Ask three people how to set up a small business and you may well get three different answers. A cousin who drives for a living says incorporate right away for the tax savings. A friend with a home bakery says she has run her business under her own name for years without any trouble. An online video says everyone needs a holding company. Each of them may be right about their own circumstances, and none of them knows yours.
The choice among a sole proprietorship, a partnership, and a corporation is really a choice about four things: who is responsible when something goes wrong, how income gets taxed, how much administration you can handle, and how easily you can bring in partners or sell later. It helps to know that the decision can be changed. Many Brampton businesses start small and simple, then incorporate once the revenue or the risk justifies it.
What follows is general information about Ontario business structures. It is not legal or tax advice, and you should involve an accountant as well as a lawyer before deciding, since the tax side depends heavily on your own numbers.
Option One: The Sole Proprietorship
A sole proprietorship is what you have when one person runs a business without forming a separate legal entity. You and the business are the same person in the eyes of the law. Income goes on your personal tax return, and business debts are your personal debts.
It is the cheapest and simplest way to start. If you operate under your own legal name, you generally do not need to register a business name. If you operate under any other name, such as “Springdale Home Repairs” rather than your own, Ontario’s Business Names Act requires registration. The fee is $60 through the Ontario Business Registry, and the registration lasts five years, after which it must be renewed. You should also search the registry first to see if the name is already in use, keeping in mind that registering a business name does not give you exclusive rights in it.
Where it fits. A sole proprietorship can suit a low-risk service business with one person, modest income, and few commitments, such as a part-time tutor or a freelance bookkeeper. Early losses can often be deducted against your other income, which can be useful for someone keeping a day job while starting out.
Where it strains. All your personal assets are exposed to business liabilities. If your hypothetical renovation business damages a client’s home and insurance does not cover the loss, a judgment against you could reach your savings and, potentially, an interest in your home. You also cannot share ownership or easily sell parts of the business, because there is nothing separate to divide.
Option Two: The General Partnership
When two or more people carry on a business in common with a view to profit, Ontario’s Partnerships Act treats them as partners. No registration or written agreement is needed for this to happen. Friends splitting the profits of a food truck may already be partners, without ever having used the word.
Like a sole proprietorship, a partnership is not generally treated as a separate taxpayer. Each partner reports a share of the income. Registration is again $60 if the firm operates under a business name.
The main risk is shared liability. Every partner is an agent of the firm, so one partner acting in the usual course of the business can bind everyone. All partners are liable for the debts and obligations of the firm. If your partner signs a costly equipment lease or causes a loss while acting on firm business, creditors may be able to pursue you personally, and you are left to seek reimbursement from your partner.
The default rules may not match your deal. Without an agreement, the Partnerships Act assumes that partners share capital and profits equally, take no salary, and can take part in management, regardless of who put in more money or works longer hours. A written agreement is therefore close to essential if you go this way.
There are two variations to know about. A limited partnership has at least one general partner with unlimited liability and at least one limited partner whose exposure is limited, provided they stay out of control of the business. It is mostly used for investment structures and is more expensive to run. A limited liability partnership gives a measure of protection from other partners’ negligence, but in Ontario it is available only for practising a profession governed by an Act where the governing legislation allows it, such as law or accounting. A pair of Brampton contractors cannot simply register as an LLP.
Option Three: The Corporation
A corporation is a separate legal person. It owns assets, enters contracts, owes debts, and pays its own taxes. Its shareholders generally risk only what they have invested in it. This is the idea of limited liability, and it is the reason many people incorporate.
A corporation also provides structure. Shares can be issued to several people in different classes. Investors can come in, and shares can be sold or passed on. Corporations can often continue seamlessly when an owner dies or leaves, while a sole proprietorship ends with the owner.
Tax. Active business income earned by a Canadian-controlled private corporation can qualify for the small business deduction, which lowers the corporate tax rate on a limited amount of income each year. Income taxed at the corporate level and left in the company can be reinvested, and personal tax is deferred until the money comes out as salary or dividends. That deferral is the real benefit. If you need every dollar for living expenses, it may be small, because the money still gets taxed when it comes out. Your accountant should run the comparison, and should also consider rules that can limit these benefits, including rules for personal services businesses and for paying dividends to family members.
Cost and paperwork. Filing articles in Ontario costs $300 in government fees, plus a name search report if you are not using a numbered company. You also need by-laws, resolutions, registers, annual filings, and a separate corporate tax return, and that usually means higher accounting fees. Your business formation and organization needs may extend to a shareholder agreement if there is more than one owner.
Losses. Unlike a sole proprietor, you generally cannot use a corporation’s early losses on your personal return. They stay in the corporation and can be carried over against its own income. A business that expects to lose money for its first year or two should factor this in.
