Forms of business organization
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This is the first module in the Canadian Small Business Course. In this module, we examine the forms of organization that a business can take in Canada. Well look at proprietorships, partnerships and corporations. We analyze the advantages and disadvantages of each form, along with the tax filing requirements for each. Also reviewed are the tax planning opportunities that are available under each form. Most importantly, we go over the decision process that you should go through when choosing the proper method.
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Forms of business organization
- 1. MODULE 1 FORMS OF BUSINESS ORGANIZATION
- 2. LEGAL STRUCTURES Three ways to organize your business are: Sole proprietorship Partnership Corporation
- 3. Owned by 1 person Simple and inexpensive Owner makes all decisions Owner & business are “one” Easy reporting & filing
- 4. SOLE PROPRIETOR Advantages Inexpensive to setup Easy to administer and get things going Simple to shut down Can use losses against other sources of income in loss years Disadvantages Unlimited liability Difficult to obtain funding or bank loans Impression to clients and customers Not as much tax planning available Not a lot of options when selling
- 5. PARTNERSHIP Association or relationship between two or more people Can also be between corporations, trusts and other partnerships Also very simple to set up with nothing more than a verbal agreement if warranted All partners are bound by each others actions in the business (except in a L.L.P) Reporting is straightforward in most cases
- 6. Relationship between people Other entities: Corps, trusts Simple to setup even verbal Partners bound by actions of other partners Reporting straight-forward in most cases
- 7. PARTNERSHIPS Advantages Duties shared by more than one owner Expertise of the partners May be easier to fund the business Losses can be used against other sources of income in loss years Disadvantages Joint and several liability Death of a partner means the end of the partnership Disagreement among partners could be detrimental to business
- 8. Separate legal entity Owners & management are separate More difficult to setup & administer Additional filing requirements
- 9. CORPORATION Shareholders supply corporation with money by buying shares of corporation but do not own business or property belonging to corporation Corporation’s income is subject to tax separately from shareholders Directors manage corporation and delegate management of day-to-day operations to Officers
- 10. CORPORATION Advantages Limited liability of all shareholders Easier to obtain funding and raise capital Shares can be sold or transferred for capital gain ($750,000 exempt) Continues after the death of a shareholder Disadvantages Expensive to setup More administrative work needed Annual filing requirements Annual legal and accounting costs More difficult to shut down
- 11. AGREEMENTS Description of business Contribution to capital Division of net profits Authority to sign contract Expulsion and admission of partners
- 12. AGREEMENTS Must deal with the “Probabilities” and issues that can arise in your business Death Disability Retirement Bankruptcy/insolvency Termination of employment Disputes
- 13. AGREEMENTS Buy/Sell Provisions How to deal with deadlock in management Shotgun clauses Funding mechanism Mediation/arbitration Non-competition/Non-disclosure
- 14. FACTORS TO CONSIDER Each form of organization has its advantages and disadvantages These will be outlined so that you can make the best decision pertaining to your personal situation Consult with a professional accountant and/or lawyer to make your final decision Once a decision is made, you are not trapped but it can be an administrative hassle
- 15. PAYING TAXES Proprietorship Business activities reported on form T2125 Statement of Business Activities to be filed with your T1 personal income tax return Return due by June 15th of the following year to avoid late filing penalties Any tax liability should be paid by April 30th to avoid interest Personal and business taxes are all filed together on one tax return
- 16. T1 General 2125 – Business statement Due June 15 Pay by April 30
- 17. PAYING TAXES Partnerships Also reported on T2125 to be filed with your T1 personal income tax return Income for the partnership is recorded on your taxes, with only your share being reported on the proper tax return line. Taxes will be paid on your share Due dates are same as proprietorship (June 15 due date, with taxes to be paid by April 30th) Partnerships with 5 or more partners will have other filing requirements
- 18. CORPORATE TAX REPORTING Corporations Being a separate legal entity, corporations file their own tax returns Federal T2 and corresponding Provincial tax returns are required filing each year Due date is 6 months after your corporation’s year end Taxes owing should be paid either 2 months or 3 months after the corporation’s year end
- 19. DECISION TO INCORPORATE Canadian Controlled Private Corporation (CCPC) Small business deduction (on first $500,000 tax is about 15 - 18% depending on your Province Ability to defer taxes The $750,000 capital gains exemption on share sale Facilitate cash management and discipline Pay dividends at a lower rate in the future Advanced tax planning strategies (IPP, PHSP, EPSP)
- 20. CHOOSING A BUSINESS NAME Three types of business names to choose from: Doing business under your own name – You do not need to register, i.e. John Smith “Doing Business As” or “Operating As” – Gives you the right to operate a business of a specific name – Smith’s Construction Incorporated name which includes the words Limited, Ltd., Corporation, Incorporated, or Inc. – i.e. Smith Construction Limited
- 23. Federal 25% Directors must be Canadian
- 24. Ontario less strict on names than federal
- 25. Federal less expensive:Online: $200 Offline: $250 Ontario: $360; do online incorporation now
- 26. REGISTRATION Corporations: Named vs. Numbered Name - More $$ - More distinct, descriptive Numbered - Less $$ - Determined for you - Depending on jurisdiction, the words “Ontario” or “Canada” will be included in a number name.
