Corporation or Sole Proprietorship: Choosing a Legal Structure for your business


By
Robert Krizman
October 12, 2009

One of the first decisions you will need to make once you decide to start a business is which form of legal structure you will use to carry on your business. Will you operate as a sole proprietorship or a corporation? This decision will to some extent be determined by the way you intend to organize your business, whether you intend to carry on business on your own or with others, and a number of other legal, tax and business factors including those listed below.

There are generally two types of legal entities: non-incorporated legal entities (which includes sole proprietorships and partnerships) and incorporated legal entities (ie. corporations). Below is a very short description of some of the characteristics of sole proprietorships and corporations along with some of the advantages and disadvantages of selecting each of those business structures.

1. Sole Proprietorship

A sole proprietorship is the simplest structure for carrying on business and requires few legal formalities to create and operate. The sole proprietor is the owner of the business and its assets and he/she receives all benefits flowing from the business. If a sole proprietor uses a business name other than the owner’s name, he/she is required to register the business name.

A sole proprietorship is not considered to be a legal entity under the law, but rather an extension of the individual who owns and operates the business. Perhaps the biggest disadvantage to operating a sole proprietorship is that the sole proprietor is personally responsible and liable for all of the debts, liabilities and obligations of the business including any obligations that the sole proprietor may have arising from any contracts relating to the business, any debts or liabilities owing by the business to its suppliers or trade creditors, and all liabilities arising from the acts, omissions or the negligence of the sole proprietor or his/her employees. Since the sole proprietor is personally responsible for all liabilities and obligations relating to the business, creditors of the business may be able to sue and/or seize both the business and personal assets of the sole proprietor to satisfy the debts, liabilities and obligations of the business. A sole proprietor may be able to limit some but not all of his/her liabilities by contract or by purchasing insurance (ex: liability insurance). Below is a very brief summary of some of the advantages and disadvantages of selecting a sole proprietorship as the structure for a business.

Advantages

  • Lower start-up costs
  • Generally easier to set-up and fewer legal formalities
  • Subject to less government regulation
  • Potential tax advantages

Disadvantages

  • Unlimited liability – Business owner is personally liable for the debts and liabilities of the business
  • Personal assets are at risk to satisfy claims of any creditors of the business
  • Lack of continuity after the business owner dies or becomes disabled
  • Perception of lack of sophistication

2. Corporation

There are two main legal characteristics which distinguish a corporation from a sole proprietorship:

Separate Legal Entity - A corporation is treated at law as though it were a natural person with separate, distinct and independent legal status from its owners. This means that a corporation can do anything an individual can do in operating a business including borrowing money, entering into contracts, suing and being sued, etc. It also means that a corporation survives the death or disability of its shareholders. Since a corporation is a separate legal entity, it must file separate income tax returns with the Canada Revenue Agency and the provincial government in which it operates; and

Limited Liability Protection – A corporation offers its owners (ie. shareholders) limited liability protection. This means that the liability of the corporation’s shareholders for the debts, liabilities and obligations of the corporation is limited to the value of the assets and investments that the shareholders of the corporation have transferred to or made in the corporation. Therefore, generally, a shareholder’s liability and losses are limited to his/her investment in the corporation. Except in certain circumstances, in the event that the corporation does not have sufficient assets to cover its debts, liabilities or obligations, creditors of the corporation can not pursue the shareholders for debts, liabilities or obligations of the corporation and creditors can not demand or seize a shareholder’s assets or property. Generally, the only way shareholders can lose their limited liability protection is by personally guaranteeing some or all of the corporation's debts, liabilities or obligations or if the shareholder also acts as a director or officer of the corporation, as directors and officers may be liable for certain types of liabilities relating to a corporation. For example, directors can be liable for a corporation’s unpaid GST, PST, source deductions, etc. It is because of the limited liability protection offered by corporations that many individuals choose to start and operate their business as a corporation.

A company is incorporated by filing articles of incorporation under the provisions of the Business Corporations Act (Ontario) with the Ontario Ministry of Government Services or under the provisions of the Business Corporations Act (Canada) by filing with Industry Canada. Below is a very brief summary of some of the advantages and disadvantages of selecting a corporation as the structure for a business.

Advantages

  • Limited liability protection for shareholders
  • Continuous existence
  • Possible tax advantages
  • Ownership is transferable

Disadvantages

  • Generally subject to more government regulation
  • Higher start-up and ongoing costs
  • Greater record keeping is necessary

If you have any questions regarding this matter, please do not hesitate to contact us.

Dated: October 2009