BUSINESS MANAGEMENT

Structuring Your Business

Each of the three basic forms of organization - sole proprietorship, partnership and corporation - has its own unique tax and legal considerations.

Understanding the structure of the business and the resultant tax and legal implications is particularly important when making a transition from one business form to another, say from sole proprietorship to incorporation, forming or dissolving a partnership, or starting up a new business.

This is also a time when professional advice from both your chartered accountant and your lawyer can be crucial. A wrong decision could result in increased taxation, increased personal liability, increased risk as a result of contin­gent liabilities and even a potential loss of house, vehicles and other personal assets.

Proprietorship

A sole proprietorship is the simplest form of operation. It offers ease of formation and termination, minimal organizational costs and flexibility of operation. No separate tax entity is created; the owner includes the net business income or loss as part of the personal tax return and is taxed at individual rates.

However, sole proprietorship has disadvantages:

• The owner assumes responsibility and liability for the business

• Outside financing can be more difficult to obtain

• Certain tax‑deferral techniques are unavailable.

In most Canadian jurisdictions, a sole proprietor is not required to register if the business is carried on in the name of the sole proprietor. However, if the entrepreneur decides to use a name other than his or her own, it may be necessary to register the business name with the provincial authorities. The bank will also require a copy of the registration when setting up the business' accounts in the business' name.

Partnerships

If you decide to share ownership, profit and loss and responsibili­ty, you will likely be forming a partnership.

Before launching a partnership, get it in writing. A partnership agreement ensures all partners understand and agree to each other's duties, responsibilities and rights. It is far easier to document the agreement when starting out than trying to work out terms when conflict arises.

It is equally important to seek advice from both your lawyer and chartered accountant to ensure all of the terms are properly documented and the agreement makes economic sense. As well, you will need legal advice regarding your province's Partnerships Act, as certain statutes will have implications in the drafting of the agreement. Most provinces also require that the partnership be registered.

Generally a partnership agreement clearly spells out:

• Each partner's contribution to the business (cash, intellectual property, labour, capital assets or other property)

• Delegation of work and/or responsibilities

• The accounting principles to be applied

• How profits/losses are to be shared (a partnership does not always mean splitting profit or losses into equal shares)

• Signing authority for cheques (with limits for a single signature), contracts and other agreements that bind both parties to not only the winds of good fortune but the burden of debt

• Provisions for dealing with a retiring or deceased partner's interest

• Provisions for allowing new partners to buy into the partnership or for existing partners to buy out another partner

• Steps for resolving disagreements. In some in­stances, the disagreements may be so strong that the partnership will have to be dissolved. The means of dissolution should also be addressed in the agreement.

A partnership has many of the same business advantages of a sole proprietorship and most important, it allows you to pool skills and raise equity capital through the joint association of owners. But as with a sole proprietorship, a partnership does not enjoy income deferral as a corporation does. As well, each partner may be responsible for the liabilities of the partnership as a whole. Additionally, partners within a partnership may find themselves "jointly and severally" liable for "wrongs" committed by any partner in the ordinary course of busi­ness. While there are exceptions in the case of a limited partnership, generally a partnership has the same liability exposure as a sole pro­prietorship.

To protect the interest of all parties to a partnership, a partnership that ends should be formally dissolved. Most jurisdictions require the filing of a "Dissolution of Partnership" form.

A Corporation

Usually denoted by Inc., Ltd. or Limited in the company's name, a corporation is a separate legal and taxable entity. Incorporation offers:

• Limited liability

• Continuity of existence

• Simplici­ty in transferring ownership

• Centralized management

• Poten­tial ownership by employees

• Ease of capital formation.

However, corporations are sometimes subject to additional government regulations and supervision.

An incorporated company can be public or private. The public company usually offers shares to the public, is listed on the various stock exchanges and does not have a limitation on the number of shares issued. A private company, on the other hand, usually offers shares to 50 or fewer shareholders. The private corporation is not listed on the stock exchange for general distribution and the directors' approval is often a requirement for the transfer of shares to another person.

A business can be incorporated federally or provincially. A federal incorporation permits the organization to conduct business in all provinces whereas provincially incorporat­ed corporations are registered to conduct business only in the province of incorporation. If a provincially incorporated business is expanding and beginning to conduct business in another province, the company may need to register within that province.

Incorporating offers several other advantages:

• Shareholders cannot lose more than they have invested in the company through loans, shares or guarantees, thereby freeing investors from the worry of other debts of the company. Unfortunately, for most owner‑ managed corporations, lending institutions require the owner(s) to personally guarantee all loans, thereby reducing the benefits of "limited liability"

• Corporate ownership can change without having to dissolve the business entity

• Incorporated companies normally have a greater ability to enthuse investors, and thus have a greater chance of raising capital than the unincorporated business.

Get Professional Advice

There are many unique implications in the formation of a business and numerous tax considerations that need to be taken into account. Whether you are planning changes or starting out on a new venture, be sure to seek advice from both your chartered accountant and your lawyer.

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