Important implications flow from the way you set up your business. If you are in the process of starting your own business or already running a growing business as a sole proprietor, you may be considering business incorporation. But what is the difference between sole proprietorship and incorporation, and what are the advantages and disadvantages of these business structures?
Difference between incorporation and sole proprietorship
Sole proprietorship is the simpler of the two business structures. A sole proprietor is a self-employed individual who operates an unincorporated business. Canadian sole proprietorships do not have separate legal status, so the sole proprietor receives all profits and claims all losses on their personal income tax return. The sole proprietor has control over all business decisions but is also responsible for all the debt, risk, and liability related to the business.
A corporation, on the other hand, is its own legal entity, separate from the shareholders who own the company. On incorporation, the company can enter into contracts, own property, go into debt, and sue or be sued. Because an incorporated company is its own entity, it is necessary to file a separate corporate income tax return. Shareholders, directors, and officers make decisions for the company and are generally speaking not personally liable for debts and liabilities of the corporation.
Getting set up: incorporation vs. sole proprietorship
When it comes to starting up, there is a significant difference between sole proprietorship and incorporation. Sole proprietorships are relatively simple. There are fewer registration requirements and the costs are low. Incorporation is more expensive, and the process is more involved. For example, the company’s articles of incorporation must be prepared, and name registration is required.
Advantages of incorporation vs. sole proprietorship
Some of the pros and cons have been touched on above. The main advantages of sole proprietorships are that they are simple and inexpensive to set up and offer the owner a greater degree of flexibility and control in operating the business. We recently discussed five of the key advantages of incorporation: limited liability; optimizing income and tax deferral; easier to raise capital; perpetual existence; and business name protection. When it comes to Canadian sole proprietorships, the converse is true: a sole proprietor has unlimited personal exposure for business debts and lawsuits; tax deferral is not possible (though there may be other tax advantages to operating as a sole proprietorship); raising capital is more difficult; the business ends if the owner dies or ceases to operate the business; and there is no name protection.
Incorporate or sole proprietorship: what is best for my business?
There are important legal, financial, and tax implications of the business structure you choose. You must weigh the needs and objectives of your business against the risks, benefits, and regulatory requirements of each legal structure. For practical advice and guidance to choose the best option for your business, contact an experienced corporate lawyer.