Methods of Carrying On Business

There are a variety of ways to carry on a business in Ontario. However, the three main ways to do so are Sole Proprietorship, Partnership and Corporation.

As you will find below, the main differences between the three are

  • the income tax consequences for the business owner,
  • the extent of liability to third parties, and
  • the cost involved in the set up.

Choosing the Best Method

Almost all commercial activities in Ontario are carried on using one of the three legal arrangements referenced below. No one method is the best in every case. Accordingly, consideration must be given to a number of issues including things such as limited liability, estate planning, income tax and, of course, the costs involved in each case.

Method 1: Sole Proprietorship

A sole proprietorship is the simplest arrangement for carrying on a business and is used in a wide variety of circumstances.

A sole proprietorship exists whenever an individual carries on business for the individual’s own account without using the medium of any other form of business organization or involving the participation of other individuals, except as employees.

  • The individual is the sole owner of the business.
  • The individual may employ others in the business but cannot employ himself or herself.

Many small businesses are organized as sole proprietorships. All benefits flowing from the business accrue to the exclusive enjoyment of the sole proprietor. All obligations associated with the business are also the sole proprietor’s responsibility. Thus, the income or losses of the business belong to its owner as do the assets used in the business, which may increase or diminish in value.

The sole proprietor is personally responsible for carrying out all the contractual relationships relating to the business. Any liabilities that arise from the actions of the sole proprietor or employees of the sole proprietor are the sole proprietor’s responsibility.

If a sole proprietor carries on business under a name or style other than his or her own name, persons dealing with him or her need a mechanism for finding out the name of the sole proprietor. This is provided by s. 2(2) of the Business Names Act, which provides that no individual shall carry on business or identify his or her business to the public under a name other than his or her own name unless the name is registered by that individual.

Currently, the cost of registering a business name in Ontario is approximately Eighty ($80.00) Dollars.

Method 2: Partnership

When two or more persons carry on business together with a view to profit, the relationship is called a partnership and the members of the partnership are called partners.

  • A partnership is like a sole proprietorship in that the partners carry on the business themselves directly.
  • The partnership is not a legal entity separate from its partners.
  • Partnerships are a common form of business enterprise. Obvious examples of the use of the partnership form are professional partnership of lawyers and chartered accountants.

The law of Ontario recognizes two types of partnerships.

  • One is a general partnership, normally just called a partnership. In a general partnership, s. 10 of the Partnerships Act, provides that the liability of each partner for the debts and other obligations of the partnership is unlimited.
  • The second type of partnership is called a limited partnership. In a limited partnership the liability of one or more of the partners is still unlimited pursuant to s.2(2) and s.9 of the Limited Partnerships Act, however, the liability of one or more of the other partners is limited to the amount which that partner or those partners have contributed to the partnership business.

Characteristics of General Partnerships

Central to the law governing the relations of a partnership with third parties is the principle that each partner is the agent of the partnership and the other partners while acting in the normal course of partnership business. Accordingly, when so acting, one partner’s action binds all the partners pursuant to the law of principal and agent and in keeping with this agency relationship, each partner in a firm is liable with the other partners to the full extent of his or her personal assets for all debts and obligations of the firm incurred while a partner.

Characteristics of a Limited Partnership

A limited partner on the other hand is usually a passive investor rather than an active participant in the operation of the limited partnership. The limited partners share in the profits of the limited partnership in proportion to their contributions to the limited partnership.
A written limited partnership agreement is normally advisable to deal with matters not addressed in either the Partnerships Act or the Limited Partnerships Act or with matters provided for in these statutes which the partners agree to alter.

Taxation of Partnerships

Unlike sole proprietorship, where any income or loss of the business belongs to its owner, in the case of a general partnership or a limited partnership the income or loss of the business carried on by the partnership is determined at the partnership level and then allocated to the members of the partnership. The partnership itself is not a taxable entity. Expenses, capital costs allowance and other costs are deductions in computing the income of the partnership to determine the partnership’s net income or loss and is included in computing that partner’s income from all sources for tax purposes. If the partner is an individual, he or she is subject to tax at the rates applicable to individuals under the Income Tax Act. Like the sole proprietor, a partner must combine his or her share of net income or loss with income or losses from all other sources.

Method 3: Corporations

A Corporation with share capital is the business entity used most frequently to carry on commercial activities.

Corporation as legal entity

Unlike the business structures already discussed, a corporation is a legal entity separate in law from its owners, the shareholders of the corporation. A corporation may own property, carry on business, possess rights and incur liabilities. The shareholders own the corporation through their ownership of the shares of the corporation. The shareholders do not own the business or the property belonging to the corporation, and the rights and liabilities of the corporation are not the rights and liabilities of the shareholders. This arrangement is unlike the previous situations considered, in which the owners of a business or of property owned the business or property directly.
Since a corporation is a separate legal entity, it is also possible for an individual to be both an owner of a corporation, as a shareholder, and an employee of the corporation. The management of a corporation can also be separated from ownership of a corporation. Directors and officers of a business corporation in Ontario are not required to own any shares of the corporation.

Because corporations are artificial legal entities, they can sue in their own names and they can have perpetual existence. A corporation also continues notwithstanding the death or withdrawal of a shareholder by the sale of his or her shares.

Role of shareholders

In order to obtain their shares in the corporation, the shareholders provide the corporation with money, property or services, which then belong to the corporation. The shareholders are said to have limited liability because their liability in connection with the property or business owned by the corporation is limited to the value of the assets they have transferred to the corporation in exchange for shares in the corporation. If the corporation’s business is run in such a way that the corporation ends up with liabilities in excess of the value of its assets, the creditors of the corporation can demand to be repaid from the assets of the corporation to the extent that this is possible. But creditors cannot demand that the balance of the unpaid liabilities of the corporation be paid by the owners of the shares of the corporation. The shareholders will own shares that have no value and will have lost their investment in the corporation, but the amount they paid for their shares is all that they will lose.

Shareholders’ income

Because a corporation is a legal entity separate from its shareholders, a corporation’s income is determined and subject to tax separately from that of its owners, the shareholders. A shareholder cannot treat the net income or loss of a corporation in which he or she owns shares as income of, or as a loss of, the shareholder. Therefore, a shareholder cannot add the net income or loss of the corporation to personal income or loss from all other sources in order to determine taxable income. Instead, a corporation’s net income is subject to tax each year. If any of the corporation’s after-tax income is to be paid to its shareholders, this is accomplished by the directors declaring a dividend to the holders of the corporation’s shares.

Corporation’s role in estate planning

A corporation may be a useful device for estate planning purposes. It is possible to structure the shareholdings of a corporation so that one class of shares has enough votes to allow the owner of those shares to control the corporation, but all increases in value of the corporation accrue to the owners of another class of shares. The most common arrangement is for the shares that represent control to be owned by a parent and the shares that benefit from all increases in value of the corporation to be owned by a child.

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