Corporation vs. Sole Proprietorship: Which is right for your business?
If you're starting a new business, you might be wondering if you should incorporate your business or remain as a sole proprietorship. In this blog, you’ll learn the advantages and disadvantages of both business structures so that you can make the best decision for your company moving forward.
Sole Proprietorship
What is a sole proprietorship?
The Canadian Revenue Agency (CRA) defines a sole proprietorship as an unincorporated business that one individual owns. Therefore, it is the simplest kind of business structure.
A sole proprietorship is a common option for entrepreneurs and freelancers who don't have any employees. With a sole proprietorship, you don't have to register your business with the government like you would have to with a corporation.
How do I run a sole proprietorship?
You can register a business name or run your business under your own name. Some sole proprietors do both. Then, you do the work, bill your clients in your name (or business name), and pay taxes on the net income generated by your business. It's pretty simple!
As the sole proprietor, you're solely responsible for everything to do with the business. You make all decisions and receive all the profits.
How do I pay taxes as a sole proprietor?
Paying taxes as a sole proprietor in Canada is similar to paying taxes as an employee of a business. You report your income on a T1 General Income Tax and Benefit Return, which must be filed every year. You must also report whether your business had a taxable capital gain, if you disposed of capital property, or if you contributed to the Canadian Pension Plan or Quebec Pension Plan on pensionable or self-employed earnings for the year.
The CRA might require you to pay your income tax in installments depending on your filed income from the previous year. You may also need to make installment payments for any contribution to CPP on your income. You can consider hiring an accountant or using tax filing software when filing your taxes. Using either of these resources will ensure you're optimizing your tax savings by entering in income, expenses, and other deductibles correctly on your return.
You might have to open a GST/HST account with the Canadian Revenue Agency, depending on the amount of revenue earned. As a sole proprietor, you are responsible for collecting and remitting provincial tax to the CRA. Other than this obligation, operating your business as a sole proprietorship requires less paperwork and accounting than working as a corporation.
For more information on filing taxes as a sole proprietor, you should seek advice from a tax accountant.
What are the benefits of a sole proprietorship vs Incorporation?
Many startup businesses are attracted to the idea of a sole proprietorship because it's easy, affordable, and super flexible. You simply start selling your products and services to your customers – and you're in business.
Full control
If you're a sole proprietor, you have complete ownership and responsibility for your business. You make all the decisions and control every aspect of the business. You won't have to worry about disputes between other owners, partners, or shareholders. As a sole proprietor, it's all you!
Less paperwork
Corporations must file yearly documentation and have a more complicated tax structure. In addition, incorporated small businesses usually require bookkeeping or accounting services to assist with various tax accounts. Sole proprietors in Canada have far less paperwork that must be filed annually.
Low startup costs
Startup costs are far lower with a sole proprietorship business structure. Often, you'll pay nothing to start your business. The ease and affordability of starting a business are often the most appealing benefits to sole proprietorship vs incorporation.
Easy banking
Dealing with your banking will also be easier as a sole proprietor. You can even use your personal chequing account for your business income. Then, your clients can send you an e-transfer for your goods and services. However, you'll have to keep track of your expenses if you operate your banking this way. For some, opening a separate bank account for business income will make tax time easier.
What are the disadvantages of a sole proprietorship?
You assume all legal and financial risks
In a sole proprietorship, you don't have separate legal status from the business. That means you assume all the business risks and essentially have no personal liability protection. If someone makes a legal claim against the business, they're making a claim against you as an individual. If there is a legal dispute or your business is getting sued, you, your personal property, and your assets are at risk.
As a sole proprietor, you're personally responsible for claiming all losses which means that any debts that might accrue are your personal responsibility. If you can't pay the debt, debt collectors can access your assets like your savings, property, cars, and other personal assets to ensure the debt is repaid. For some, it is just not worth the risk to remain as a sole proprietor.
It's hard to scale
Unfortunately, it's hard to scale a company if it isn't incorporated. Sole proprietors can find themselves with limited resources and fewer growth opportunities. You'll need to hire employees to scale, and most people would rather work for an incorporated company. That could make it challenging to find and retain high-quality sub-contractors.
