Hey Guys! Today’s post compares incorporation vs sole proprietorship in Ontario.

I am a lawyer and have been doing this for more than ten years. I have had the privilege of working with entrepreneurs in a wide variety of industries. (It is one of the best parts of this job.)

Last year, when we first got locked down, I was, of course, a bit shocked. As time goes on, I started thinking about how I can give something back to our community. One idea was to create this blog as a source of credible, reliable information. In particular, I hope that this first set of blog posts is helpful for guys (and girls) who may be first-time entrepreneurs.

It’s all good, man. Let’s do this!

Overview: Incorporation versus Sole Proprietorship 

There is a joke that lawyers love to say 'it depends'. While it's not especially funny (am I missing something?), it is true. The best vehicle for taking your business to the next level will depend on your circumstances and the facts of your business.  

Incorporation is a powerful legal structure that works well for many entrepreneurs. It has both legal and business advantages.  

BUT, starting and maintaining a Canadian corporation may be outside of your budget when first starting up. Just because the corporation is a good option in many cases does not mean that it is the best option in all cases. 

Let's dive in a little deeper. The most obvious alternative to incorporation is simply using a sole proprietorship. In the following, I am going to compare three features of the corporation versus the sole proprietorship

• Limited Liability
• Tax treatment
• Branding

As the big homie Freddy Mercury liked to say: “The Show Must Go On.” …. Let’s dive into some details. 

Feature 1: Limited Liability

At law, a corporation is a separate entity from its owners.

The corporation's separate legal identity results in limited liability for its owners. A corporate shareholder has limited liability because his financial liability is limited to whatever amount he has invested in the corporation's share capital. Put more simply, the most the shareholder can lose is whatever he (or she) has put into the corporation. Even if the corporation goes into debt and is ultimately unable to pay back its creditors, those creditors will not go after the shareholder's personal assets.

In contrast, a sole proprietorship is not a legally separate entity from its owner. The owner of a sole proprietorship is personally liable for the business's obligations. If your business incurs debt, you are personally liable to re-pay those debts. As a result, the business' creditors can and will go after the sole proprietor's personal assets. 

This difference between limited liability and personal liability is the first point of comparison between a corporation and a sole proprietorship. 

Feature 2: Tax Treatment

A corporation is a separate and distinct legal person. As a result, a corporation must file its own annual corporate income tax return. The Canada Revenue Agency ("CRA") refers to this as a T2.

To file a T2 with the CRA, a corporation's accountant will need to prepare thoroughgoing financial statements. Also, there are administrative requirements directly related to the preparation of the T2, such as maintaining corporate books in case the CRA decides that an inspection is needed. Therefore, a corporation is not going to provide its owner with tax simplicity.

But, the corporation does provide the opportunity for tax savings. The possibility of tax savings is going to be especially relevant if the corporation is profitable or at the very least has significant cash flow. For example, a corporation with several hundred thousand dollars of income will pay a much lower tax rate than a person with equivalent income would pay.

In contrast, a sole proprietorship is not a legally separate entity from its owner. This is going to result in greater tax simplicity but less scope for tax savings.

In short, the sole proprietorship will not file its own tax return with the CRA. Instead, the sole proprietorship's profit will go directly to the proprietor as income. The individual entrepreneur will then include that income on his tax return with the CRA, i.e., on his T1. The income is then taxed, all other things being equal, at the higher rate for high-income individuals.

Therefore, tax-treatment is another significant difference between a corporation and a sole proprietorship.

Feature 3: Branding

Sometimes the perceived prestige of a corporation is attractive, especially if your business relies on its brand. Here are a couple, specific legal considerations related to branding.

Naming. One of the first documents that is created when you incorporate is a name search. The details of the name search will differ slightly depending on whether you incorporate federally or provincially. The key point is this: once you incorporate, your corporate name goes into a database. In this respect, your business name is protected. 

When you register a sole proprietorship, you are registering the name you use to do business. The government does not, however, guarantee that you have exclusive use of the name. Furthermore, there are certain kinds of business names that can not be registered under a sole proprietorship. For instance, a sole proprietorship can not register John Smith Painting Co. because “Co.” indicates that the business is a corporation. 

Perpetual existence. Furthermore, because a corporation is a distinct legal entity, it enjoys perpetual existence. The result is that if something unfortunate happens to the founding shareholder, the corporation will continue to exist. On the other hand, a sole proprietorship will cease to exist upon the death of its proprietor. As a result, a sole proprietorship lacks permanence and may be less suitable for building a long-term brand.

And The Winner is ...?

I get asked about alternatives to incorporation fairly regularly. The above compared three specific features of the corporation against the sole proprietorship. There are, however, other features that a responsible entrepreneur will want to consider in comparing these two solutions for doing business in Ontario.

As already noted in this post and elsewhere on the blog, the corporation is a powerful legal structure. Suppose you are serious about running a successful business. In that case, you are going to gradually ‘transform’ from an entrepreneur into an executive. It is highly likely that you and your business will make use of the corporate form along this path.

Starting your own business is already a big step. Incorporation is that much more serious. If you want to know more about starting and maintaining a corporation, you are not alone. It turns out that a lot of guys are wondering about this topic.

Some of these guys have been writing to ask for more information. I am here to be a resource. I’ve put together a guide. The guide is more than 40 pages long -- yeah, its probably too long -- and it is 100% free.

In any case, the best vehicle for taking your business to the next level is going to depend on your own personal circumstances and the facts of your business. There are certain circumstances where a sole proprietorship might be most appropriate. For example, a sole proprietorship might be the best fit for an entrepreneur who is the sole owner of their business and has less than one hundred thousand dollars of annual business income.

Bottom Line

It really does depend on your personal circumstances and the facts of your business: the best vehicle for taking your business to the next level is going to depend on your own personal circumstances and the facts of your business.  

Incorporation entails extra work and extra costs. If your business is just getting started, then the sole proprietorship might be good enough. As your business grows, you can always incorporate.