When starting a company, it’s essential to select the business structure that best supports your goals.
There are three types of legal structures for a business:
- sole proprietorship
- partnership (which is a form of proprietorship)
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 can be paid as employees of the corporation or through dividends.
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 register the business and report corporate taxes annually
Many entrepreneurs are not interested in the idea of incorporating, at least not in the early stages of building a business or until the business starts earning income.
4 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:
- Choose and register the corporation name (company name or number).
- Create articles of incorporation – Basic incorporation suggests pre-determined articles of incorporation that can be modified later if necessary.
- Establish the initial address of the head office and board of directors. Choose an address where you can be sure you will receive any documents that are sent there, as legally it will be assumed that they have been received by the organization. You must also decide who will sit on your board of directors.
- Pay the fees at the registry office.