What Limited Liability Does Not Cover
This topic deserves its own section, because it is the most misunderstood aspect of incorporation. People often assume that once they have a corporation, nothing can touch their personal assets. In reality, there are several significant gaps.
Personal guarantees. Banks, landlords, and many suppliers routinely ask the owners of small companies to guarantee debts personally. If you sign a guarantee, you are liable if the company does not pay, and the corporation offers no shield on that debt.
Your own wrongful conduct. A person who personally commits a wrong, such as negligently performing work or making a fraudulent statement, could be sued personally even though they were working for the company. Professionals also usually remain personally responsible for their own work.
Director liability. Directors can be held personally liable in certain cases, including up to six months’ wages and some vacation pay for employees under the Business Corporations Act (Ontario), and for unremitted source deductions and HST under federal tax legislation, subject to defences such as due diligence.
Mixing money. Treating the company’s bank account as your own makes things harder at tax time, weakens your records, and can invite claims that the separation between you and the company should be disregarded. Courts do not lightly ignore a corporation’s separate existence, but sloppy habits do not help.
Insurance remains important no matter what structure you choose. A corporation does not replace commercial general liability coverage, and it does not replace professional coverage where required.
Comparing the Options Side by Side
Keeping the main questions together can help:
- Who is liable for business debts? Sole proprietor: you. General partnership: all partners. Corporation: generally the company, subject to guarantees and statutory exceptions.
- Who pays tax on profits? Sole proprietor: you personally. Partnership: each partner personally. Corporation: the company, and then the shareholder when funds are paid out.
- What does it cost to start? Sole proprietor or partnership: $60 if you register a business name. Corporation: $300 plus setup costs, or a bit less for federal filing fees, along with higher ongoing accounting costs.
- Can you bring in investors? Very difficult for a sole proprietor. Partners must all consent by default. Corporate shares make this much easier.
- Can you sell the business? A sole proprietor or partnership sells assets. A corporation can sell either its assets or its shares, which may have tax advantages for the seller.
All three structures have to think about the same practical obligations: GST/HST registration once you pass the small supplier threshold of $30,000 in worldwide taxable revenue over four calendar quarters, payroll accounts if you have employees, possible WSIB coverage, and City of Brampton licensing or zoning rules for certain types of business.
Scenarios to Help You Think
These hypothetical examples show how the factors can play out. They are illustrations, not recommendations.
A part-time Brampton photographer earns a modest side income, works alone, has insurance, and has few contracts. A sole proprietorship with a registered business name may be enough for now. Her losses in the first year can offset her employment income on her return.
Two friends opening a restaurant will sign a five-year lease, hire staff, buy kitchen equipment, and take out a loan. Their exposure is much higher, and they need to divide ownership clearly. A corporation with a shareholder agreement is likely to be a more natural fit, even if the landlord and bank insist on personal guarantees, since it provides limited liability against many other claims and a clear ownership framework.
A family trucking operation that is growing quickly and retaining profits to buy more equipment might benefit from the deferral available through a corporation. It should also get advice about worker classification and federal rules that may apply.
A hypothetical graphic designer with one main client may be tempted to incorporate for the tax rate. If she is effectively an employee of that client, personal services business rules could remove the tax benefit, leaving her worse off. That is why the accountant needs to be involved early.
Changing Your Mind Later
You are not locked in. A sole proprietor or partnership can transfer a business to a new corporation, and Canadian tax rules can allow certain assets to move on a tax-deferred basis if the right election is filed on time. Contracts, permits, insurance, and bank accounts all have to be moved or reissued in the corporation’s name, and some contracts require the other side’s consent. Liability for debts you incurred personally does not vanish because you incorporated afterwards.
Because of this, a sensible strategy is often to start with what you need today and identify in advance what would prompt a change. That prompt could be a certain level of annual profit, your first employee, a large contract, a commercial lease, or the arrival of a partner.
Questions to Bring to an Advisor
Before meeting a lawyer or accountant, try to answer these:
- What is the worst thing that could realistically go wrong in this business, and could insurance cover it?
- How much profit do you expect, and how much of it do you need to live on?
- Will you have partners, investors, or employees in the next two years?
- Will you need to sign a lease or take out a loan?
- Do you expect losses at the beginning?
- Might you want to sell this business one day, or leave it to your children?
Your answers will usually narrow things down quickly. If you would like to talk it through with someone, you can learn more about the firm’s corporate law services or book a consultation. Getting the structure right early is not complicated, and it is much easier than fixing it after a dispute with a partner, a creditor, or the tax authorities.