- 27. CHANGING STRUCTURE Sole Proprietorship Corporation Been running your business as a proprietor but not want to incorporate Section 85 Rollover Transfer all business assets to new corp. Typically will put the proprietor in the same tax position as before he/she incorporated
- 28. CHANGING JURISDICTION Provincial Federal Most jurisdictions will allow corporations to migrate to another jurisdiction File a Continuance - Permission from jurisdiction you wish to leave - Requires shareholder approval Legal matter – see your lawyer
- 29. OWNER RESPONSIBILITES Decision-making and business management Contractual obligations Employees – Standards, Human Rights etc. Collect and remit sales taxes (GST, PST) Withhold taxes from employees and remit (CPP, EI and tax) File appropriate tax returns as discussed
- 30. SHAREHOLDER DUTIES Own the corporation – liable to 100% of investment May be asked to guarantee corporate debts Annual S/H meetings: pass resolutions, elect officers, auditors Approve bonuses, dividends, loans, etc. Receive and approve financial statements Approve fundamental changes (USA)
- 31. ROLES/DUTIES OF DIRECTORS Manage or supervise management of business Fiduciary Duty and Standard of Care (make further inquiry if a reasonable person would) Errors that could have adverse impacts Not responsible for breach duties if acted in good faith by relying on financial statements of independent experts
- 32. Canadian Small Business Course www.sbclearnbusiness.com Visit us online and take the Canadian Small Business Course for the in depth video tutorials related to these slides
- 33. Canadian Small Business Course www.sbclearnbusiness.com Or take individual modules such as this presentation: Module 1: Forms of business organization Module 2: Starting a business step-by-step Module 3: Compensation strategies Module 4: Tax planning and strategies Module 5: Expenses and deductions
Notes de l'éditeur
- One important determination is where you want to take your business. Is it something you’re doing on the side? Do you plan on expanding your business? Hiring employees? How much money will you realistically be making? How much money will you need for your living expenses and lifestyle.These are important considerations when deciding whether or not to take the simple approach and run your business as a proprietorship.Example: Jason is a painter who does work for various contractors and clients around the city. After expenses, he expects to make about $40,000. He will need to draw on all of this income for his lifestyle.From NOP PresentationA sole proprietorship is the simplest arrangement for carrying on a business. It exists wherever a person carries on a business for their own benefit. The individual is the sole owner of the business and the income or losses of the business belong only to the individual. In a sole proprietorship, there is no difference between you and the business. You are solely responsible for carrying on the obligations of the business. You are also liable for any tortious acts of the sole proprietor or employees of the sole proprietor. All of your business and personal assets can be taken by creditors if the sole proprietorship cannot fulfill its debts/liabilities. However, you can limit your liability by contract or by buying insurance.
- Typically in a partnership, a partnership agreement is drawn up between all the partners.Example: James is a photographer and David is a videographer. They formed a partnership specializing in wedding photos and videos. After expenses, the partnership expects to make about $100,000From NOP Presentation:A partnership is two or more people carrying on a business together with a view to profit. There are three things needed to make a partnership: First, there must be a “business.” Any commercial activity will be considered a business. Second, the reason for the activity must be to make money (i.e. to profit) Third, there must be an agreement between the partners to carry on the business together andto share the profits.A partnership is like a sole proprietorship because the partners carry on the business themselves directly. There is no separation in law between the partnership and its partners. Examples of partnerships include: law and accounting firms, or a hot dog vending business owned by two brothers.There are two types of partnership. General and Limited Partnership. The main difference between the two is LIABILITY.General: In a general partnership, partners agree to be bound by all the actions of the other partners who are acting in the normal course of the business. All the partners are jointly and severally liable for any debts and obligations incurred by the partnership or another partner. Joint and severally liable means that each partner is liable with the other partners for the full amount of the debt. Where one partner lacks enough for his/her share, it comes out of the other partners’ pockets. Each partner is personally liable for the partnership, meaning that all of the partner’s personal assets are also up for grabsLimited: In a limited partnership, the liability of each limited partner is restricted to the amount of money that the partner has contributed. The law requires that the partnership have one general partner who is liable for the partnership. A limited partnership is NOT the same as an L.L.P. (Limited Liability Partnership). With an L.L.P. if one partner is negligent, the claim will only be against that partner’s personal assets who was negligent.
