Legal Structures for Carrying on Business
Sole proprietorship, partnership, corporation, or co-operative?
A successful business frequently begins with an idea for a product or service that will improve the life or activities of society or one or more segments of the population. As the idea is further explored and planned, one of the many decisions to be made is how that service or product will be offered or delivered to those who will pay for and use it. There are many aspects of this determination, from naming the business or product, to protecting its ideas by patent or trademark if applicable, to renting or purchasing the equipment needed to make the product or deliver the service.
Before registering a business you should learn about what forms or method of carrying on business will be most suitable. Conclusion of this sort are best made after receiving advice from a lawyer and other business advisers, including an accountant.
The sole proprietorship is the simplest form of business in Canada. A sole proprietor is an individual. This individual can use his or her own name or a business name to identify the business. The sole proprietor may have employees, but he or she is the sole owner of the business.
All income or loss derived from the business is included in the personal income tax return for the sole proprietor, which is filled for the tax year ending December 31 by April 30 of the following year. The rate of income tax is based on the rate applicable to the individual for the year of filling.
A sole proprietor is personally responsible for all the obligations of the business. These obligations include all losses and liabilities, including those arising from wrongful acts of the sole proprietor or those of his or her employees. The sole proprietor also receives all the benefits of the business, including all the profits.
Should one of the sole proprietor’s customers or business associates decide to sue the business, the claim is made against the individual sole proprietor personally. All business and personal assets of the sole proprietor may be seized by an order of the court to satisfy debts and obligations of the sole proprietorship. It may be possible for a sole proprietor to reduce personal liability by purchasing insurance and by implementing creditor-proofing strategies on the advice of its legal and financial advisers.
A sole proprietorship ends with the death or incapability of the sole proprietor. Although assets of the proprietorship, which may include its name, domain names, secret recipe, or building and equipment, may be sold, that particular business dies with its owner.
All profits go to you directly. Major advantage of carrying on business as a sole proprietorship is that the single owner will keep all the profit from the business after paying all the expenses.
Full control of decision making. The owner also has full control of the business, making every decision herself, with no requirement to obtain the agreement of anyone else. This does not mean that the owner cannot employ others in the business or ask for the advice of others – it simply means that she is the sole owner.
No corporate tax payments. Business entity is not taxed, as the profits and losses are passed through to the sole proprietor. You’re taxed as a single person.
Minimal start-up costs compared to corporations.
Fewer formal business requirements compared to a corporation.
The spouse of a sole proprietor can be employed without being formally declared as a worker, although legal responsibility can be solely assumed by one particular person.
Unlimited liability. Just as the sole proprietor will reap all profit from the business, if that business flounders under financial or other difficulties, the owner will be personally liable for any breach of contract or loss arising from the business. This is true even if the business name differ from the proprietor’s personal name. Additionally, this risk extends to any liabilities incurred as a result of acts committed by employees of the company.
Difficult to raise capital. Investors won't usually invest in sole proprietorship. Therefore, capacity to raise capital is limited.
Retaining high-caliber employees can be difficult.
Limited life. The life of the business is limited and business continuity ends with the death or departure of the owner.
A “partnership” is basically a “contract” between parties. The Ontario Partnerships Act Ontario (PA), which is modeled on the British Partnership Act, defines partnership as follows:
Partnership is the relation that subsists between persons carrying on a business in common with a view to profit.
The definition in the PA goes on to exclude corporations: “but the relation between the members of a company or association that is incorporated by or under the authority of any special or general Act in force in Ontario or elsewhere, or registered as a corporation under any such Act, is not a partnership within the meaning of this Act.”
In Ontario there are three basic types of partnership:
General Partnership – a partnership in which each partner is liable for the debts and other obligations of all partners to an unlimited degree;
Limited Partnership – a partnership in which there are one or more general partners who are liable for the debts and other obligations of the other partners to an unlimited degree and one or more limited partners whose liability is limited to the amount such limited partner has contributed to the partnership business; and
Limited Liability Partnership – a partnership in which each partner is jointly and severally liable for all the debts and obligations of the partnership except for liabilities arising from professional negligence, which remain those of the partner whose acts or omissions or whose subordinates’ acts or omissions resulted in the professional liability.
