, but the corporation exists until it is wound down.
Incorporation is most often done under a charter in the operator’s home province, but some companies that operate in many provinces or internationally, or that require enhanced credibility, incorporate federally, which is more costly and complicated. Corporations must keep meticulous records and report their financial situations to competent authorities yearly. Therefore, their financial statements must be audited annually by chartered accountants.
Four Steps to incorporate a business in Canada
Entrepreneurs who want to incorporate can do so directly online on the Corporations Canada website. Here are the four steps to incorporate in Canada: