For busy entrepreneurs focused on running a company, deciding how to structure their business may seem like a distraction or minor technicality. However, it remains an important legal question that can have significant impacts on a business’s operations and taxes.
Three common business structures in Ontario are sole proprietorships, partnerships, and corporations. Each has its own legal benefits and drawbacks.
Sole Proprietorships
Sole proprietorships are the form of business organization that most enterprises will resemble at the start. They are the easiest to set up and, in effect, are created automatically when you begin doing business. Operated by one person, income generated by the business is attributed to that person (the owner) and characterized as business income.
Legal Status & Liability in Sole Proprietorships
Importantly, sole proprietorships do not have a separate legal status separate from their owners, meaning that the owner assumes all the risks of the business. All revenue and expenses of the sole proprietorship should be included in the owner’s income tax filings (note that in some instances, owners may need to register for an HST number). Other liability for debts and obligations also remain with the owner. The same is true for assets, where there is no legal distinction between business and personal assets.
Owners operating a sole proprietorship may hire employees but cannot hire themselves, as owner, as an employee. In these instances, any legal obligations that apply to all businesses also apply to sole proprietorship – meaning the owner is responsible for contracts they enter into. The owner is solely responsible for his or her actions and the actions of any employees they may have. If an owner is sued, the successful party can seize the owner’s personal assets. Note also that an owner cannot bring anyone on as a partner.
While a sole proprietorship is often how a business begins, as they grow, it may be prudent to organize the business differently.
Partnerships
A partnership is a distinct legal entity that is formed by two or more individuals (or two legal persons such as corporations, trusts, or other partnerships) carrying on business “with a view to profit.” In a partnership, partners are responsible for contributing defined items, such as money, skills, property, or labour.
While partnerships can occur organically and don’t require a partnership agreement to be formed, it is sound practice to have a partnership agreement in place. These agreements ensure there is a framework for such things as dissolving the partnership, rules for joining or leaving the partnership, division of duties, and distribution of profits. It is good practice to ensure each partner obtains independent legal advice about the terms of a partnership agreement before signing.
Legal Status & Liability in Partnerships
As with sole proprietorships, partnerships do not have a legal status that is distinct from the partners themselves, so the income derived from the partnership is included in the partners’ personal income tax return. The partners also remain personally liable for any debts or other obligations (except for limited partnerships, in which at least one partner must be fully liable). Accordingly, partnerships themselves are not taxable entities. Any profit or loss of the business operated by the partnership is determined at the partnership level and then divided among the partners pursuant to the partnership agreement.
Partnerships are also similar to sole proprietorships in that the partners are the sole owners and cannot be employees of the business. Therefore, while all of the benefits of the partnership accrue to the partners, they are also personally responsible for all contractual obligations undertaken by the partners.
Corporations
In contrast to sole proprietorships and partnerships, a corporation has a separate legal existence from the people who own it. As a result, corporations require separate tax filings, can change owners, own property, and have a continuous existence distinct from the owners (known as shareholders). Because of its independent legal existence, a corporation can also provide its shareholders with limited liability.
Business owners often choose to incorporate because this legal structure offers a number of advantages with respect to succession planning, taxes, capital raising, and limiting the personal liability of the business’s directors and officers. However, one burden that corporations face relative to sole proprietorships or partnerships is that they are more strictly regulated and have higher costs associated with legal compliance. Corporations have significant reporting obligations with respect to tax filing, and directors of a corporation may also have similar obligations.
Shareholders, Directors & Officers
Incorporation requires the filing of a document known as the articles of incorporation, which lists shareholders, directors, and officers and sets up a separate bank account for the corporation.
Shareholders own “shares” in the business and are effectively the owners of the corporation, meaning they are entitled to any profits and have the power to make changes to the corporate structure. Directors are either elected or appointed by shareholders and manage the corporation. Finally, officers are appointed by the directors, who define their duties and assign day-to-day business operation tasks. Note that for smaller businesses, it is common for the same people (or even one person!) to fulfill all three of these roles simultaneously.
Which Structure Works Best for Your Business?
It is very common for businesses to begin as a sole proprietorship and/or partnership and ultimately incorporate as the business grows. However, each company’s needs vary depending on its circumstances. A qualified business lawyer can help determine the best structure for you based on your business goals, operational structure, and tax preferences. There are both advantages and disadvantages to each type of structure, and an experienced lawyer can help guide you through the process.
Contact the Corporate Lawyers at Tierney Stauffer LLP in Ottawa, Cornwall, Arnprior, Kingston & North Bay for Advice on Business Law Matters
At Tierney Stauffer LLP, we provide comprehensive and forward-thinking advice to our business clients, no matter the size of the operation. Our team has extensive experience in business law matters, including incorporations, reorganizations, and partnership and shareholder agreements. Contact us at 1-888-799-8057 or contact us online to arrange a consultation today.