Ontario offers several options for entrepreneurs who are deciding on the manner that they would like to carry on their new business. These options include: sole proprietorships, partnerships, corporations, joint ventures, franchises, licenses, not-for-profit organizations, and charities. However, each of these options have differing advantages and disadvantages, and may not be suitable for your business depending on a variety of factors. This article will address the three most common business organizations mainly, sole proprietorships, partnerships, and lastly corporations.
Sole Proprietorship: Simplicity and Flexibility
A sole proprietorship is a very accessible and flexible method of carrying on business that has some of the lowest costs of setting up. There are also fewer legal formalities in setting up a sole proprietorship. As the name suggests, a sole proprietorship comes into existence when the business owner or founder carries on the business individually. Generally, the sole proprietor operates the business in their own name, but the sole proprietor can register a business name that differs from their personal name. Registering a business name carries a cost of $60.00 and is valid for a period of five (5) years from the date that the Registrar accepts the business for registration (s.4 (1.1) Business Name Act, R.S.O. 1990, c. B.17 (“BNA”)). Additional business licenses and permits may need to be required depending on the nature of the business. Sole proprietors do not create a legal entity to operate their business and as a result have the control and flexibility to unilaterally change the direction of the business without the formal requirements that would apply in a partnership or corporation.
However, the flexibility of operating a sole proprietorship can be a double-edged sword when it comes to liability faced by the business as there is no entity to help mitigate risks or liabilities faced by the sole proprietorship. Instead, the sole proprietor is personally liable for any risks, debts or other liabilities encountered by the business. For instance, if a sole proprietorship fails to pay their debts, creditors can seize any assets personally held by the sole proprietor including their home and vehicles. Another drawback of the sole proprietorship is longevity. The existence of the sole proprietorship is linked to the sole proprietor and is therefore, restricted to the lifetime of the sole proprietor. The result is that it would not be possible to sell a sole proprietor business or pass it on to your children. Lastly, income earned from a sole proprietorship is taxed as personal income, which limits some tax planning option available to different business organization structures.
Partnership: Shared Responsibilities and Risks
Much like a sole proprietorship, a partnership has few formal requirements to come into existence than other methods of carrying on business. A partnership can be found to exist when two (2) individuals carry on business in common with a view to profit. But there are other factors used to establish the existence of a partnership including:
- Jointly owned property that can be used for profit
- Sharing gross returns
- Receiving a share of the profits of a business
Each of these factors alone are not enough to establish a partnership and must be considered in the context of the relationship. The obligations and responsibilities of the partnership relationship are clarified in sections 20 -31 in Ontario’s Partnerships Act, R.S.O. 1990, c. P. 5. However, sections 20-31 are meant to serve as more of a guideline in instances where the partners have agreed to different arrangements in a partnership agreement. Alternatively, a written partnership agreement can be drafted which formalizes the internal structure of the “firm” (i.e., the partnership) and the nature of each partner’s responsibilities.
Like sole proprietorships, partnerships also carry on business directly without an entity that shields the partnership from liability. The risks of a partnership’s direct liability include personal liability for partners, and equal liability for the actions of the other partner. For instance, unless a partnership agreement states otherwise, if one partner enters into a contract through the partnership, both partners are fully liable for performing this contract even if the second partner was not a signatory. However, a well drafted partnership agreement can remedy the personal liability for the second non-signatory partner. As with any business in Ontario, partnerships must register their names under the BNA (s.2(3)), and apply for a business license from the Ontario government.
Finally, income tax for a partnership is calculated at the partnership level, meaning that the partnership’s profits are accounted, related expenses are deducted, and the partners are each allocated their proportion. The partner’s portion will be set either by Ontario’s Partnerships Act, or by a partnership agreement, if there is one in place.
Corporations: Benefits, Roles, and Responsibilities
Selecting a corporation as the method of carrying on business is complex and requires adherence to strict regulatory requirements; however, there are significant benefits that can outweigh the challenges of setting up and operating a corporation.
Unlike sole proprietorships and partnerships which can arise from simply carrying on business, a corporation must be created through a process called “incorporation,” which is determined by the selected jurisdiction of the corporation. In Ontario, corporations have two options under which to incorporate: the Ontario Business Corporation Act, R.S.O. 1990, c. B.16 (“OBCA”), or the Canadian Business Corporation Act, R.S.C., 1985 C. c-44 (“CBCA”). If you’re considering incorporation, you should be aware that the operation, structure, and organization of a corporation is heavily dependant on the statute of incorporation. For this reason, there are some differences worth considering when deciding on the OBCA or the CBCA as the statute of incorporation. For instance, the classification of a corporation as a “national” one or a “provincial” one is determined by the incorporating statute, the cost of incorporating under the OBCA is $300 versus $200 under the CBCA, and in contrast the OBCA requires a single filing for tax and the annual corporate filing requirement whereas the CBCA requires two separate filings.
Under the law, corporations are considered persons and therefore, form a separate entity. The separate legal existence of a corporation grants the corporation the power to carry on business, own property, have certain rights such as entering contracts, loaning or borrowing money, and paying taxes among others. Most importantly, a corporation’s separate legal existence provides additional benefits such as some protection from liability, being able to exist in perpetuity and lastly, being taxed as a separate entity.
The separate existence of a corporation also means that there are different roles that must be filled for a corporation to be valid, and these are the roles of shareholder, officer, and director. Each of these roles have different responsibilities and obligations to the corporation based on their specific role, and both the OBCA and the CBCA govern the limits of each of these roles within a given corporation. For instance, the CBCA distinguishes directors as having managerial and supervisory powers over the activities and business of the corporation, which are powers that can be delegated to officers in some degree but ultimately, are not shared with shareholders.
Lastly, another important function that corporations accomplish through the issuance of shares is wealth and tax planning. With the appropriate legal and financial advice, shares can be used to accomplish share roll overs, income tax splitting, and estate freezes. An experienced corporate lawyer will be your best ally in navigating the seemingly never-ending regulatory compliance that a corporation faces and in maximizing the benefits of operating your business through a corporation. Your preferred lawyer should have experience in drafting articles of incorporation, corporate by-laws, resolutions, share certificates, shareholder agreements, and maintaining a corporate minute book.
Role of a Lawyer
A well-versed and experienced lawyer will be one key to helping you start your business. If you’re at the beginning of launching a business and have not decided on which method of carrying on business you would like to proceed with, then the right lawyer will guide you through your options and explain which one is most suitable with a view of your business idea, structure, and scale.
- Easier registration process
- Low cost of setting up
- Unilateral control
- Small business governmental support programs and benefits
- Personal liability and lack of limited liability
- Taxed at a personal income rate
- Easier registration process
- Relatively low cost of setting up
- Flexible arrangement
- No unilateral control
- Personal liability for whole of the partnership
- Taxed at a corporate lower tax rate
- Limited liability
- Protection of the business mission/goal/purpose
- Lack of control and twisting of the protection of the business mission/goal/purpose
- Costly to set up
Selecting the right business structure is a fundamental step for entrepreneurs in Ontario. As outlined, each structure has its own set of advantages, disadvantages, and implications. Whether you are leaning towards a sole proprietorship for its simplicity, a partnership for shared responsibilities, or a corporation for its enhanced benefits and protections, the choice must be an informed one. While this guide provides an overview for better understanding seek professional assistance.
To ensure that you make the best choice tailored to your specific business needs, objectives, and future aspirations, it is essential to seek expert legal advice. Connect with MBLAW today and receive a comprehensive consultation that will set you on the right path to business success.