- Corporations are separate legal entities so they can sue and be sued in the corporate name. A corporation's income is determined and subject to tax separately from the shareholders. In this way, the corporation owns and operates the business and incurs the liabilities, the shareholders do not. Because a corporation is a separate legal entity, an individual can be an owner (shareholder), a manager, and an employee of the corporation. A corporation is managed by directors. Directors of the corporation make the big management decisions and delegate day-to-day management decisions to the Officers of the corporation. Officers manage the employees of the corporation. In a simple world, shareholders are passive, with their only power being to vote for the election of directors or on proposals.
- Corporations are separate legal entities so they can sue and be sued in the corporate name. A corporation's income is determined and subject to tax separately from the shareholders. In this way, the corporation owns and operates the business and incurs the liabilities, the shareholders do not. Because a corporation is a separate legal entity, an individual can be an owner (shareholder), a manager, and an employee of the corporation. A corporation is managed by directors. Directors of the corporation make the big management decisions and delegate day-to-day management decisions to the Officers of the corporation. Officers manage the employees of the corporation. In a simple world, shareholders are passive, with their only power being to vote for the election of directors or on proposals.
- Partnerships are governed by the Ontario Partnerships Act. This Act sets out the default rules for a partnership. Often you will want to change these standard rules, to do so, you need to create a partnership agreement. Partnership Agreements describe the business. For instance, they will deal with how the partnership name will be used upon the death of a partner. Agreements will discuss how each partner will contribute to the capital of the business and set out the division of net profits. An agreement can also indicate who has the authority to sign contracts. Finally, it provides a scheme for the expulsion and admission of partners. Under the Act, dissolution takes place upon death or insolvency of a partner but an agreement can require unanimous or majority consent for dissolution.
- SHOTGUN CLAUSEThis is often used to force a buy-outIt works like this:Meredith and _______ are shareholdersMeredith offers _______ a certain price to buy-out my shares._______ can accept my offer or offer the same terms to me in which can I must accept.The essence is that one-party will buy out the other shareholder. This is easy if a shareholder wants to pursue other interests* Ideal for small businesses where the share values are not too highDuty of Confidence There will be trade secrets that arise in the course of businessConfidential information may be disclosed to shareholders, particularly those in a director’s roleAgreement will deal with remedies for breachConsider the scope of the information that will be received* NDAs should be considered for employees as well
- The Business Names Act regulates the use of names in Ontario. Sole Proprietorships: S. 2(2) of the BNA requires the sole proprietor to register the business name if it is different from the name of the individual.Partnerships: BNA states that no persons associated in a partnership shall carry on business or identify themselves to the public unless the partnership is registered by all partners. However, you do not need to register unless the partnership name is different than names of the partners. If the partnership is an LLP under the BNA, the Partnerships Act requires that specific words or abbreviations for LLP are included in the name. Note that limited partnerships are governed by the Limited Partnerships Act.The partnership name forms part of the goodwill of the business and therefore can be used by each partner if the partnership is dissolved. In order to avoid this, a partnership agreement should speak to this.
- National, or federal incorporation, allows you to carry on businesses in different jurisdictions throughout Canada. However, with federal incorporation, at least 25% of your directors must be Canadian.
- A business can incorporate under the laws of Ontario (OBCA) or Canada (CBCA). It is less expensive to incorporate in Ontario and there are also less reporting requirements. However, your business name will only be protected in Ontario and there is often more prestige associated with national incorporation. Both Acts require the word “Limited,” “Limitée,” “Incorporated,” “Incoporée,” or “Corporation,” or the corresponding abbreviations to be part of the name of every corporation. Name:If the you want to incorporate under a name, the name will be searched (NUANS search) to determine if there are other businesses with the same name.Names are important because people strongly associate names with products etc…Thus, your business will have a stronger identity. In this way, names are more distinct and descriptive than numbers. However, names are more expensive than numbers. Number:The number will be assigned to your business when you apply to incorporate. Depending on which jurisdiction you incorporate under, the words “Ontario” or “Canada” will be included in the number name.