Advantages of General Partnership:
Tax advantage. Businesses as partnerships do not have to pay income tax; each partner files the profits or losses of the business on his or her own personal income tax return. This way the business does not get taxed separately.
Easy to establish and start-up costs are low.
Wider pool of knowledge, skills, experience, and contacts.
Better decision-making. Improved management with more than one owner.
Privacy. Compared to a corporation, the affairs of a partnership business can be kept confidential by the partners.
Disadvantages of General Partnership:
Unlimited liability. Since the business does not have a separate legal personality, the partners are personally liable for debts and losses incurred. This means that if a third party were to sue the partners, the third party can sue any one of the partners without suing all of them. If a partner has been sued but cannot pay the third party the full amount, the third party may collect the money from the remaining partners.
Possible development of conflict. A partner cannot transfer interest in the business without the unanimous consent of the partners.
Partnerships can potentially be unstable because of the danger of dissolution if one partner wants to withdrawal from the business or dies.
There is a risk of disagreements and friction among partners and management.
Can be difficult to find a suitable partner.
Advantages of a Limited Partnership:
Limited liability. The limited partner is only going to be liable for the amount of capital it contributed to the business; a business creditor cannot come after the limited partner’s personal assets.
Easier to attract investors because limited partners have limited liability to the business debts.
Tax advantage. Profits and losses pass through the business to the partners, who are taxed on their own personal income tax returns.
Limited partners get to share in the profits and losses without having to participate in the business itself.
Disadvantages of a Limited Partnership:
If the limited partner becomes active in the business he or she may have general-partner personal liability. General partner is personally fully liable for the debts of the business.
Partnerships can potentially be unstable because of the danger of dissolution if one partner wants to withdrawal from the business or dies.
Possible development of conflict between you and your partner(s).
The most popular method of carrying on business today is by way of a corporation. A corporation has a separate legal identity from that of its principals and is brought into existence by filing a document – for example, articles of incorporation – under the appropriate statue or special statue of the jurisdiction in which the corporation carries on business (federal or provincial). Corporations have perpetual existence and cease to exist only when their charter is cancelled either voluntary or for failure to comply with the requirements of their governing statue.
Types of corporations:
Share capital corporations with limited liability for their owners. These corporations can be “closely held” – for example, a small family-owned business – or “offering” – for example, a corporation that lists its shares on a recognized stock market.
Share capital corporations with unlimited liability for their owners.
Professional corporations. These are corporations that hold a valid certificate of authorization or other authorizing document issued under an act governing a profession. For example, The Chartered Accountants Act, Law Society Act, Social Service Work Act, or Veterinarians Act.
Not-for-profit corporations. These corporations do not issue share capital and are typically formed for social, community, or charitable purposes. The business of a not not-for-profit corporation is limited to its stated objects and is carried on for purposes other than the financial gain of its members.
Not-for-profit charitable corporations. These are not-for-profit corporations with charitable objects. These corporations are registered as charities with Canada Revenue Agency (CRA) to benefit from special tax statues.
Co-operative corporations. A co-operative is defined as “a type of member-owned organization in which people with common interests and goals join forces to advance a cause such as providing housing assistance or promoting the interests of workers.
Condominium corporations. A condominium is defined as “a method of land ownership in which the entire property is owned by a corporation, which is in turn owned by the owners of individual units within the condominium; the ownership of the units is registered separately from the ownership of the complex as a whole.
Other special types of corporations. The above list is not exhaustive of the different types of corporations. For example, many corporations are formed and governed by a special act of Parliament, such as CN Railways, loan and trust corporations, certain hospitals, religious organizations and other charities, and Crown corporations, both federal and provincial.
