There are three principal forms of business entities: sole proprietorships, partnerships and corporations. In additions, there are two types of partnerships: general partnerships and limited partnerships. Each form has distinct advantages and disadvantages which will need to be weighed before choosing which is right for your business. The following information is intended to give you a basic understanding of the issues you need to consider in making this choice.
A sole proprietorship is the simplest form and it exists whenever an individual carries on business. In Ontario, if you are carrying on business as a sole proprietorship under any business name other than your personal name, you will be required to register with the Ministry of Consumer and Commercial Relations. The current cost of this registration is $60 and it is valid for five years, after which is must be renewed if you continue to carry on business under the name. Failure to register your business name is an offence under the Business Names Act.
Unlike corporate shareholders, a sole proprietor is personally liable for all the liabilities of the business. These include debts incurred in the ordinary course of business as well as any claims for torts committed by the proprietor or his employees.
While the sole proprietor experiences unlimited personal liability for debts arising from his business, under some circumstances he may enjoy a tax advantage over a corporate owner. If the proprietor is experiencing losses, he may deduct those losses against income earned from other sources so as to reduce his income. On the other hand, if he has income outside of the business, his business income would be added to that other income causing him to be taxed at a higher rate.
A significant advantage of sole proprietorships was eliminated by the 1995 federal budget. Sole proprietors are no longer allowed to choose their own taxation year, as corporations are allowed to. The result of this is the loss of the tax deferral which was formerly possible. For example, a business could choose its taxation year end as January 31, 1995. The income from February 1994 to January 1995 would then be considered part of the 1995 taxation year and not due for payment until April 1996. Since the budget, new businesses are no longer eligible for this deferral and it is being phased out for existing businesses over a ten year period. Corporations, however, may still choose their own fiscal year.
Under Ontario law, a partnership is any two or more persons carrying a business in common with a view to a profit. There is no need for a written contract to form a partnership. So long as two or more people are carrying on business together to make a profit, they are a partnership. Every partnership in Ontario must be registered with the Ministry of Consumer and Commercial Relations. As with sole proprietorships, the fee for this is $60 and is valid for five years. Failure to register the partnership is an offence under the Business Names Act.
Like a sole proprietorship, partnerships allow the owners of the business to deduct losses against other income. This is a major reason why some businesses choose partnership over incorporation. Each partner in a firm may also be liable to the full extent of his personal assets for the debts of the business including tortious acts committed by other partners or employees in the course of the business.
It is advisable to have an agreement among the partners setting out the nature of the business, how it is to be managed and carried out, and how profits are to be shared. In addition to these, a partnership agreement may deal with unusual circumstances such as the admission of new partners, the raising of additional capital, and the dissolution of the partnership.
In some circumstances it is desirable to form a partnership while limiting the liability of some of the partners. This can be done with a Limited Partnership. A limited partnership consists of at least one general partner who has unlimited personal liability and who is involved in the management of the business along with any number of limited partners who may not participate in the management of the business and whose liability is limited to their investment in the business. The advantage of this arrangement is that the limited partners have the limited liability of a corporation along with the ability to deduct business losses against their personal income.
It is highly recommended that anyone considering a limited partnership obtain legal advice. In most instances a written partnership agreement should be formed. Every Limited Partnership must be registered with the Ministry of Consumer and Commercial Relations. The fee for this is $190 and is valid for five years.
A business corporation is the most common entity for carrying on commercial activity. The chief advantages of the business corporation are limited liabilty of the shareholders, who may also manage the business, and a lower rate of tax for Canadian controlled private corporations.
In Ontario, a Canadian controlled private corporation is taxed at one half the rate of non-Canadian businesses on the first $200,000 of income. This rate is substantially lower than the personal tax rate paid by sole proprietors and so may lead to a significant savings or deferral of taxes if the owners can keep the profits in the corporation, such as for reinvestment and expansion. Salaries paid to directors and managers of a corporation are deductible to the corporation, but are taxed as personal income of the directors or managers receiving the income at their personal tax rates. Business losses of a corporation cannot be deducted from personal income of the shareholders or managers.
It is very common for businesses to start out as sole proprietorships or partnerships in order to allow the deduction of startup losses against other income of the owners. Once they have become profitable, the business is then incorporated in order to provide the limited liability and tax deferral advantages of the corporation.
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