Significant growth usually means the proprietor takes on more work. Sure, you'll earn more income (and pay a higher personal tax rate), but is it worth the overtime?
It's hard to sell a sole proprietorship
If you own a corporation, you could more easily sell your company down the road. You might not be thinking about passing the baton any time soon, but it is something you should consider for the future.
It's challenging to sell a sole proprietorship. Often, the proprietor is the commodity, and the business can't go on without them. If it can, a buyer would have to take on the business debt and face paying capital gains taxes depending on the situation. In most cases, the business ends when the proprietor moves on.
Corporation
What is an incorporated business?
People often get "incorporation" and "corporation" mixed up. Incorporation refers to the legal act of registering a business to become a corporation. A corporation is the actual legal entity that is used to conduct business. You might also hear people refer to a business as incorporated, meaning that an individual or group of people took steps to create a new legal entity for their business. You can incorporate your business to get a provincial business license or incorporate federally.
A corporation has formal ownership shares and is owned by its shareholders. Once a business is incorporated, it becomes a separate legal entity and reduces tax and legal liability between the shareholders (business owners) and the company itself.
How do I run an incorporated business?
Operating a corporation is perceived as more complicated but often worth it. When you incorporate, you assign a share structure among owners. In most cases, startup founders are owners of 100% of the company's shares to start. Then they can bring on investors and assign shares moving forward.
You'll need a separate business bank account with a corporation to receive payments from your customers. In addition, your corporation will need to set up several accounts with the CRA, including a GST/HST account, income tax account, and payroll tax account for paying yourself and your employees.
Then, essentially, you just run your business how you would as a sole proprietor. You and your company do the work, collect payments, and pay taxes. You can pay yourself employment income via payroll and dividends. You should seek guidance from a professional accountant for financial and tax advice regarding your corporation.
What are the benefits of incorporating?
No personal liability
One of the greatest advantages of an incorporated company is that you are not personally liable for legal or financial matters. The business is. If something goes wrong and the company finds itself in legal or financial trouble, you are not personally responsible, and your assets are safe. If your business goes bankrupt, the shareholders only lose what they invested.
Easier access to funds
Corporations gain better access to capital to grow their business. Your business can borrow money at lower rates and raise funds by selling bonds and shares to investors. Incorporated Canadian businesses can also apply for many startup grants available from federal, provincial and municipal governments.
Lower taxes
You may find yourself paying higher taxes if you do not incorporate your business. There is no separation between business income and personal income, and personal income tax rates are higher. However, if you own an incorporated business, the CRA will tax those same earnings at a much lower rate. Then, you pay yourself a reasonable salary and save on your personal income taxes too.
Unlimited growth opportunity
If you incorporate your startup or consider incorporating a sole proprietorship, you are setting yourself up to grow! You can attract investments, and shareholders, hire employees and scale your business.
Longer lifespan
Unlike a sole proprietorship, a corporation can live on far after the founder has moved on. This allows owners to sell shares, create a succession plan, and see the business carry on into the future. Corporations need to be wound down or amalgamated to stop existing.
What are the disadvantages of incorporating?
Higher startup fees
Incorporating your business will have higher startup fees than starting a sole proprietorship. You'll have to register the business provincially or federally, which costs money. You'll have to pay for a business name search, register the business, and consider hiring a bookkeeper or accountant.
There are also reoccurring fees. For example, depending on your province, there could be renewal fees, the cost of filing an annual report, and other annual maintenance fees.
More paperwork
Incorporated businesses have more paperwork as you'll be required to provide annual filings and corporate records. Taxes are also more complicated to file as you'll have to deal with your business taxes in addition to personal income taxes. Most business owners seek counsel and services from a professional accountant or contract a part-time bookkeeper to help with this aspect of the business.
Rules and regulations
The rules and regulations for incorporated businesses are more strict than for a sole proprietor. For example, you'll need to ensure your paperwork is in order and provide annual documentation to the government as required.
Goodlawyer is here to help
Do you still have questions about which business structure is best for your company? Do you feel overwhelmed by the extra steps and paperwork required to incorporate? No worries. Goodlawyer is here to help.
There are so many positive advantages to incorporating a startup, and making sense of the process of incorporating is an excellent first step.
