Business structure plays an important role in tax perspective. Business structure in Canada determines how you will report income and which tax forms/returns you will have to use to report income to CRA. There are three most common types of business structures being used, which are as follows:
- Sole Proprietorship
A sole proprietorship is the simplest business structure, which is unincorporated and owned by one individual who is solely responsible for business risks, profits and losses. It has no separate legal status; the sole proprietor reports business incomes/losses in his/her personal tax return. The sole proprietor takes full risk of operating the business and exposes personal properties and assets to risks in case creditors come after them due to business failure.
Business can be operated under an operating name or in sole proprietor’s personal name or both. Sole proprietors pay small business tax, if any as part of their personal income tax reported on the individual tax return i.e., T1 return.
A partnership is an association of two or more individuals or corporations or partnerships or trusts who joined together to carry out a venture or a trade or a business. This is also a simple form like as sole proprietorship. Although a partnership can be formed on verbal agreement but the written agreement should be in place to avoid any disputes regarding the contribution of money, labor, property and skills, the share of profits/losses, enter/exit of partners, and any other matters.
Partnership is considered as a person for GST/HST purposes, which reports and remits any GST/HST owing to CRA. Partnership affairs should be written in a clear and understandable manner in order to avoid any confusion. However, unlike sole proprietorship, partnership income is divided among the partners who ultimately report partnership profits/losses in their respective tax returns.
A corporation is a separate legal entity with lasting existence, the owners or shareholders of which are considered as the separate persons. Few important factors of a corporation are as follows:
- It can enter into and enforce any contract and own property in its name.
- It can raise capital and borrow funds easily than a sole proprietorship or a partnership.
- It reports its profits or losses in corporation income tax return i.e., T2 return, and shareholders cannot report its losses in their personal income tax return.
- Shareholders’ liability is usually limited, that means that they are not liable for a corporate debt. However, if they provide any personal guarantee for corporate debt, then they are liable to repay in case the corporation fails to repay the debt.
- Directors (most small business owners/shareholders are directors as well in their corporation) are personally liable for paying to CRA for any owning for income tax, GST/HST and payroll deductions on behalf of the corporation.
A corporation can be set up with federal or any provincial government by filing articles of incorporation appropriate to your business. A corporation can be set up as a numbered or named corporation. In case of named corporation, you need to search first for availability of the proposed name. While incorporating shareholders usually transfer money, property and services to the corporation in exchange of shares issued by the corporation. You can buy and sell shares of the corporation. A corporation exists until and unless it winds up or merges or declares as a bankrupt or so.
Taxpayers may use a corporation for tax deferral purpose. At present, corporations entitled to small business deduction pay a lower rate of 15% federal and Ontario combined. Taxpayers with higher income may choose to set up a corporation and receive either a payroll or a dividend or mix of both to the extent they need personally and leave remaining income into the corporation by paying taxes at a lesser than personal tax rate.
Business number and program accounts
Whenever a business is registered with CRA, they assign a 9-digit business number (BN). A corporation receives a BN after the incorporation. However, for a sole proprietorship or a partnership it is not automatic. If annual taxable supplies are more than $30,000, then you (sole proprietorship, partnership and corporation) need to have GST/HST registration from CRA. Four most common program accounts you may be required to register for, their identifiers are: (a) RT for GST/HST, (b) RC for corporation income tax, (c) RP for payroll deductions and (d) RM for import/export. You can register with each program accounts whenever you need to.
Tax Tips: Consult with a Small Business Accountant or business incorporation service provider to decide on the proper business structure and to get started.
Tax Accountants Toronto or Professional Accountants can help you decide on appropriate business structure based on your specific situation.
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