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Corporate Structuring for Start Ups: Sole Proprietorships, Partnerships and Corporations


By Millie Bojic

Are you looking to start a business in Canada, and are scratching your head as to what the best structure for your business would be? Below lies a bullet-point summary of the principal structures under which to conduct business in Canada – whether as a sole proprietorship, a partnership or corporation – as well as some commercial considerations and tax advantages to bear in mind before making any decisions:

1. Sole Proprietorships

  • What is a sole proprietorship?
    • A sole proprietorship is the most basic form of a business organization
    • A sole proprietorship exists whenever an individual carries on a business solely on his/her account, with no involvement from other individuals (with the exception of any employees taken on)
  • What are the advantages of a sole proprietorship?  
    • Low start-up costs
    • Simplicity of formation
    • Sole control over the business
    • Reports business income every calendar year, same as an individual in Canada
  • What are disadvantages of a sole proprietorship?
    • Unlimited Liability – all business & personal assets are subject to seizure
    • Challenging to attract investments
    • Unable to offer equity incentives to employees, which may be attractive as a start-up that has limited funds to pay employees
  • What are the tax advantages of a sole proprietorship? 
    • Able to offset any business losses of the sole proprietorship against other sources of income – really attractive for a start-up given it is likely incurring a lot of losses in the beginning
    • Tax Deferral Opportunity:
      • Business losses may be carried back for 3 years & carried forward for 20 years
      • Capital losses or non-business losses may be carried back 3 years & carried forward indefinitely, offset against capital gains only

2. Partnerships

  • What is a partnership?
    • A partnership is a relationship between two or more persons carrying on a business in common with a view of making a profit
    • A partnership can exist without a written agreement
    • There are two types of partnerships:
      • General Partnerships (“GPs”) – Each partner’s liability is unlimited to the full extent of their personal assets
      • Limited Partnerships (“LPs”) – Each limited partner’s liability is limited to how much they put into the partnership
  • What are the advantages of a partnership?
    • Low start-up costs
    • LPs can limit their liability risk as described above
  • What are the disadvantages of a partnership?
    • GPs are subject to liability risk as described above
    • Does not have a distinct legal personality separate from its partners, which means it cannot maintain its own liability in the way a corporation can – see below
  • What are the tax advantages of a partnership?
    • While a partnership is not a separate legal entity, the Canadian Income Tax Act (“ITA”) treats the partnership like a person resident in Canada in order to calculate each partner’s income
    • Income & loss of the business is calculated at the partnership level & then allocated at the partnership level, & then allocated to the partners
    • A partner’s capital gains can be offset by its share of the partnership’s capital losses:
      • As for sole proprietorships, this is a key advantage
      • For a corporation this is not possible, as there is no “flow-through” of the corporation’s losses to its shareholders – see below

3. Corporations

  • What is a corporation?
    • A corporation is a legal entity separate in law from its owners
    • A corporation has the right to:
      • Carry on business
      • Own property
      • Maintain its own liability
    • Few differences in taxation compared to other structure:
      • While most shareholders file their income taxes on a cash basis, a corporation may not use the cash basis of accounting and must use the accrual basis
    • While a sole proprietorship can report its income on a calendar-year basis, a corporation may select its fiscal year on any 12-month basis
    • The actual total tax on corporate income is obtained by adding the applicable provincial rate to the federal rate
    • No “flow-through” of the corporation’s losses to its shareholders
    • Corporate income subject to double taxation:
      • at the corporate level; and
      • at the shareholder level, when distributed as a dividend 
  • What are the advantages of a corporation?
    • Provides limited liability for shareholders – there is a ‘corporate veil’ between the corporation and its owners
    • Has a separate legal personality that exists perpetually (unless formally dissolved)
    • Flexibility when raising capital – attractive for start-ups raising funds
    • Provides legitimacy to the business model and allows for equity incentives – attractive to clients and investors alike
  • What are the disadvantages of a corporation? 
    • More expensive to set up and more expensive to maintain – i.e. corporate annual filings and quarterly filings as may be required; transactional structuring complexity
    • Directors of the corporation have a duty of care under common law and may be directly liable if they knew or ought to have known their decisions would be in breach of the duty of care
    • The ITA can pierce the ‘corporate veil’ & hold shareholders personally liable for corporate tax-related acts – though only in clearly convincing cases of fraud, shams, or outrageously offensive conduct
    • The ITA can also pierce the ‘corporate veil’ in certain circumstances that hold directors personally liable – an example is liability for corporate taxes due to:
      • Improper payment of dividends
      • Failure to remit withheld taxes
  • What are the tax advantages of a corporation? 
    • Generally, lower tax rate for corporations than for individuals (depending on your individual tax bracket)
    • Small Business Deduction (“SBD”) eligibility – Canadian Controlled Private Corporations (“CCPCs”) receive a further tax deduction on the first $500,000 of active business income*
    • Shareholders are eligible to receive federal dividend tax credits – which is done to avoid double taxation when the shareholder receives their share of the corporation’s earnings – see above
    • Scientific Research & Development (“SR&ED”) – Canadian government offers tax incentives for certain innovative taxpayers to deduct their expenditures & receive input tax credits (“ITCs”), which is especially attractive for tech start-ups
    • Lifetime Capital Gains Exemption (“LCGE”):
      • Utilized by shareholders of CCPCs when a shareholder disposes of his/her shares in the corporation and wants a tax break – so long as the shares qualify as shares of a small business corporation