Tax practitioners have a responsibility to not only minimize or defer tax – but to also meet our client’s non-tax objectives. This is often done through careful consideration of business structures. There are a number of business structures available that include sole proprietorships, partnerships, joint ventures, corporations and trusts. Here we will discuss the three more common structures.
Sole-proprietorships is an individual that carries on business personally – there is no tax or legal differentiation between the business and the individual. This form can be advantageous if you are looking for a low start-up cost and have a higher likelihood of losses to be incurred (at least in the first few years) along with other income. Such a scenario could include an individual with a full time job that is starting a side business that will incur some costs before it gets going.
The sole-proprietorship does have its drawbacks that include no separation of assets between the business and the individual (there is no separate legal status). This makes personal assets of the business owner susceptible to lawsuits arising from the business. Sole-proprietorships also use the same tax filings and tax rate of the individual owner – which may result in using the higher personal tax rate that could be pushed into and even higher marginal rate if the business is profitable. Another drawback is that the business also ceases to exist when the individual dies.
Regardless of sole proprietorship status – best practices would be for the business to keep a separate bank account, a set of books and financial statements to support the business activities and maximize the potential of future rollovers into another business structure.
Tax filings for your sole-proprietorship are included in your personal tax return (T1) on the T2125. This income or loss is applied against your other sources of income.
A partnership is a relationship between two or more persons carrying on a business with a mutual view to profit. The income or loss in a partnership retains its character and flows through to each partner. As such, losses are not trapped within the partnership (as is the case with a corporation) and may be utilized by the partners when incurred.
The partnership is bound by the decisions and actions of any of its partners as long as these are in the normal scope of the partnership. However, a limited liability partnerships may provide a level of liability protection for each limited partner. Also for consideration is that “persons” for tax purposes are taxpayers – while the partnership is not a person, individuals, corporations and trusts are and can be partners in a partnership.
Accounting for partnerships is different than those for a corporation and it’s advisable to have this undertaken by a professional experienced in this area. The business profits and losses are divided amongst the partners in accordance with the partnership agreements – therefore we always advise to have a written agreement.
While the tax act requires all partnerships to file a partnership information return – CRA has an administrative policy that only requires a return to be filed if at the end of the fiscal period the partnership has revenues plus expenses exceeding $2 million, has more than $5 million in assets or has a corporation as a partner, or is a tiered partnership, invested in flow through shares or is requested by CRA. Such partnerships would file a T5013 return.
In any case, each partner includes their share of income on its own tax filings. As such, the partnership should have a proper set of books since often the proceeds received by the partners does not match the amount that should be reported on their tax filings.
An incorporated company is the most commonly used business structure. A corporation is a separate legal entity from its owners and considered a separate person for tax purposes. As such the corporation can own property and enter into contracts separate and distinctly from its owners. This status provides limited liability and a continuous existence for the business. A corporation also has greater access to financing plus tax incentives that include the lowest small business tax rate, the lower corporate tax rate, tax deferrals, income splitting opportunities, lifetime capital gains exemptions on the sale of shared of qualifying corporations and a number of credits.
Disadvantages of corporations are the larger start-up costs and the risk of trapped losses within a corporation. Done incorrectly – there is also a risk of double taxation on the withdrawal of funds. There is also an ongoing costs for a corporation that include annual tax filings and registration with the provincial government as well as the cost of maintaining the company books and records.
A corporation files an annual corporate tax return (T2) along with its provincial tax return.
Seeking professional advice on setting up your structure is highly recommended. The team at Shajani is well versed in advising on an optimum structure and taking you through the setup process. We are also happy to discuss the set-up of a Trust or Joint Venture should it be suited for your purposes.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.