The simplest structure is the sole proprietorship, which usually involves just one individual who owns and operates the enterprise. Because of how easily a sole proprietorship is created, it tends to be the most common business structure for new and / or part-time business operations.
In a sole proprietorship, the business and the operator are one and the same from both a legal and tax perspective. Selecting the sole proprietorship business structure means you are personally responsible for your businesses liabilities. As a result, you are placing your assets at risk, and they could be seized to satisfy a business debt or a legal claim filed against you. This means creditors are not only entitled to claim business assets, but personal assets of the proprietor as well. While the liability factor may present as a disadvantage, it also presents opportunities for tax management as businesses in the start-up phase generally tend to incur losses and those losses can be claimed against other sources of income in a personal tax return.
A partnership is similar to a proprietorship; however, a partnership is defined as two or more persons (which can be either individuals or corporations) carrying on a business with a view to profit. The terms of a partnership should be legally defined by a partnership agreement, although a partnership agreement is not necessary for a finding at law that a partnership exists; an informal partnership is still a partnership. With that being said, as the partnership continues, a written partnership agreement is essential to clarifying the terms, conditions and relationships between the partners. For example, a legal agreement could govern the sharing of revenues, expenses and tasks.
For tax purposes, a partnership is considered an entity for GST/HST, which means the partnership can be a separate registrant for GST/HST purposes. For income tax purposes, a partnership is an entity in the sense that the income and expenses are accumulated and calculated at the partnership level; however, a partnership is not a ‘taxpayer.’ Instead, the net income is determined at the partnership level but then taxed in the hands of the partners. In short, the taxpayer in the operations of the partnership are the individual partners.
As a consequence of the hybrid treatment of a partnership for income tax purposes (business profits or losses are calculated at the partnership level but the net income or loss is taxed at the partner level), partnerships have more complex tax filings than proprietorships. While retaining the advantage to start-up businesses that proprietorships have in that losses are available to offset other income of the partners, the tax filing requirements are more onerous. A separate partnership information return is generally required for most partnerships; however, the CRA has granted administrative relief for farming partnerships of individuals and for partnerships having below a 5 million dollar asset size or transactional volume of less than 2 million.
Similar to proprietorships, the liabilities of the partnership are attached to the individual partners. One of the notable concerns we see with a partnership as a business structure is that partners are jointly and severally liable. This means if one partner incurs significant liabilities without the knowledge of the other(s), the other(s) could still be held responsible for their percentage or even all of that liability. That unlimited liability can be of concern when using a partnership as a business structure. To address this, there are agreements which can be put in place to create what are called limited liability partnerships.
Joint ventures are often considered to be simply a partnership by another name. Unlike a partnership, which can exist without a partnership agreement, a joint venture will not be considered in existence until a joint venture agreement is created. A joint venture is an association of two or more persons who contractually agree to contribute to a specific venture which is usually limited to a specific project or for a period of time. In these situations, the venture would conclude upon the completion of the project. This structure tends to be quite popular in business enterprises such as real estate property development and/or business ventures where participants to the venture need to combine their skills and capital to complete a large project. The terms of the joint venture agreement are critical in such arrangements.
Like a partnership, a joint venture is not recognized as a separate taxable entity. A joint venture arrangement is effectively treated as a co-ownership for tax purposes and each joint venturer independently reports their own share of the joint venture’s gross revenues and expenses. This means that each of the venturers may treat the individual items of revenues and expenses on their own income tax returns differently from the other joint venturers. This allows significant flexibility for income tax planning within the group of joint venturers. Parties involved in a joint venture may also offset the profits and losses from other businesses against the profits and losses as derived from the joint venture. One of the most compelling aspects of a joint venture versus a partnership is that each venturer is carrying on their own separate business and thus is potentially able to claim the full small business deduction on their earnings from participation in the venture.
In contrast with a partnership, a joint venture is not considered an entity for GST/HST purposes. As a consequence, each venturer is responsible for accumulating and filing their proportionate share of the joint venture activities. Where the separate reporting of GST/HST on behalf of each venture would be administratively difficult, an election is allowed to appoint a participant in the joint venture as being responsible for all GST/HST filings on behalf of all of the venturers.
Corporations are more complex and expensive legal structures than proprietorships or partnerships. The fundamental difference is that a corporation creates formal ownership shares, which produces a tax and legal separation between the company and the shareholders, in turn protecting personal funds and assets. There are also significant tax advantages for the active business shareholders, who may be paid by wages or through dividends. Incorporation provides some liability protection for the corporation's debts, and offers some measure of protection for a company's name. Company officers and shareholders may come and go, but the corporation exists until it is wound down.
As an independent legal entity, separate from its owners, a corporation requires compliance with more regulations and tax requirements. Unlike a proprietorship or partnership where losses incurred can be claimed against other sources of income, losses realized in a corporation are ‘trapped’ in the corporate tax paying entity and not available to be claimed or deducted by the shareholders. For this reason, one would generally only move into a corporate structure once the business is consistently generating operating profits. As a rough rule of thumb, businesses usually do not incorporate until they generate at least $50,000 in revenue annually. With that being said, if there is substantial creditor or liability risk with the business operations, an incorporation might be chosen at the commencement of the business operation for the limited liability protection rather than the tax savings from using losses against personal income.
As your business grows and becomes more complex, so too will its structural needs. You may begin your business operation as a sole proprietor but later decide to take on partners and / or incorporate. MNP’s Tax Services team can help you evaluate your business and decide which structure is appropriate for your business not just for today, but as your business continues to thrive to ensure you are always structured for prosperity and success.
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