Each jurisdiction has its own legal requirements for incorporation. When forming a business, the first step is deciding what type of entity is best for your business and its goals (for example, a sole proprietorship, partnership or corporation). The optimal form of entity depends on several factors, including the corporate structure, liability, tax and management considerations.
In this Legal Guide, Toronto business and technology lawyer, Sukhi Hansra, of Hansra Law, provides some insight into choosing the best form of business between a sole proprietorship, partnership and corporation.
1. Sole Proprietorship
A sole proprietorship is defined as the operation of a business by an individual, rather than a group of partners or an intermediary corporation. In a sole proprietorship, there is no legal distinction between you (the owner of the business) and the business itself. All profits generated by the business are part of your taxable income, but you also assume all of the risks and liabilities of the business. This includes any obligations to pay business debts, loans and potential lawsuits directly from your personal assets.
A sole proprietorship offers many advantages to a business owner. This type of business structure offers lower set-up costs, direct control of decision making and fewer administrative requirements. Tax implications of a sole proprietorship may include the ability to write off losses against other sources of business income, in addition to other important considerations. We strongly encourage you to seek the advice of an accountant or tax planning expert for guidance on tax implications of a sole proprietorship.
Partnership describes the legal relationship between two or more persons carrying on business in common with a view to profit (section 2 of the Partnerships Act). Business is defined to include every trade, occupation or profession (section 1 of the Partnerships Act). There are several different types of partnerships including general partnerships, limited partnerships and limited liability partnerships.
A partnership is formed when two or more people in a venture go into business together with a view to sharing the venture’s profits. According to the court in Red Burrito Ltd. v Hussain, a partnership exists even in the absence of an express agreement or when there is only a partial agreement.
Rather than rely on the default provisions of the Partnerships Act and the law relating to general partnerships, it is common to have a partnership agreement which set out in detail the workings of the partnership. There is a great flexibility in how partners choose to deal with their rights and obligations towards each other. Similar to a shareholder’s agreement, a partnership agreement is a private document that does not need to be filed with the registrar appointed under the Business Names Act to be operational.
While entering into a written partnership agreement is not mandatory for general partnerships, it is often considered good practice to formalize how the general partnership will operate. However, a partnerships agreement is a mandatory requirement in the formation of a limited liability partnership.
Under Ontario’s partnership law (and the law of all other provinces and territories in Canada including under the Civil Code of Québec), a partnership is not generally considered a separate legal entity or person. However, there are many examples where legal statutes in Canada define a partnership as a person or entity. See, for example, the definition of “entity” in the Canada Business Corporations Act (the “CBCA”) and the definition of “person” in the Ontario Business Corporations Act (the “OBCA”).
Partnerships are also not taxable entities for the purposes of the Income Tax Act. While a partnership is not a separate legal entity, a partnership may sue and be sued in its own name (just as a corporation may sue or be sued in its own name).
A registered corporation is a distinct legal entity from the owner(s) of the corporation. For this reason, a corporation is often called a legal person or artificial person. The “ownership” of a corporation is generally broken into “shares”, and each share represents a percentage of the overall assets, liabilities and profits of the company. Therefore, if a corporation’s share or shares are owned by a single person, that person will be entitled to 100% of the corporation’s profits. If you own half of the shares (50/100, for example), you are entitled to half of the profits of the corporation.
A corporation, which is distinct from its owners, can sue and be sued, and can own property, borrow money, and possess rights as a separate “person” under the law that are independent of its owners. As such, your liability will be limited to the extent that you have invested in the corporation.
Before incorporating a corporation, you must determine which jurisdiction to incorporate in – whether it will be a provincial corporation or a federal corporation. This is an important distinction because corporations are governed by the laws of their jurisdiction of incorporation. The jurisdiction of incorporation also determines the legal guidelines for certain transactions, such as amalgamation procedures, duties of corporate directors and officers, shareholder rights and remedies, annual filing requirements and annual fees.
Federal incorporation under the CBCA is a popular jurisdiction of incorporation for several reasons, such as the right to conduct business across Canada, the right to use a corporate name throughout the entire country and the consistency of federal corporate law.
Provincial incorporation under the OBCA is generally preferable where the corporation knows that it will only carry on business within that province. Provincial incorporation may also be preferable for its simple filing requirements, since the corporation’s tax and annual filing requirements are combined into one form for provincial corporation in Ontario.