What Is The Best Corporate Structure for My Business? Find Out Here!

For those starting out with a new business or self-employment now is a good time to consider the best legal structure for your business.  Having an appropriate corporate structure for your business will allow the owner to take full advantage of tax planning opportunities, manage operating risk and facilitate decision-making at future points in the life of the business.

For small or family-owned businesses there are most often two choices to make – to operate as a proprietorship or a corporation.  Partnerships are another type of corporate structure, but are beyond the scope of this article.  Which type of corporate structure to select will depend on the objectives and goals of the business which generally include a number of factors: operating risk, tax planning considerations, financing needs, and factors affecting business transitions, each of which will be discussed below.

Business Objectives

 Having an understanding of not only the nature of the business today, but also that of tomorrow will allow you to select the appropriate structure that will allow for timely decision making and reduce legal and other related costs along the way.  Will this be a full-time or part-time business venture? How will the business receive financing?  Who will manage the business?  Will the business engage is contracts with external parties or the public for products or services?  Will the business operate with parties outside of the province or country?  The answers to these questions and more will determine an appropriate structure for your business.

The selection of a business structure is highly dependent on the nature of a particular business, its owner and family situation.  Generally speaking, where an owner can answer ‘yes’ to one or more of the questions below regarding the operation of the business, then a corporation structure would be appropriate:

-          Will the business operate outside of the home?

-          Will more than one individual be actively managing the business?

-          Will financing be obtained from a bank or other third party?

-          Will the company enter into contracts for goods or services with other companies?

-          Will the company delivering goods or services to the general public?

Tax Planning Considerations

 Operating a business as a corporation provides some tax planning opportunities not available with a sole proprietorship.  Tax advantages may be achieved with a corporation structure when family members are employed or are shareholders in the corporation.  With a sole proprietor, net income is reported as personal income and taxed at the individual’s marginal tax rate with less opportunity to share this income across the family (unless family members were employed and paid fair wages).  In a corporation, income from the corporation may be distributed as wages (when family members are employed), or as dividends (when family members are shareholders), or retained in the corporation to finance operations and distributed at a later date.  Wages and dividends may be allocated accordingly to minimize the collective family taxes for shareholders who are active in the corporation.

Tax planning considerations should also include eventual business transitions – succession planning or the sale of the business.  In a sole proprietor arrangement, selling the business may take the form of selling of assets and goodwill, again taxed in the hands of the owner, at a higher rate of tax than may be obtained if sold as shares of a small business corporation.

A further consideration may be the maintenance time and costs of the selected corporate structure.  A corporation is required to file an annual tax return (often prepared by an accountant) and maintain a corporate minute book containing records of shareholders, directors, and resolutions approving the distribution of dividends (often maintained by a lawyer).  A sole proprietor does not need to report separately to tax authorities and need only retain records related to the daily operation of the business to meet normal tax reporting requirements.   Relative to the other considerations, this one is less critical, however is important for financial budgeting and planning purposes.

Before deciding on or changing entities, a thorough review of the options and a consultation with both an accounting and legal professional are recommended.

Additional resources & Links:

1.       Business Start-up Assistant (**Good source of information for those starting out**)

http://www.canadabusiness.ca/eng/

2.       Canada Revenue Agency (CRA) Information for New Businesses:

http://www.cra-arc.gc.ca/tx/bsnss/sm/menu-eng.html

3.       Canada Revenue Agency guides to setting up your business:

http://www.cra-arc.gc.ca/tx/bsnss/sm/sttng/menu-eng.html

Stay tuned for more articles for small business owners!

Regards,

Stephen Beech MBA, CMA

www.smallbizprosmississauga.ca

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© Stephen Beech 2010