- What do you do if you start off as a sole proprietorship and want to become a corporation?NOTE: A s. 85(1) rollover is available to a taxpayer, which includes an individual or a corporation, but not a partnership; however, a similar rollover for partnerships is available under s. 85(2). What is a s.85 rollover?It is a tax-deferred transfer of certain assets from one taxpayer to a taxable corporation.How does a s.85(1) rollover work?In this case, the sole proprietor and the corporation must both elect to claim the rollover with the CRA. They must state an elected amount for each asset that is transferred. The elected amount is then deemed to be the sole proprietor’s proceeds of disposition (proceeds of sale) for the asset and the corporation’s cost to purchase the asset. In order for the parties to avoid tax, they must choose an elected amount that will not give rise to income or capital gain for the sole proprietor (this is why they usually pick the tax cost of the sole proprietor, ie: the amount that the sole proprietor paid for the asset). What is the result?The corporation inherits the assets at the tax cost of the sole proprietor, which means that the corporation does not pay tax on the assets until it disposes of them. When it sells the assets for fair market value, the corporation will pay tax on the FMV – the tax cost (usually the Adjusted Cost Base ACB of land or shares) of the asset.The sole proprietor sells the assets to the corporation but only has to claim the elected amount (the amount equal to what she paid for the assets (tax cost (ACB)). This means that the sole proprietor does not have to pay tax on the income, nor does she incur a capital gain. One thing to keep in mind though, is that the sole proprietor must receive at least one share in the capital stock of the purchasing corporation as consideration for the transfer.
- Most jurisdictions in Canada allow corporations governed under their corporate law to migrate to another jurisdiction and be continued under and governed by the corporate laws of another jurisdiction. This is called a Continuance.How does a continuance work? First, you must get permission from the jurisdiction you wish to leave.Second, you may require shareholder approval. Import: If you wish to be governed by the CBCA, than you must apply by articles of continuance. These articles of continuance become your articles of incorporation after the migration. Export: If you wish to leave a jurisdiction, the CBCA requires that you have received the authorization of your shareholders by special resolution. Then you must file an application for permission to continue. Why do business get continuances?One reason may be because they want to amalgamate and in order to amalgamate in Canada all corporations must be governed under the same corporate law. Another reason may be to take advantage of a certain corporate law not available in your jurisdiction (uncommon in Canada because all so similar).
- Being the sole persons responsible for the business, owners have many varying responsibilities. Not only do they make the major decisions of the company, but they may manage the day-to-day operations of their business unless they delegate these to their employees. Speaking of employees, owners have general duties to conform with the Charter of Rights and Freedoms as well as with the Human Rights Code, ex: duty to accommodate. They also have to fulfill promises arising out of employment contracts, ex: notice. There is also a duty to fulfill obligations in contracts with suppliers, manufacturers, etc…In all businesses, there is a duty to remit certain monies to provincial authorities, ie: GST, EI, etc… and a duty to file regular tax returns
- As we discussed earlier, shareholders invest money in the corporation in return to share in the growth of the business. Their liability is capped at 100% of the money they invested, unless they agree to guarantee a loan from the bank. (Shareholders should limit their liability in guarantees). Shareholders have annual and/or special meetings, these are where the shareholders are entitled to vote as to whether or not to pass a resolution of the directors. The most important right of a VOTING shareholder is to elect and remove directors. VOTING shareholders also appoint an auditor at each annual meeting. Shareholders also have a right to receive the corporation’s financial statements at the annual meeting of shareholders. Another important role of shareholders is the approval of fundamental changes of the corporation. An example of a fundamental change is an amalgamation. Shareholder agreements are contracts between the shareholders about how they will vote their shares. Unanimous Shareholder Agreements (USAs) restrict the powers of directors to manage the corporation and give shareholders the rights, powers, duties and legal obligations that they have removed from the directors.
- Directors are required to manage or supervise the management of the business and affairs of the corporation (s.115(1) OBCA). This includes assigning the offices of the corporation, appointing officers and their duties, delegating to officers day-to-day powers of management. There are two obligations imposed on directors by the OBCA:The first is a fiduciary duty and the second is a standard of careFiduciary Duty:A director has a duty to act honestly, in good faith, and in the best interests of the corporation. They must make their decisions based on the best course of action for the company. This is because a director’s decisions may expose others to the risk of loss. For example, a director cannot take advantage of a corporate opportunity Standard of Care:Each director (and officer) must “exercise the care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances” (OBCA s.134(1)(b)). If a director fails to meet this minimum standard of care, they will be liable to the corporation for damages resulting from negligence or bad faith. In order to meet this standard, directors should be aware that if they are not present at a director’s meeting they are deemed to have consented to the resolutions passed unless they dissent within 7 days of becoming aware of it. Further duties:Directors must disclose any interests they have in material contracts of the corporation. A Director is liable for making errors that could adversely impact the finances of the corporation. For example, directors cannot declare a dividend if there are reasonable grounds to believe that the corporation will not be able to pay its liabilities. However, Directors are NOT responsible for breach these duties if they acted in good faith in reliance on financial statements of independent experts