Methods of Carrying On Business PDF

Chapter 16 Methods of carrying on business 1. Sole proprietorship than the sole proprietor’s own to sue or be sued in the A sole proprietorship is the most basic form of business...

Chapter 16 Methods of carrying on business 1. Sole proprietorship than the sole proprietor’s own to sue or be sued in the A sole proprietorship is the most basic form of business name of the sole proprietorship. organization and can be used in a wide variety of The federal Income Tax Act (ITA) requires that circumstances. Sole proprietorships are relatively individuals with business income report that income on a inexpensive to set up and require few legal formalities. calendar-year (fiscal period) basis (ITA, s. 249.1(1)(b)(i)). Rather, a sole proprietorship exists whenever an This rule applies to sole proprietorships. However, an individual carries on business for the individual’s own individual carrying on a business may file an election to account without the involvement of other individuals, use a non-calendar-year fiscal period (s. 249.1(4)(a)), except as employees. Many small businesses are organized provided the Minister of National Revenue (MNR) agrees. as sole proprietorships. All benefits flowing from the Should the MNR not accept the election, the individual business, such as income and assets, accrue exclusively to must revert to reporting income on a calendar-year basis. the sole proprietor, and correspondingly, all obligations An individual may also file a further election to revoke a including losses and contractual and tortious liability previously accepted election to use a non-calendar year associated with the business are also the sole proprietor’s (s. 246.1(6)). To ensure there is little or no deferral of responsibility. reporting income by an individual using an off-calendar­ A major disadvantage of sole proprietorships is that there year fiscal period, the rules in s. 34.1 of the ITA require is no limited liability for the sole proprietor; all business that such business income be effectively calculated on a and personal assets may be seized in satisfaction of the calendar-year basis. The operation of s. 34.1 is illustrated sole proprietor’s business obligations and liabilities. The in the following example. sole proprietor can limit personal liability exposure by Example 1 contract or through insurance. Assume a sole proprietor begins a new business on May 1, Before beginning to carry on business, sole proprietors 2024, and elects to have a fiscal period that ends on should review municipal, provincial, and federal licensing April 30, such that the first fiscal period for this new requirements, since licences are required for a number of business would end on April 30, 2025. In addition, in activities. order to maximize the deferral of the first year’s income, Furthermore, sole proprietors must comply with s. 2(2) of this sole proprietor does not voluntarily report any income Ontario’s Business Names Act (BNA), which states that no from this business in 2024 when filing the sole individual shall carry on business or identify the proprietor’s 2024 personal income tax return. individual’s business to the public under a name other Section 34.1 requires the sole proprietor to report in the than the individual’s own, unless the name is registered by sole proprietor’s income tax return for 2025 the income that individual. Under s. 7(1) of the BNA, leave of the court from the business for its first fiscal period (from May 1, is required if an individual, corporation, or partnership 2024, to April 30, 2025) plus the additional income from commences or defends an action under a name other than the business for the period from May 1, 2025, to the registered name of the business. “Business” includes December 31, 2025 (this is estimated based on a proration every trade, occupation, profession, service, or venture of the income earned in the previous fiscal period that carried on with a view to profit. The registration must be ended on April 30, 2025). filed with the Ministry of Public and Business Service Delivery through its Ontario Business Registry when the The tax deferral enjoyed by the sole proprietor for the name or designation is first used. The BNA contains business income earned in 2024 comes to an end, and the additional requirements for renewals and amendments to income tax is now paid in 2025. As well, it is important to the registration. In addition, a penalty is provided on note that because of the ITA’s graduated tax rate structure summary conviction for non-compliance with these and the lack of a reserve mechanism for purposes of requirements. s. 34.1, the sole proprietor may end up paying more tax in total in 2025 than if the sole proprietor had paid tax in Subrule 8.07(1) of the Rules of Civil Procedure enables a 2024 on the business income by having a calendar-year sole proprietor carrying on business under a name other fiscal period for the business. LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION 143 CHAPTER 16 BUSINESS LAW In 2026, this same process repeats itself, which means the their WIP from income, thereby giving them a tax deferral sole proprietor will report in income for 2026 the income (ITA, s. 34). Income tax was therefore deferred because from the business’s fiscal period that ended on April 30, their professional income was only recognized when their 2026 (i.e., May 1, 2025, to April 30, 2026), plus additional work was billed (i.e., billed-basis accounting), while the income from the business for the months of May 1, 2026, costs associated with generating or creating their WIP was to December 31, 2026. To ensure there is no double expensed immediately without a “matching” of the taxation of previously reported and taxed income, the revenue associated with those expenses. taxpayer deducts the additional previously reported The 2017 amendment repealed s. 34 of the ITA (effective income in 2025 (i.e., the estimated business income for January 1, 2024), thereby removing the s. 34 election and the months of May 1, 2025, to December 31, 2025). disallowing the deduction of the associated costs until the The income or losses from a sole proprietorship must be work is billed. There were transitional rules (ITA, included with the sole proprietor’s income or losses from s. 10(14.1)) for five tax years of professionals who other sources during the year. This aggregated income is previously made the s. 34 election. The elimination of the subject to