by Jillian Ali, Associate
Making the decision to start a business can often be overwhelming amidst the excitement. Following the development of a business endeavor, determining the business structure best suited to help build a successful business will be an important initial consideration for all prospective business proprietors. Specific tax implications and insurance liability coverage regularly impact the business structure prospective business proprietors will choose.
A sole proprietorship is the most basic form of business organization requiring few legal formalities in its set up. It exists whenever an individual decides to solely carry on business for his/her own benefit without the involvement of others, save and except for the employment of employees if they so choose. As is true of all business structures, there are advantages and disadvantages to becoming a sole proprietor, which include the following:
Advantages
- Fairly low start-up costs and working capital requirements in addition to having few legal formalities and regulations to abide by;
- Relatively inexpensive to form with the ability to directly maintain all profits made; and
- The ability to deduct losses of the business from the sole proprietor’s personal income, which may cause him/her to qualify under a lower tax bracket and create a tax advantage when profits are low.
Disadvantages
- Unlimited and sole responsibility for all liabilities, obligations and losses associated with the business, meaning that all business and personal assets of the sole proprietor may be seized in order to satisfy the obligations and liabilities of the business; and
- As income is taxable at the sole proprietor’s personal rate, the profitability of the business may move the sole proprietor into a higher tax bracket.
Overall, a sole proprietorship can be a very attractive option to those individuals who are looking for a simplified business structure and feel that the probability of a substantial uninsurable risk is low, thus making them more comfortable with the commingling of their personal assets and liabilities with those of their business.
Alternatively, the incorporation of a corporation is the most common form of business organization. Incorporation can be completed at either the federal or provincial level depending on whether or not the business will be carried on nationally or provincially. A corporation is considered at law to be a legal entity separate and apart from its owners, also known as shareholders. As such, a corporation has the ability to carry on business, own property, incur liabilities and sue in its own name. The advantages and disadvantages associated with the incorporation of a corporation include the following: Advantages
- Separate legal entity with limited liability;
- Shareholder liability is limited to the value of the assets, such as money or property, they have transferred to the corporation in exchange for shares; and
- Potential for a tax advantage as the taxes attributed to an incorporated business may be lower than the tax bracket a sole proprietor may qualify under.
Disadvantages
- More expensive to incorporate than to set up a sole proprietorship;
- A corporation is closely regulated and will require the annual filing of corporate records with the government;
- Directors must meet certain residency requirements; and
- Potential for conflict between the directors and the shareholders of the corporation.
When considering the limited liability advantage of incorporation, while the shareholders of a corporation own the corporation through their ownership of its shares, they do not own the property or other assets of the corporation. In the same token, the liabilities of the corporation are not the liabilities of the shareholders. Thus, should the liabilities of a corporation exceed the value of its assets, the creditors of the corporation will have the right to demand repayment from the assets of the corporation but they will have no further recourse for any liabilities that remain unpaid as a result of the corporation’s lack of funds. In other words, the personal assets of the shareholders will not be at risk unless they have guaranteed the obligations of the corporation in their personal capacity.
As a part of the Lancaster Brooks & Welch LLP Corporate and Commercial team, Jillian Ali can assist you in all aspects of your business legal needs. She may be contacted at 905-641-1551, jali@lbwlawyers.com. Lancaster Brooks & Welch LLP are Niagara’s Lawyers since 1882.
With respect to a corporation’s income, it is determined and subject to tax separate and apart from that of its shareholders. Therefore, a net income or loss of the corporation cannot be treated as income or loss for an individual shareholder. If the corporation desires to pay any of its after-tax income to its shareholders, the directors will be required to declare a dividend regarding same. While dividends declared to individual shareholders do constitute taxable income, in certain circumstances dividends to corporate shareholders may be received tax-free by way of an inter-corporate dividend.
In being a separate legal entity, a corporation will also continue in existence notwithstanding the withdrawal of a shareholder from the corporation by way of a sale of his/her shares or as a result of the death of a shareholder. The dissolution of a corporation may only be accomplished by a resolution of the majority of the shareholders, by way of court order or pursuant to statute if it is deemed to be inactive or in breach of its governing legislation.
On the whole, the incorporation of a corporation is often the most appealing option to those individuals who may be planning to open their business with other owners or who may one day like to provide their family members with financial benefits without relinquishing any control of the business. A more comprehensive share structure can enable a proprietor to maintain control of the business while permitting the growth in its equity to be owned by successive generations. Corporations also provide more financial flexibility while shielding the shareholder(s) from the obligations and liabilities of the corporation.
As a part of the Lancaster Brooks & Welch LLP Corporate and Commercial team, Jillian Ali can assist you in all aspects of your business legal needs. She may be contacted at our St Catharines Office at 905-641-1551.