How to choose the right legal form for your business

What is a business?

A business is an organization that operates with the aim of turning a profit. Generally speaking, it produces goods or services that meet the needs of its customers to sell for a profit.

For example, a charitable organization isn’t considered a business, as the funds it raises through its activities are used to support its mission rather than make a profit.

What are the different legal forms for businesses?

A business’s legal form indicates whether it’s a separate entity from its owners. The legal form you choose therefore influences the business’s legal status, tax obligations and responsibilities.

In Canada, most businesses generally operate under one of the following three legal forms:

• Sole proprietorship
• General partnership (which is a form of sole proprietorship)
• Corporation

However, some businesses adopt a different legal form, such as a cooperative.

Here’s a summary of the pros and cons of the three most frequently used legal forms.

As you can see, each legal form has distinct characteristics. Here is more information about how they differ.

1. Sole proprietorship

A sole proprietorship is informal and easily created, which is why it’s the most common legal form chosen by new businesses.

The business and the person running it are one and the same in the eyes of legal and tax authorities.

Tax law treats a sole proprietorship as an income source for the owner. As such, the business’s financial details must be listed in a separate section of the personal income tax form.

Owners have access to several tax advantages. For example, if the business reports a loss, that loss can be used to reduce income from other sources. That’s why most part-time businesses are sole proprietorships.

However, sole proprietorships have a major downside: the owner is personally liable for the business’s debts.

Should you register your business as a sole proprietorship?

You only need to register a business as a sole proprietorship if:

• You operate a business in your own name
• Your income is less than $30,000 per year

You will need to apply for a registered trade name with your provincial or territorial government if:

• You use a business name other than your own name
• Your income is more than $30,000 per year

You may also want to register your business to:

• Take advantage of government programs
• Open a business bank account
• Apply for a business loan
• Apply for a business credit card

You will also need to get a business number and pay sales tax if your annual business income is more than $30,000 or if you hire staff.

2. General partnership

A general partnership is similar to a sole proprietorship but with two or more owners.

Likewise, the business and the individuals running it are one and the same in the eyes of legal and tax authorities.

However, the partners usually have some type of contractual agreement that governs, in terms of percentages, how income, expenses and tasks are shared. On their income tax returns, they apply those percentages to their income and expenses.

Should you register your business as a general partnership?

Any general partnership must be registered with your province or territory, except for Newfoundland and Labrador.

In some provinces and in the territories, you will also need to get a federal business number.

3. Corporation

A corporation, also called a company, is a more complicated legal structure than a sole proprietorship or a general partnership. It is a separate legal entity from its owners.

The process for a business to become a corporation is called incorporation.

Legally and from a tax standpoint, issuing formal shares creates a separation between the corporation and its shareholders. This can be a tax advantage for the owners, who are usually paid salaries as employees of the corporation.

The number of shareholders varies according to the type of corporation. Some have a single shareholder, while others have thousands.

A corporation provides a certain level of protection regarding liability for the business’s debts.

Members of the board of directors and shareholders may come and go, but the corporation exists until it is wound up.

Corporations must keep meticulous records and report their financial situation to the proper authorities each year. Their financial statements must therefore be audited annually by chartered accountants.

Should you register your business as a corporation?

Corporations must be registered. Generally, this is done in the province in which the corporation is based.

However, some corporations that operate in several provinces or countries, or that need more credibility, register at the federal level. This procedure is more complicated and costly.

Is incorporating your business worthwhile?

Many business owners aren’t interested in the idea of incorporating, at least not in the early stages of building their business.

“Starting a business takes a lot of time and energy. There’s a lot of information to sort through, and entrepreneurs often put off questions about incorporating until later. Many don’t yet understand the benefits of incorporating,” says Stefanie Ricchio, a chartered professional accountant (CPA) and founder of the consulting firm The Modern Accountant.

Laura Didyk, Senior Vice President, Prairies at BDC, agrees. “Incorporating is often seen as an administrative burden for self-employed people starting a business, especially women. It’s common to think that the quickest and easiest way is to use your own name.”

“However, it’s not so time-consuming and complicated,” says Yasmine Chaouni, a manager at Corporations Canada. “If the company structure is not too complex, you can do it in less than 20 minutes,” she says.

The issue of cost, often perceived as high, is also a misconception and should not be an obstacle to incorporating. “Obviously, it depends on whether you want or need legal and accounting advice, but you can initially incorporate a business for as little as $200 under federal jurisdiction, with subsequent fees for extra-provincial registration, which vary depending on the provinces where the business intends to carry on business” adds Chaouni.

How to incorporate a business in Canada

Business owners who want to incorporate can do so directly on the Corporations Canada website. Here is the five-step process for incorporating a business in Canada:

1. Choose and register your company’s name (corporate word name or numbered name).
2. Create your articles of incorporation. Basic incorporation involves articles of incorporation, legal documents containing pre-determined information that can be amended later if necessary.
3. Establish the initial registered office address and first board of directors. Choose an address where you will be sure to receive any documents sent there since, legally, they will be assumed to have been received by the corporation. You also need to decide who will make up your corporation’s board of directors.
4. File information on individuals with significant control.
5. Pay the fee.

Is a cooperative the right structure for your business?

Cooperatives are another option for legally registering a business. Like corporations, a cooperative is a legal entity.

However, cooperatives are jointly owned by their members, meaning that usually, these individuals use its products and services.

All members have equal voting rights. This allows them to elect the board of directors and decide how profits are used.

Cooperatives are often born out of citizens’ initiatives. The board of directors is accountable to the members, which makes this model a good fit for those who need specific services.

Cooperatives often share common values, such as concern for the community, voluntary and open membership, and cooperation among cooperatives.

This legal form is also more expensive and complicated to implement than a general partnership.

What’s the most appropriate legal form for your business?

Choosing the legal form that best fits your business isn’t always easy. Here are some tips that may be useful:

• Carefully weigh the potential risks and benefits of each legal form.
• Consult legal advisors to help you in your decision.
• Develop a business plan. You can download our free business plan template to help you describe and define your business and explain how you plan to make it profitable.