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Author: Kimberley Cunnington-Taylor
The three most common types of business entities in Ontario are sole proprietorships, partnerships and corporations.
- Sole proprietorships
A sole proprietorship is the simplest form of business organization, is the easiest to set up and is automatically created as soon as you begin to carry on business in your name. You can enter into contracts with other people and entities and can hire employees, but you cannot hire yourself as an employee. The rules for sole proprietorships can get more complicated if you have employees or want to carry on business in a name other than your own; for example, setting up the necessary tax accounts with Canada Revenue Agency, registering a business name with the Ontario government, registering for WSIB or obtaining other industry-specific certifications or approvals.
Note that the same legal obligations that apply to all businesses apply to sole proprietorships. You are solely responsible for all “obligations” contained in contracts you enter; you are solely responsible for your actions and the actions of any employees you may have, and you have unlimited liability – meaning in a successful lawsuit against you, a third party can seize your personal. Further, you cannot bring on anyone as a partner; and it is difficult to attract investors to raise money for the business.
A sole proprietorship is often the best type of business organization to start off with. Then, as your business grows you can decide if an alternative business organization is more suitable.
- Partnerships
A partnership is automatically formed when two or more individuals or corporations carry on a business with a view to profit. The Partnerships Act (Ontario) determines the rights and obligations of each partner unless a formal partnership agreement is entered into. Often, a sole proprietorship will automatically become a partnership as soon as the sole proprietor wants to bring on a business partner.
A partnership itself is not a taxable entity. First, the income or loss of the business carried on by the partnership is determined at the partnership level and then allocated to the partners, according to each partner’s entitlement under a partnership agreement or the Partnerships Act. That income or loss is divided among the partners, and each partner’s share of that income or loss is included in computing each partner’s income for tax purposes.
The partners are the sole owners and cannot be employees. While all of the benefits of the partnership accrue to the partners, each partner is personally responsible for the obligations undertaken in contracts entered into by the partners.
- Corporations
A corporation is its own legal entity (i.e. a pretend person), unlike a sole proprietorship or a partnership. The corporation owns the assets and has the liabilities, not the shareholders (or the directors). A corporation may own property in its own name, and it may sue and be sued in its own name. It is the corporation who owns the business, not the shareholders (or the directors). To set up a corporation, you have to file articles of incorporation with the government. You also have to set up a separate bank account for the corporation, and the corporation files its own tax return. The corporation is the employer (not you).
You can incorporate a corporation to operate your business, and you can be the only director, officer and shareholder. If two or more people set up a corporation they are not partners in the legal sense; they are likely the directors and shareholders of the corporation. Because the corporation is a separate legal entity, you can be an employee of the corporation.
Further, the corporation is taxed on its own, and you pay tax on what the corporation pays you (either by way of salary or dividends).
The big advantage of a corporation is limited liability. Unless you have given a personal guarantee to guarantee the debts and obligations of the corporation, and as long as you enter into contracts properly (i.e. in the name of the corporation and not your own name), you should have protection from personal liability.
Conclusion
It is common for a business to progress from a sole proprietorship to a corporation as the business grows. While the two types of businesses may look alike on the surface, they are completely different types of business organizations. It is important to understand the difference, particularly as it relates to exposure to personal liability when you are investigating which type of business organization is best suited to you.
This document contains general information about certain legal and other related issues. It is not intended to be a complete statement of the law and is not a substitute for legal advice. To receive legal advice, you must speak with a lawyer. No part of this publication may be reproduced without the prior written permission of Nelligan O’Brien Payne LLP.
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