Limited liability. The shareholders of a corporation are only liable up to the amount of their investments.
Perpetual life. There is no limit to the life of a corporation, since ownership of it can pass through many generations of investors.
Tax Advantages. Certain expenses are tax deductible. Owners can receive tax-free benefits such as deductions for retirement plans and insurance.
Credibility. Incorporating may help a new business establish credibility with potential customers, employees, vendors and partners.
Raising Capital. Capital can be raised more easily through the sale of stock. Additionally, many banks, when providing a small business loan, want the borrower to be an incorporated business.
Funding. If you’re looking for government funding, incorporating will open up more options.
Ownership is transferable. Ownership in a corporation is typically easily transferable.
Double taxation. Depending on the type of corporation, it may pay taxes on its income, after which shareholders pay taxes on any dividends received, so income can be taxed twice.
Forming a corporation requires more time and money than forming other business structures.
Complicated tax filings. Depending on the kind of corporation, the various types of income and other taxes that must be paid can require a substantial amount of paperwork.
Corporate formalities. Corporations are required to follow both initial and annual record-keeping tasks, such as holding and properly documenting initial and annual meetings of directors and shareholders, adopting and maintaining bylaws and issuing shares of stock to the owners.
A corporation is closely regulated.
A co-operative is owned and controlled by an association of members. It can be set up as a for-profit or as a not-for-profit organization. This is the least common form of business, but can be appropriate in situations where a group of individuals or businesses decide to pool their resources and provide access to common needs, such as the delivery of products or services, the sale of products or services, employment, and more.
The key point to note is that the parties’ relative interests remain separate and they are free to dispose of their interest without the consent of the other co-owners, subject to any agreement that the parties may have entered into.
Owned and controlled by its members.
Democratic control (one member, one vote).
Longer decision-making process.
Participation of all members is required in order to succeed.
Possible conflict between members.
Extensive record keeping.
Less incentive to invest additional capital.
Other Legal structures for carrying on business
A joint venture is a commercial business activity that is carried on by two or more parties for a common purpose in compliance with established terms and conditions. Joint ventures are usually created for a specific purpose or time period to share resources, profits, and losses. A “joint venture agreement” will set out the rights of the parties.
There are two forms of joint venture:
Equity joint ventures. Equity joint ventures constitute a separate legal entity pursuant to a contribution of capital by the parties. The agreed form of ownership interest generally entitles each party to participate in the control of the business and share in the profits.
Contractual joint ventures. Contractual joint ventures include strategic alliance, partnership, teaming arrangements, co-ownerships, licensing and distribution arrangements, and franchising systems.
FRANCHISES AND LICENSES
A franchise is an agreement formed by a written agreement whereby one person – the franchisor – grants a right to another person – the franchisee – to use a trademark or trade name in connection with the supply of goods or services by the franchisee. A franchise agreement requires the franchisee to conduct its business in accordance with operating methods and procedures developed and controlled by the franchisor. The franchisor has a continuing right to receive compensation from the franchisee through royalty fees, lease payments, or its sale of products to the franchisee for resale.
A licence is a contractual arrangement whereby the owner of certain property such as a trademark, copyright, or patent – the licensor – grants to another person – the licensee – the rights to use such property for a royalty fee. Usually, the licensor has little control over the operation of the licensee’s business.
Both franchisees and licensees are independent from the franchisor or licensor, and are not their employees.
Unincorporated associations are associations of persons carrying on a not-for-profit activity without the protection of incorporation. Like not-for-profit corporations, they may have charitable or non-charitable objects. Typically, members formulate a “constitution” or “memorandum of association” that sets out the purpose, management, and other rules of the association.
There are no registration requirements for unincorporated not-for-profit associations. If the association has charitable objects, its members may apply to the CRA for charitable statue registration and, if the association deals with property situated in Ontario, its members must file certain prescribed information with the Public Guardian and Trustee.