tax under the ITA at the marginal tax rates s. 34 election applies regardless of the form of the business applicable to individuals. (e.g., sole proprietorship, partnership, or professional corporation). A sole proprietor’s business losses (i.e., non-capital or operating losses) can be used to offset the sole proprietor’s A 2018 CRA views letter (#2018-0743031E5, “Work in other income. If a sole proprietor is unable to utilize a progress,” dated May 1, 2018) should assist these business loss (i.e., does not have sufficient other income designated professionals seeking guidance on the CRA’s against which to deduct the loss) in the year it occurs, the position with respect to valuing WIP. In addition, the entire loss can be carried back to reduce the sole comments in the letter may also offer insight to lawyers proprietor’s income in any of the three previous taxation who are retained and working with contingency fee years and in the 20 years following the year the loss is arrangements, particularly where it is possible to establish incurred (ITA, s. 111(1)(a)). that some amount can reasonably be expected to become receivable in the future. Example 2 2. Partnership If a sole proprietor’s operating loss was incurred in 2024, When two or more persons, whether individuals or the loss could be used (carried back and/or forward) to corporations, carry on business together with a view to reduce the income of the sole proprietor for any of the sole profit, the relationship is called a partnership, and the proprietor’s fiscal years in the period from 2021 to 2044. members of the partnership are called partners. A The 20-year carryforward period for non-capital losses partnership is like a sole proprietorship in that it is (i.e., business losses) applies to such losses arising in relatively inexpensive to set up, there are few legal taxation years ending after 2005 (e.g., a loss arising in formalities required to create it, and the partners carry on 2006 will expire in 2026). the business themselves directly, since the partnership is not a legal entity separate from its partners. There have been no changes to the three-year carryback period for business losses (ITA, s. 111(1)(a)). The laws of Ontario recognize three types of partnerships: general partnerships, normally just called partnerships; Similar rules apply to capital losses realized by a sole limited liability partnerships (LLPs); and limited proprietor from the disposition of capital assets. However, partnerships. In Ontario, general partnerships and LLPs capital losses may only be used to reduce capital gains (not are governed by the Partnerships Act whereas limited business or operating income), and the carryover period partnerships are subject to the requirements of the for capital losses is three years back and forward Limited Partnerships Act. indefinitely (s. 111(1)(b)). In a general partnership, the liability of each partner for In 2017, the tax treatment of work-in-progress (WIP) was the debts and other obligations of the partnership is changed by an amendment to ITA s. 34. Generally unlimited. This is in contrast to limited partnerships. In a speaking, all taxpayers must include the value of WIP in limited partnership, there is one or more “general computing their income. However, in computing income partners” whose liability is unlimited and one or more from a “professional business,” taxpayers who are one of “limited partners” whose liability is limited to the amount six designated professionals (i.e., accountants, dentists, they have contributed or agreed to contribute to the lawyers, medical doctors, veterinarians, and partnership business, as stated in the record of limited chiropractors) were previously allowed to elect to exclude partners. LLPs are essentially a cross between general 144 LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION METHODS OF CARRYING ON BUSINESS CHAPTER 16 partnerships and limited partnerships and are typically owns and is free to deal separately with the co-owner’s used by groups of professionals for whom it may not be interest in the property, unless the co-owner has limited advantageous to incorporate, but who may wish to obtain the freedom to do so by contract with the other owners; the benefit of limited liability. Subsections 10(2)–(3.1) of whereas in a partnership, the partners have no separate the Partnerships Act outline the extent of the liability of a interest in the property. Each partner’s right is to a partner in an LLP. While the assets of the LLP are division of the profits of the partnership. If a partner available to satisfy debts and claims against it, partners wishes to sell the partner’s interest, it must be sold as a are liable only for their own negligence or the negligence partnership interest, not an interest in the assets of the of employees under their direct supervision and control. partnership. Although a judgment against an LLP for negligence is not Furthermore, co-owners are not agents for each other. enforceable against the other partners, a partner’s interest Partners are agents of each other with respect to activities in the partnership property is not protected from claims falling within the scope of the partnership. Majority rule against the partnership in respect of a partnership normally exists in partnerships in that most, if not all, obligation. business decisions can be made by some specified The income or loss of the business carried on by a majority against the will of the minority as set out in a partnership is determined at the partnership level and partnership agreement. This is not true of a co-ownership then allocated to the partners. Although a partnership unless the co-owners agree to enter into such an itself is not a taxable entity, the income of a partner is arrangement by contract. calculated as though the partnership was a separate Often there will be an agreement between the owners, and person resident in Canada (ITA, s. 96(1)(a)). Expenses, care must be taken in preparing this agreement to ensure capital cost allowance (CCA), and other deductions that the terms of the agreement do not result in co-owners generally are deductions in computing the income of the being viewed as partners. partnership to determine the partnership’s net income or loss. That income or loss is allocated among the partners, There may also be tax benefits to a co-ownership and each partner’s share of that income or loss is included arrangement because of the separate ownership interest