Search
  • Froese Law

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

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



0 views

© 2020 by Froese Law

Froese Law provides its Canadian law services by a professional corporation.  

Froese Law provides its U.S. legal services in affiliation with a U.S. based law firm.

  • Instagram
  • LinkedIn
  • Twitter