By structure, we really just mean who is in business here? Is it you? Is it you and another person or group of people? Or will it be a company, separate from you but owned and controlled by you?
So, for your purposes, the three options just mentioned are the following:
- If its just you, that is called a sole-proprietorship – which makes sense – ‘sole’ – you are the lonely single soldier owning and operating the business, and proprietor – or ‘the owner’.
- If it a partnership, there’s going to more than one owner of the business. Maybe its a ‘Mom and Pop’ shop. Or maybe a colleague or a few colleagues.
- And then there’s incorporated or limited company (which mean the same thing, by the way!) And again, there’s separation from the owner or owners under this structure.
Let’s break the three choices down:
Sole Proprietorship – Legally, a sole-proprietorship is you. You are the entity that enters into contracts. You are the one that transacts with customers. You are the one that is liable or responsible if you default on a loan or lose a civil suit for damages caused by your business. As a result, your personal assets are exposed. If you default on a loan or get sued and lose, you can lose your house, your savings, everything. Not a big deal if you’re selling baskets at a farmer’s market, but if you provide skydiving services, there’s a lot more at stake if you’re not careful with how you’re operating things. For tax purposes, the reporting is easy because its just another schedule on your individual personal tax return called a T2125. My suggestion, now that you are in business for yourself, is to find a tax preparer to do your taxes. Its not going to be too expensive, but having a professional do it will save you a bunch of time and it will get done right. Besides, you have more on your mind than getting taxes done. Now you’re going to want to check with your provincial company registry bureau (or what might be called business registries or registry of joint stock, or something to that effect) as to fees, but likely, there’s very little in opening registration costs as a sole-proprietor, other than if you want to operate under a different name than yours. For example, ACME Painting. The registry will do a name search and if the search is acceptable, you will be entitled to operate under that name providing you continue to pay your registry fees every year. A sole-proprietorship is definitely the cheapest of the three forms of structure, at least in terms of reporting and administration. However, the personal tax cost might not be the overall cheapest depending on how much money your sole-prioretoship generates in net earnings. You see, this is the big disadvantage to operating under a sole-proprietorship structure: you have no control over how much tax you will be paying, overall, from year to year. Whatever you earn will be the amount that is reported and taxes will need to be paid at whatever tax brackets you stratify. Make sure you’ve watched the related content on Tax Brackets and Marginal Taxes. It makes no difference as to whether you actually withdrew the money from your bank account or didn’t need all the money the business generated. You will be taxed on the total earnings. So, you really want to try as best you can to gauge how much earnings (which is determined by deducting your estimated expenses from your estimated revenues) you think you will be able to achieve and how much of that you need to draw to fund your cost of living expenses. If you think you won’t need it all, incorporation may be the ticket. Now, please don’t get overly worked up over this decision. Depending on the business you are starting, there maybe a good chance that your income will be low this first year. And even if its not, there’s a good chance that it doesn’t generate more money than you know what to do with. So, a lot of the time, when clients of mine just starting a new business struggle with whether or not to incorporate, we just take a ‘wait-and-see approach’ and start out as a sole-proprietor. And that’s okay. As long as you have a good relationship with your accountant, they will steer you right.
Partnership – A partnership is basically like a sole-proprietorship, except there’s more than just you in the mix. Like a sole-proprietorship, all of the same liability exposures are there for the partners. An exception to this would be if you plan to set-up a limited partnership. For the purposes of this article, I’m not going to go into limited partnerships as this is out-of-scope to what I’ve seen in practice at this level of start-up. Now, if you are a professional services business and plan to have a main partner or general partner in the mix, make sure you talk to your accountant. But for the purposes of this article, I’m going to assume that if you are planning a general partnership where two or more people have come together to run an unincorporated business together. So, you can still lose your house on this one! Tax reporting is the same – total partnership income and expenses are reported on a schedule of your individual tax return and your portion will be divided out as per your agreed % partnership interest. And like a sole-proprieotorship, there’s no control over how much tax you pay – you pay what you earn, not what you draw. Now there are some specific additional reporting requirements that may apply at this stage. These specific instances are out-of-scope for this article but I will provide reference to the CRA guide. LIke a sole-proprieotorship you’ll register a business name under the company registry of whatever jurisdiction you are in, assuming you plan to operate under a trading name. Administratively, things are pretty much the same as a sole-proprieotorship. You’ll keep records the same way and save receipts the same way. But one of the most important things I will suggest here is that you have a partnership agreement drafted and you’ll want to get a lawyer for this. Now, I’m going to blunt here: a good majority of partnerships start out nice and positive and exciting, and everyone is getting along, and then things don’t work out and one or more partners want out or want to buy out the other. A good partnership agreement is worth its weight in gold in these situations.
