Should you Register or Incorporate Your Small Business?

When embarking on a new business venture one of the first decisions that a new business owner has to make is the type of legal structure that best suits the needs of the new business. In Canada there are essentially two choices - set up a business registration, which is either a sole proprietorship or partnership, also referred to as an unincorporated entity OR set up a corporation which results in the creation of separate legal entity.  Like many small business decisions, the answer in not necessarily straightforward and depends on the business owner’s specific set of circumstances:

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What is A Business Registration? i.e. a Sole Proprietorship

According to CRA, a sole proprietorship (registered business) is defined as follows:

A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest kind of business structure.

The owner of a sole proprietorship has sole responsibility for making decisions, receives all the profits, claims all losses, and does not have separate legal status from the business. If you are a sole proprietor, you also assume all the risks of the business. The risks extend even to your personal property and assets.

In other words, a registered business is simply an extension of the individual and as such the regulatory and tax obligations are relatively minimal .  Setting up a small business is a fairly simple and inexpensive process.  The owner is responsible for the debts of the business and pays taxes (or can deduct losses) on their personal tax return.

Note that a registered business can also be a partnership.

What is a Corporation?

According to CRA:

A corporation is a separate legal entity. It can enter into contracts and own property in its own name, separately and distinctly from its owners. 

A corporation is a legal entity whose shareholders are separate from the business.  Setting up a corporation is more complex than a business registration - decisions have to be made regarding the jurisdiction of the corporation (federal vs provincial), directors, shareholders, share structure and owner-manager remuneration. The corporation assumes the debt obligations and pays taxes at a corporate level.

Finally, a corporation, being a separate “person” enjoys limited liability which is defined by Revenue Canada as follows:

This means that, as a general rule, the shareholders of a corporation are not responsible for its debts. If the corporation goes bankrupt, a shareholder will not lose more than his or her investment (unless the shareholder has provided personal guarantees for the corporation's debts). Creditors also cannot sue shareholders for liabilities (debts) incurred by the corporation, even though shareholders are owners of the corporation. Note, however, that if a shareholder has another relationship with the corporation — for example, as a director — then he or she may, in certain circumstances, be liable for the debts of the corporation.

Related Resources

This article presents a more detailed discussion of whether to incorporate

You can also check my video on taxes that every new corporation owner should know

Business Registration vs Incorporation

When deciding on whether to register your business as a sole proprietorship/partnership or incorporate, there are several questions you should consider:

• Does the new business venture need limited liability? Or will insurance be an adequate replacement? Limited liability might be needed where there is an expectation that you might be sued for issues with your product or service and you don’t want to put your personal assets at risk.

• As the owner/shareholder of the corporation are you able to leave funds in the business or will you need to withdraw all of the profits  of the business for living expenses? If you are able retain funds in the business, then a corporation might make sense.

• Are you willing and able to spend additional fees on incorporation costs? Do the other benefits of having a corporation outweigh the additional administrative costs.

• Are you comfortable with the increased reporting requirements for a corporation as you will mostly likely require the services of an accountant and possibly a lawyer?.

• Do your clients, bank or other stakeholders require that you incorporate or do you need the credibility/professionalism that is associated with having a corporation?

• Do you have plans to build an enduring business which you might want to transfer upon your retirement or death?

• Are you a startup or planning to devote resources to R&D? (a corporation simplifies the process of claiming R&D credits)

• Do you have a special purpose entity eg. incorporation of a rental property

Other Factors to Consider:

• If you do decide to incorporate, you will to have to decide whether a federal or provincial incorporation is more appropriate.  A federal incorporation is more expensive , however, it provides heightened name protection and additional credibility and might make more sense if you are planning to operate your business in the rest of Canada and/or internationally.

• Owner managed corporations need to determine the method and amount of remuneration.  While registered business owners are simply taxed on the profits of the business, a corporation must pay salaries or dividends to its owners as employees or shareholders respectively.  Note that you can have employees whether you are registered or incorporated.

• If you feel that your business is still in its infancy and there are no issues relating to liability or external requirements to incorporate, it might make sense to wait and see how the business evolves.  A sole proprietorship can decide to incorporate at any time, although if you do decide to take the next step and incorporate, you should speak to an accountant as there can tax ramifications.
  

Interested in starting a sole proprietorship or corporation?

• Download my free starting your sole proprietorship or starting your corporation checklist

• Take a look at my books to help you to start your new business with ease

• Book a consultation for personalized guidance on the best structure for your situation.