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Proprietorship
A sole proprietorship is one person operating a business, without forming a
corporation. The income of the business is then taxed in the hands of the owner (the proprietor), at personal income tax rates. The income is considered income from self-employment, and
is included on the personal income tax return of the owner.
Advantages of proprietorship:
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Setting up a business in the form of a proprietorship is
relatively simple and the costs are low.
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If the business loses money, the losses can be written off against
other income of the proprietor.
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Proprietorships are less regulated than corporations. The
administration of a proprietorship is less costly than that of a corporation. However, proprietorships are regulated by the provincial/territorial governments, and the proprietorship may have
to be registered.
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The proprietor is in control of all decision making, and receives
all profits of the business.
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Disadvantages of a proprietorship:
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The biggest disadvantage of a proprietorship is unlimited
liability. The proprietor is liable for all debts and other liabilities of the business. If the business is sued, all the business and personal assets of the owner are at risk.
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If the business is profitable, it will usually be paying
higher taxes than if it was incorporated as a Canadian
Controlled Private Corporation (CCPC). The lowest personal income tax rate paid by a
proprietorship would range from approximately 20% to 29%, depending on the province/territory. This rate increases with income. Taxable income over $120,887 (in 2007) is taxed at the
highest marginal rates, which range from approximately 39% to 48%, depending on the province/territory. See the Marginal Tax Rates page.
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A proprietorship has a lack of permanence - if the owner dies, the
net business assets pass to the heirs, but valuable leases and contracts may not.
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Partnership
A partnership is also an unincorporated business. It is similar to a
proprietorship, except two or more entities are partners in the business. For partners who are individuals, the income from the partnership is taxed at personal income tax rates, and a
percentage of the income is included on the personal income tax return of each owner.
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Advantages of partnership:
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The setup costs of a partnership are relatively low.
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A partnership is less regulated than a corporation. A
partnership agreement should be drawn up to outline the terms of the partnership, what happens in the event of a dissolution, and what happens in the event of disagreements among partners. In
the absence of an agreement, or if certain provisions are not addressed in the agreement, provincial or territorial laws will determine some or all of the terms of the partnership.
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Business losses can be written off against other income of the
partners.
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Broader base of experience, knowledge and skills to draw
from.
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Disadvantages of a partnership:
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The biggest disadvantage of a partnership is unlimited
liability. The partners are jointly liable for all debts and other liabilities of the business. If the business is sued, all the business and personal assets of the partners are at
risk. An exception to this is a Limited Partnership. Limited Partners, who contribute capital but do not
participate in the management of the business, will have their liability limited to the amount of capital that they have contributed. The partners who participate in the management of the
business are called General Partners, and will still have unlimited liability.
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Decisions must be made jointly.
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If the business is profitable, it will usually be paying higher
taxes than if it was incorporated as a Canadian controlled private corporation
(CCPC). See this same topic above
under proprietorships.
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The death or retirement of a partner will not end the partner's
liability for debts and obligations of the partnership that were incurred prior to the death or retirement. Also, if a partner retires and does not make the retirement publicly known, he/she
could still be held liable for obligations incurred by the partnership after the retirement.
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Corporation
A corporation is a separate legal entity, which is formed by application to
either the federal government, or one of the provincial/territorial governments. The corporation issues shares to the owners, or shareholders. The funding of the corporation can be done
through the issue of shares, or by borrowing. Instead of investing a large amount in shares, shareholders can lend money to the corporation, and invest only a minimal
amount in the shares. This way, when the corporation has available cash, the shareholder loans can be repaid without attracting personal income tax.
Being a separate legal entity, a corporation pays corporate income
tax, which is calculated completely separately from the owners' personal income tax. If the corporation pays wages to the shareholders, income tax and Canada Pension Plan contributions, and
sometimes Employment Insurance premiums, must be deducted and remitted to Canada Revenue Agency.
Advantages of incorporation:
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One of the biggest advantages of incorporating a business is
limited liability. This means that the liability of the shareholders is usually limited to the amount that they have invested in their shares in the corporation. However, many
incorporated small businesses are not able to get bank loans without the personal guarantee of the shareholders, so this eliminates part of the advantage of limited liability. The personal
assets of the shareholders are protected from lawsuits against the corporation. However, shareholders who are directors of the corporation can be held legally liable for some debts of the
corporation (such as GST/HST and payroll taxes) in certain circumstances.
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Another major advantage for a profitable small business is the
income tax advantage. A Canadian controlled private corporation, or CCPC, pays a much lower rate of federal tax (small business
rate) on the first $400,000 (in 2007) of active business income than would be paid by an unincorporated business, due to
the small business deduction. Active business income generally does not include
investment income or rental income, which is taxed at regular corporate tax rates. The combined federal + provincial small business tax rate
varies from approximately 16% to 22%, depending on the province. The threshold amount subject to the lower small business rate also varies between provinces. Keep in mind that this tax
advantage is mainly a deferral of taxes until the profits are paid out to the shareholder. If all the profits are paid out to the shareholder as they are earned, leaving the corporation with
little or no taxable income, then they will be taxed entirely as income of the shareholder, at personal income tax rates.
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Another tax advantage of incorporation is the $750,000 capital gains deduction on the sale of shares of a qualifying small
business corporation. One of the
qualifications is that the corporation must be a CCPC with active business income.
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Private Health Service Plans can be used to provide tax-free benefits to employees.
This deduction is also available to sole proprietors and partners, but the
treatment for corporations is more favorable than that for unincorporated businesses.
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Generally, the higher the net income of your small business, the
more advantageous it is to incorporate instead of remaining as a proprietorship.
No matter what the type of business structure, spouses and
children can be employed by the business, thus effectively splitting income. However, amounts expensed must be reasonable amounts based on services provided, and must actually be
paid to the spouse and/or children.
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