Considerations on Sole Proprietorship and Incorporation for Small Business

Spring, summer and autumn are exciting seasons in Saskatchewan. Vacationers, like the rest of nature, enjoy summering in the agreeable climes of the north. Locals seize the opportunity to get outside once again (though I am personally a hearty advocate for winter activities too)! Either way, there are business opportunities to be had in the tourism and hospitality sector. For those looking to monetize a good idea, it is helpful to give some thought to the business form to be employed. This brief article sets out a number of benefits to sole proprietorships as a business form for small businesses.

The pursuit of a business adventure necessitates selection of business form. Often enough, the corporate form comes to mind. Entrepreneurs can incorporate under local business corporation law or federal corporate law, depending largely on preference. And there are many good reasons for seeking incorporation. Clients often desire to incorporate their business in order to benefit from protections against personal liability. This is because legislation provides corporations distinct legal personality, separate from the shareholders and directors.

Other reasons clients desire incorporation are to take advantage of income-splitting possibilities, such as paying dividends to spouses in tax-efficient manners, or to encourage investment. For small businesses, however, these benefits are not always immediately available, and there might be potential draw backs.

For instance, a number of circumstances arise where small business owners are compelled to pledge their own personal liability notwithstanding their business has incorporated. One example is conventional financing. Banks often seek personal guarantees from principals in order become comfortable extending credit. Another example is commercial leasing. Often landlords will require personal indemnities from principals of small businesses prior to making leased premises available. Major suppliers also occasionally request personal guarantees from the principal of a small business prior to extending product on credit. Each of these examples cause principals to expose themselves to personal liability to significant creditors in the small business sector, even though the business has incorporated.

In addition, directors of corporations, who are typically principals of the business, can bear personal liability towards the Canada Revenue Agency for certain tax obligations of the corporation. Directors can also find themselves personally liable for employee wages as well as environmental liabilities of corporations, in certain scenarios.

As a rule, corporations do protect shareholders and directors from exposure to personal liability for ordinary course business activities and contracts. But even here, many risks incurred ordinary course business can often be hedged with commercial insurance, whether the business is incorporated or not.

From a basic taxation perspective, small businesses typically incur many expenses and sometimes minimal income at the start. Consider analyzing your business plan to compare your personal income under a corporate scenario versus a sole proprietor scenario after taxes and fees. While the income of Canadian-controlled private corporations is taxed at a lower rate than personal tax rates, funds held at the corporate level are not available for personal use, such as costs of living. In order to access profit held by the corporation, a dividend must be paid, upon which personal income tax is generally payable. It may be advantageous to incur the expenses of the small business at the personal level to be able to benefit from corresponding deductions.

Incorporation also introduces a certain level of administration, in terms of time and cost. Taxes, corporate filings pursuant to applicable legislation and compliance with corporate governance documents are some prominent examples of this administration. There are many good professionals who can assist with this administration, but those services can be expensive, relative to start-up costs.

Small business owners may wish to consider deploying new business ideas under sole proprietorships, migrating to the corporation form once marketability is proven. The Income Tax Act permits the roll-over of assets from sole proprietorships to corporations on a tax-deferred basis, provided certain conditions are met. These provisions permit the sale of the assets without the immediate obligation to pay tax on the increase in value as would otherwise be the case. At this stage, the benefits of incorporation may be better appreciated.

McKercher LLP prides itself on its local knowledge and experience. A number of the lawyers operate or have operated businesses and understand the associated considerations. The Firm has recently developed an Entrepreneur Group to better respond to the needs of our clients. You can find more information about us and this Group online at www.mckercher.ca/entrepreneurlaw. Do not hesitate to contact us with questions. We are here to help you be successful.

Christopher Porter is an associate in the Saskatoon McKercher LLP office and has a general commercial law practice.