When embarking on a new business venture one of the first decisions that has to be made is the type of legal structure best suits the needs of the new business. In Canada there are essentially two choices - business registration (sole proprietorship or partnership/unincorporated entity) or incorporation. Like many small business decisions, the answer in not necessarily straightforward and depends on the business owner’s specific set of circumstances:
Registered businesses are simply an extension of the individual and as such the regulatory and tax obligations are relatively minimal . Setting up a registered business is a fairly simple and inexpensive process. The owner is responsible for the debts of the business and pays taxes (or can deduct losses) on their personal tax return.
A corporation is a legal entity whose shareholders are separate from the business. Setting up a corporation is more complex than a business registration - decisions have to be made regarding the jurisdiction of the corporation (federal vs provincial), directors, shareholders, share structure and owner-manager remuneration. The corporation assumes the debt obligations and pays taxes at a corporate level. Finally, a corporation, being a separate “person” enjoys limited liability which is defined by Revenue Canada as follows:
This means that, as a general rule, the shareholders of a corporation are not responsible for its debts. If the corporation goes bankrupt, a shareholder will not lose more than his or her investment (unless the shareholder has provided personal guarantees for the corporation's debts). Creditors also cannot sue shareholders for liabilities (debts) incurred by the corporation, even though shareholders are owners of the corporation. Note, however, that if a shareholder has another relationship with the corporation — for example, as a director — then he or she may, in certain circumstances, be liable for the debts of the corporation.
Business Registration vs Incorporation
When deciding on which structure there are several questions that a small business owner should consider:
Does the new business venture need limited liability? Or will insurance be an adequate replacement?
As the owner/shareholder of the corporation are you able to leave funds in the business or will you need to withdraw all of the profits of the business for living expenses?
Are you willing and able to spend additional fees on incorporation costs?
Are you comfortable with the increased reporting requirements for a corporation as you will mostly likely require the services of an accountant and possibly a lawyer?.
Do your clients, bank or other stakeholders require that you incorporate or do you need the credibility associated with having a corporation?
Do you have plans to build an enduring business which you might want to transfer upon your retirement or death?
Are you a startup or planning to devote resources to R&D? (a corporation simplifies the process of claiming R&D credits)
Other Factors to Consider:
If you do decide to incorporate, you will to have to decide whether a federal or provincial incorporation is more appropriate. A federal incorporation is more expensive , however, it provides heightened name protection and additional credibility.
Owner managed corporations need to determine the method and amount of remuneration. While registered business owners are simply taxed on the profits of the business, a corporation must pay salaries or dividends to its owners as employees or shareholders respectively. Note that there are no restrictions on having employees whether you are registered or incorporated.
If you feel that your business is still in its infancy and there are no issues relating to liability or external requirements to incorporate, it might make sense to wait and see how the business evolves. A registered business can decide to incorporate at any time, although if you do decide to take the next step and incorporate, you should speak to an accountant as there can tax ramifications.