Incorporated or Limited Company – We talked a little about incorporated entities when we discussed sole-proprietorships and you’ve also, hopefully, watched the related content video so you’ve got some background on this. Now in a nut-shell, the very biggest reason why people will incorporate their businesses is because they hope to or are already generating more money than they need to fund the cost of their regular living expenses. That’s the big reason, to be honest. Now secondary to this, in my opinion, is liability protection. Now this is a valid reason, but I’d like to make sure that any undue fear is managed in relation to protection against civil suits. Now, the way civil law, which you might also hear called common or tort law is there’s generally accepted standards of care that we have to our customers. This is generally a question of judgment as to how reasonable peers in your industry would conduct themselves in order to deliver a product or service to you in a way that will not bring the customer, whether personal or financial, harm. Now this ‘harm’ is called damages. Damages result as a consequence of you not meeting your duty for the standard of care acceptable to your industry. If your customer suffers damages, and it is proven that your conduct caused those damages, there is usually a monetary award to your client decided upon by the courts. So there’s a very quick and dirty lesson on civil law. Now here’s what I want you to think about – because I know this all likely sounded a little scary – but first off, you’ll need to have liability insurance if you’re going into business for yourself and likely this will be at a minimum of $1million dollars. I’m going to assume that you will do the very best you can to operate your business safely. I will assume that if you are providing a professional service that you will try to deliver what you say you will and you will do the best job you can to ensure things are correct and accurate. In other words, you’ll take pride in your work and you won’t do anything super-stupid. You will make mistakes. That’s going to happen. But let me paint a picture here to illustrate: let’s say you’re going to own a retail shop on the mainstreet of your town and on an icy snowy day, you don’t salt your entryway. Now, in this case, you are exposed to liability if someone falls. Now don’t forget that the insurance that we have in place is most likely adequate, and remember, a customer can only sue you for damages – so if someone slips but suffers no harm other than a little embarrassment, they won’t have a case – at least not one that will provide any awards. But if there was harm, then you have to think about the kinds of damages your clientele could possibly suffer. For example, if your retail store is a teenage hang-out, then someone slipping on your unsalted step may sprain an ankle, but will only miss out on a few shifts at MdDonalds, as a result. You see, the damages wouldn’t be that high. You could either put in a claim with your insurance provider or pay outside of that. You won’t lose your house, though! But what if your retail shop supplies high-end jewelry for the ultra rich and Elon Musk slips on your front door step. Your $1million dollar liability policy is not going to cover the damages that this client will suffer. So, incorporation is this case, would have saved your house. It would have been another layer of protection for you, in addition to your insurance. I’m telling you this story, because the fact is that most people reading this article will not have Elon Musk as clients and most people are going to make sure they have controls in place to operate their business with an acceptable standard of care. Its just normally the way people run their businesses. So, losing sleep over incorporating because you are afraid of losing your house is not rationale. But, reasonably take yourself through the algorithm I just gave you and see how you feel after you’ve done this. If you’re still fearful, get yourself incorporated or really have a good conversation with your insurance provider.
Okay now, lets assume that at this point, you feel pretty informed on when to incorporate, whether its now or down the road. What is the process to make this happen. Great question. Okay, understand that incorporating a legal entity is a highly legal exercise, and should be undertaken by an experienced corporate lawyer used to doing these kinds of engagements, and overseen by a CPA, also experienced in doing these kinds of engagements. Generally speaking, lawyers will require full-blown instruction from a CPA on the steps necessary to incorporate the company. On rare occasions, a corporate lawyer will not request this, but in my experience this better be one hell of a seasoned corporate lawyer – I’m talking master level – like 30 years plus in the business. If you don’t get this sense and the lawyer doesn’t ask for the CPA to be involved, you should be wary and rely on your CPA to arrange for a corporate lawyer to assist in this work – you don’t have to bail on your current lawyer, but just for this particular engagement. You see, there can be and usually are some complex moving parts that come with this process – and it really depends on your particular situation, but having a good CPA and lawyer on this will ensure things get done right and nothing bad in terms of unwanted liabilities or design flaws creep up on you in the future. Now what kind of unforeseen liabilities or design flaws are we talking about here? For one, lets say you have an existing business that you are incorporating. Understand that you will be related to your new company – think of it like one of your children. Now the CRA has this rule that when you transact with a related party, like one of your children or your corporation, that you are deemed to transact at fair market value, regardless of the transaction value. So when you incorporate an existing business, this is deemed (and by deemed I kind of mean ‘pretend’) to have happened at if not handled correctly by your CPA and lawyer will create a possibly nasty tax bill for you at the date of incorporation. Now that would be a pretty untended consequence of not having a good team in place to ensure that the provisions under the income tax act that alleviate this tax burden are exercised and proper clauses in the purchase and sale agreement are drafted to protect you. And lawyers and accountants that don’t do this all the time will miss this. There are also GST or HST issues that can arise that accountants and lawyers can protect you from. You also want to make sure that your shareholder register is structured in a mindful way. So, again, its important to just get the pros to help you here and don’t be tempted to scrimp on this stage or worse yet, do it yourself. Yes, you can go online and do this stuff yourself at a fraction of the cost of having a good team do it for you, but I highly discourage you from taking this route. You will end up paying copious amounts more money in the future either fixing the problems arising as a result of the DIY model or worse yet, CRA tax liabilities, penalties and arrears interest that may arise.
Now, costs for incorporation should be discussed with your accountant and your lawyer. And this can vary from professional-to-professional, but be sure you get a comprehensive quote that includes disbursements that will be billed alongside the incorporation fees. Examples of disbursements include company registry incorporation fees, minute book fees, etc. Sometimes, in my experience, I’ve found that lawyers sometimes quote an engagement for their time, but won’t include the disbursements I’ve just mentioned and it can come as surprise, because sometimes the disbursements are close to the same amount as the lawyer’s time, and this can almost be double your expectation. So definitely ask about this.
