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If you are starting a new business in Canada, you might be wondering whether you should operate as a sole proprietorship or a corporation. Both business structures have their advantages and disadvantages, depending on your goals, needs and preferences.
We will break down the main differences between sole proprietorship and corporation, and help you figure out which one is better for you.
What’s a sole proprietorship?
A sole proprietorship is the easiest and most common way to start a business in Canada. It’s basically just you doing your thing. You are the only owner of the business, and you have total control over it. You also get to keep all the money you make and write off all the expenses you have.
But you also have to pay taxes on your income as if you were an employee and pay into the pension plan yourself. And if your business gets into trouble or gets sued, you are on the hook for everything. Your personal stuff, like your house or car, could be taken away by creditors or lawyers if your business can’t pay its debts.
What is a corporation?
A corporation is a separate legal entity that is created by law and has its own rights and obligations. A corporation can own property, enter into contracts, sue and be sued, and pay taxes separately from its owners.
The owners of a corporation are called shareholders, who elect directors to manage the business. Shareholders have limited liability, which means they are not personally responsible for the debts or obligations of the corporation
How to choose between sole proprietorship and corporation?
Here are 4 factors to consider when choosing between sole proprietorship and corporation.
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Liability
As a sole proprietor, you are personally liable for all the debts and obligations of your business. This means that your personal assets, such as your home or car, could be seized by creditors or lawsuits if your business fails or faces legal problems.
As a shareholder of a corporation, you are only liable up to the amount you invested in the business. Your personal assets are generally protected from the creditors or lawsuits of the corporation
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Taxation
As a sole proprietor, you pay taxes on your business income at your personal income tax rate. You can deduct your business expenses from your income, but you also have to pay self-employment tax (Canada Pension Plan or Quebec Pension Plan) on your net income.
As a shareholder of a corporation, you pay taxes on the dividends you receive from the corporation at your personal income tax rate.
The corporation pays taxes on its income at the corporate tax rate, which is usually lower than the personal tax rate. The corporation can also deduct its business expenses from its income, but it does not have to pay self-employment tax.
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Complexity
As a sole proprietor, you do not have to register your business with the government (unless you use a business name other than your own name), file separate tax returns for your business, or follow any formal rules or regulations for running your business. You simply start selling your products or services to your customers and report your income and expenses on your personal tax return.
As a shareholder of a corporation, you have to register your business with the government, file separate tax returns for your business and yourself, and follow various rules and regulations for running your business. You also have to keep proper records and accounts of your business activities.
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Flexibility
As a sole proprietor, you have full control over your business and can make any decisions you want without consulting anyone else. You can also change or end your business at any time without any legal formalities.
As a shareholder of a corporation, you have limited control over your business and have to follow the decisions made by the directors (who may or may not be yourself). You also have to comply with certain legal formalities if you want to change or end your business
Sole proprietorship or corporation. Which is better for you?
The primary difference between a sole proprietorship and a corporation is the legal structure. A sole proprietorship is just you personally. So, if your business is sued, you are liable. A corporation is a separate legal entity with limited liability.
There is no definitive answer to which business structure is better for you in Canada. It depends on your personal situation, goals and preferences. However, some general guidelines are:
- Choose sole proprietorship if you want simplicity, flexibility and full control over your business; if you have a low risk of liability or lawsuits; if you have low or moderate income; if you want to use your losses to offset other income; if you do not need external financing or investors.
- Choose a corporation if you want limited liability and asset protection; if you have a high risk of liability or lawsuits; if you have high or variable income; if you want to save taxes by splitting income or retaining earnings; if you need external financing or investors.
If you are still unsure about which business structure is better for you, you should consult a lawyer, an accountant or a business advisor for professional advice. They can help you weigh the pros and cons of each option and guide you through the process of setting up your business.
