Sole Proprietorship vs Incorporation

You’ve grown your business rapidly over the last few years and are wondering when, if ever, you should transition from a sole proprietorship to a corporation

First, let’s compare a sole proprietorship and an incorporated business:

*note: the references to “corporation” throughout the article refer to Canadian Controlled Private Corporations (CCPC)

Sole proprietorships are not separate legal entities, meaning there is nothing that separates the owner from the business. All profits earned in the year are reported on their personal tax return; if they pass away, the business goes with them; and anyone suing the business is, in essence, suing the owner as well.

On the other hand, an incorporated business is a separate legal entity. The business owner will hold private shares of the corporation, which serves as their ownership in the business.  There is a clear distinction between the business and the owner, meaning different tax treatment and increased liability protection, amongst other differences.

It is important to note that this distinction has nothing to do with the business name. A sole proprietor can name their business in the same fashion as an incorporated business, which is done via provincial or federal registries. Incorporated businesses will often be apparent by having “Inc.” or “Ltd.” at the end.

What are the advantages to operating your business as a sole proprietorship?

Simplicity and cost. You do not need to hire a lawyer to incorporate your business or a corporate accountant to do your year-end tax filings. Therefore, the costs of operating the business will be much lower compared to incorporation and the ownership structure remains incredibly straightforward.

What are the advantages to operating your business as a corporation?

1. Income planning – incorporated businesses can manage their income more effectively than sole proprietors, in which every dollar of profit is automatically labeled as income in that given year. For corporations, they can choose to leave excess profits in the business for a safety net, to expand operations, or merely to invest.
2. Business succession & estate planning – expanding the business in the form of adding shareholders is much easier to do when your business is a separate legal entity. While this may not be your current reality, the potential to grow the business by offering share ownership to interested parties could be an enticing avenue down the road. This is also a great way to attract and retain employees.
3. Liability protection – corporations are separate legal entities. If a supplier, customer or vendor were to sue the business, your personal assets could be safe from a lawsuit. However, liability could be affected if the owner personally guaranteed corporate loans, which is why is it always important to seek legal advice before entering into contracts.
4. Tax planning – in addition to managing income as mentioned above, there are opportunities for corporations and their owners to utilize various components of the Income Tax Act in their favour. The specifics are beyond the scope of this article, but the Small Business Deduction on corporate profits under $500k, the Capital Dividend Account, and the Lifetime Capital Gains Exemption are just a few mechanisms that allow for diligent tax planning.

So, which structure is right for my business?

When I am asked this question by my clients, I respond with four follow-up questions:

1. Is the business earning significantly more money than you require to meet your living expenses?
2. Is there a scenario in which you could be sued by an employee, customer, vendor or supplier?
3. Do you envision adding more owners to the business as a way of expansion or attracting new employees?
4. Would you be able to sell the business in the future if you chose to do so?

If the answer is YES, to any of these four questions, I recommend they consider incorporating their business. There are lawyers who specialize in this field and will ensure your incorporation is done properly. You are welcome to reach out if you have any questions or want to be referred to a business lawyer or accountant; Jeff Graham can be reached at (604) 363-7549 or jeff@firstoakfinancial.ca.

DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.