Business Structures in Canada: Sole Proprietorships, Partnerships, and Corporations

Choosing the Right Business Structure

When starting a business in Canada, one of the most important steps is choosing your legal structure. The three most common forms are sole proprietorship, partnership, and corporation. Each has unique implications for taxes, liability, cost, and growth potential.

Sole Proprietorship

Features:

• Simplest and least expensive structure.

• Owned and controlled by one person.

• Business and owner are legally the same.

• Income and expenses are reported on the owner’s personal tax return using CRA Form T2125.

Benefits:

• Easy and low-cost to register.

• Business losses can offset other personal income.

• Full control of decision-making.

Costs/Drawbacks:

• Unlimited personal liability. If the business owes money, creditors can go after personal assets.

• Limited access to financing since banks often prefer corporations.

• Less credibility with investors and suppliers.

Estimated Costs:

• Ontario: ≈ $60 to register.

• British Columbia: ≈ $40–$70.

• Alberta: ≈ $60–$100.

• Quebec: ≈ $39.

Income & Tax Flow:
Business → Owner → Personal Tax Return (T1).

• The sole proprietor reports their business results personally.

• CRA requires the use of Form T2125 – Statement of Business or Professional Activities.

• T2125 is attached to the individual’s T1 General Tax Return each year.

• If there’s a profit, it gets added to other personal income (employment, rental, investment, etc.).

• If there’s a loss, it can often offset other personal income (reducing total taxes owed).

• All income sources, including sole proprietorship net profit, are combined in the T1 General Return.

• Taxes are calculated based on personal marginal tax rates, which increase as total income rises.

• Unlike corporations, there is no deferral option — all business income is taxed in the year earned.

  ✅ Example:

  • Your business makes $80,000 in sales.

  • You have $30,000 in expenses.

  • Net profit = $50,000.

  • You report this $50,000 on Form T2125 → carried into your T1 return → taxed along with any other income you have (like employment or investments).

Partnership

Features:

• Two or more people share ownership.

• Governed by a partnership agreement that sets responsibilities and profit sharing.

• The partnership is a pass-through entity: it does not pay taxes directly. Profits or losses are allocated to the partners.

• Each partner reports their share on Form T2125 and files it with their personal return.

Benefits:

• Shared startup costs and pooled resources.

• Flexibility in how profits and responsibilities are divided.

• Business losses pass through to partners’ personal returns.

Costs/Drawbacks:

• Personal liability: partners are personally responsible for debts.

• Joint liability: one partner’s actions can affect all.

• Potential for disputes if no solid agreement exists.

Estimated Costs:

• Ontario: ≈ $60 to register.

• British Columbia: ≈ $40–$70.

• Alberta: ≈ $60–$100.

• Quebec: ≈ $39.

Income & Tax Flow:

• Just like a sole proprietorship, the partnership calculates net business income:

  • Total revenues (sales, services, etc.)

  • Minus allowable expenses (rent, payroll, supplies, etc.)

  • = Net profit or loss for the year.

• Once the total is known, it is allocated to the partners based on the partnership agreement (e.g., 50/50, 60/40, or another split).

• Each partner receives their share of the profit (or loss).

• Importantly:

  • Partners pay tax individually on their share of partnership income.

  • If the partnership has a loss, each partner can usually claim their portion of the loss against other personal income.

• Each individual partner completes Form T2125 – Statement of Business or Professional Activities.

• They report their share of partnership income/expenses on this form, and then carry it into their T1 General Personal Tax Return.

• The CRA taxes each partner at personal marginal rates, based on their total income from all sources.

✅ Example:

• Partnership earns $120,000 net.

• 3 partners, equal split = $40,000 each.

• Each partner fills out T2125 with their $40,000 share.

• They add it to their T1 return, where it’s combined with any employment, rental, or other income.

Corporation

Features:

• A corporation is a separate legal entity from its owners.

• Must be incorporated federally or provincially.

• Pays its own taxes via a corporate tax return (T2).

Benefits:

• Limited liability (with exceptions for guarantees, payroll/HST remittances, etc.).

• Lower corporate tax rates for active business income (small business deduction).

• Easier to attract investors and financing.

• Business continues to exist beyond the owner.

Costs/Drawbacks:

• More expensive and complex to set up and maintain.

• Requires corporate tax filing (T2), annual returns, and corporate records.

• Credit reality: At the beginning, the corporation has no credit history, so shareholders are often required to co-sign loans, leases, or credit lines. This means personal liability still exists in practice until the business builds its own credit.

Estimated Costs:

• Ontario: ≈ $360.

• British Columbia: ≈ $351.50.

• Alberta: ≈ $500.

• Quebec: ≈ $392.

Income & Tax Flow (Graphic):

• The corporation calculates net income = revenues – expenses.

• This net income is taxed at corporate tax rates.

• In Canada, most small corporations qualify for the Small Business Deduction (SBD), which lowers the tax rate on the first $500,000 of active business income.

Salaries (Optional)

• The corporation may pay its owners a salary or wage if they also act as employees.

• For the corporation: salaries are a deductible expense, which reduces taxable profit.

• For the shareholder/employee: the salary is reported as employment income (T4 slip) on their personal tax return (T1) and taxed at personal income tax rates.

• CPP contributions and possibly EI apply.

Dividends (Optional)

• Instead of (or in addition to) a salary, the corporation may distribute dividends from after-tax profits.

• For the corporation: dividends are not deductible, so they don’t reduce corporate taxable income. They are paid out of profits after corporate tax is paid.

• For the shareholder: dividends are reported on a T5 slip and taxed personally. However, Canada has an integration system:

  • Dividends are “grossed up” (increased) on the personal tax return.

  • A dividend tax credit is then applied, so overall tax (corporate + personal) is designed to be roughly equal to if the income was earned directly.

Shareholders

• Shareholders can receive income from the corporation in two ways:

  1. Salary (T4 slip, taxed like employment income).

  2. Dividends (T5 slip, taxed as investment income with dividend tax credit).

• Each shareholder reports this income on their T1 personal return.

✅ Example:

• Corporation earns $100,000 net income.

• Option 1: Pay $80,000 in salary to the owner → reduces corporate income to $20,000. Corporation pays less corporate tax, but the owner pays personal income tax on the $80,000 salary.

• Option 2: Leave the $100,000 in the corporation, pay corporate tax, then declare dividends. The owner pays personal tax on the dividends received, but benefits from the dividend tax credit.

When Is It a Good Time to Incorporate?

It may be time to incorporate if:

• Profits exceed what you need for personal living expenses.

• You want to limit liability and protect personal assets.

• You plan to attract investors or scale operations.

• You’re thinking of selling one day (shares of Canadian corporations may qualify for the Lifetime Capital Gains Exemption).

• You want to reinvest profits inside the corporation at lower tax rates.

From Sole Proprietor to Corporation (Rollover)

Many entrepreneurs start as sole proprietors and later “roll over” into a corporation. Under Section 85 of the Income Tax Act, you can transfer assets (equipment, customer list, goodwill) from your sole proprietorship into a corporation without triggering immediate taxes. This allows you to restructure as your business grows.

Rules of Thumb

• Start as a sole proprietor if income is modest (< $100K) and you want simplicity.

• Choose a partnership if two or more people share ownership and income is in the $100K–$150K range.

• Incorporate once net profits exceed $100K or when liability protection, reinvestment, or investor credibility are needed.

 In Brief:

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