in computing that partner’s income for tax purposes. in property. For example, co-owners may wish to claim Various sources of income and loss (such as capital gains, CCA at different times or at different rates. In a co- interest, and incentive deductions) flow through a ownership arrangement, each owner can make his or her partnership to the partners and retain their characteristics own claim for CCA based upon the owner’s separate as to source and nature. For example, a taxpayer’s interest in the property and in light of the owner’s other property income can be offset by partnership property tax circumstances. This difference would allow one co- losses. If the partner is an individual, the partner is subject owner who has losses and does not wish to claim CCA to to tax at the marginal tax rates applicable to individuals postpone claiming CCA to a later year when the co-owner under the ITA. Note that for limited partnerships, special has taxable income. On the other hand, another co-owner rules apply to restrict a limited partner’s deduction of with taxable income may wish to claim CCA as a deduction business or property losses to only the partner’s to shelter some income from current taxation. In a investment in the partnership (i.e., the partner’s “at-risk partnership, this flexibility to claim (or defer claiming) amount” which is defined in s. 96(2.2)) (s. 96(2.1)(b)). CCA by co-owners is not available to the partners There have been recent legislative changes to clarify s. 96 individually since CCA is claimed at the partnership level of the ITA. For more information on these changes and the and the partners must agree on whether and how much use and taxation of partnerships in the creation of “tax CCA the partnership should claim in each year. shelters” for investors, see Chapter 17 (Partnerships) of 4. Corporations these Study Materials. A corporation is the most common form of business 3. Co-ownership organization. When two or more persons jointly own property they are A corporation is a legal entity separate in law from its known as co-owners. Section 3 of the Partnerships Act owners and can own property, carry on business, possess makes it clear that such a relationship alone does not rights, and incur liabilities. Although the shareholders result in a partnership even if the co-owners share in the own the corporation through their ownership of shares, profits generated by the property. they do not own the property belonging to the corporation, The most significant difference between a partnership and and the rights and liabilities of the corporation are not the co-ownership is the level of ability to deal with one’s rights and liabilities of the shareholders. interest in the property. In a co-ownership, each co-owner LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION 145 CHAPTER 16 BUSINESS LAW Shareholders’ liability is limited to the value of the assets ▪ the types of activities and income generated they have transferred to the corporation (in the form of therefrom (e.g., from business activities or passive money, property, or past services) in exchange for shares. investments). If a corporation incurs liabilities in excess of the value of In addition, since 1994, Ontario has imposed a corporate its assets, its creditors can demand to be repaid from the minimum tax based on financial statement income. assets of the corporation but have no further recourse for The taxation of corporations and shareholders is the unpaid liabilities. described in detail in Chapter 18 (Taxation of corporations If shareholders in their personal capacity guarantee the and their shareholders) of these Study Materials. obligations of the corporation, they will effectively lose 5. Joint ventures their limited liability. Typically, not all debts of a corporation will be guaranteed by the shareholders. There is no precise legal definition for joint ventures. Various meanings have been attributed to the term, Because corporations are distinct legal entities, they can including sue in their own names and enjoy perpetual existence. A corporation continues notwithstanding the death or ▪ a partnership; withdrawal of a shareholder by the sale of the ▪ an association of two or more persons for a limited shareholder’s shares. Corporate dissolution may only purpose without the participants becoming occur in the following situations: partners; or ▪ The requisite majority of shareholders resolve that ▪ any combination of resources by two or more the corporation should be dissolved. persons in order to conduct a commercial venture jointly under agreed-upon rules. ▪ A court orders that the corporation be dissolved. Whatever the relationship among them, in most cases, the ▪ Pursuant to statute, the corporation is deemed to be co-venturers should have a written agreement setting out inactive, or the corporation has breached certain statutory provisions. the rules by which the venture will be governed. Matters to be considered in such agreements include As a separate legal entity, a corporation’s income is determined and subject to tax separate from that of its ▪ the nature of the commercial activity in which the owners, the shareholders. A shareholder cannot treat the joint venture will engage; net income or loss of a corporation in which the ▪ the contribution of each co-venturer; shareholder owns shares as the shareholder’s income or ▪ each co-venturer’s share in the profits and losses; loss. A corporation’s net income is subject to tax each year. ▪ the duration of the joint venture; If any of the corporation’s after-tax income is to be paid to ▪ the management arrangements; and its shareholders, the directors may declare a dividend to the corporation’s shareholders. Paying dividends is not a ▪ the dissolution of the joint venture. deductible expense to a corporation (i.e., dividends are The provisions accepted by the co-venturers are paid after a corporation’s income-earning process and are implemented by including them in the joint venture not incurred or paid as an expense of the corporation in agreement or, if a joint venture corporation is utilized, in earning its income). However, dividends do constitute a separate shareholder agreement or in the articles or by­ income (income from property) to shareholders who are laws of the joint venture corporation. individuals, and this income is generally taxed again. On Generally speaking, members of joint ventures retain their the other hand, in certain circumstances, dividends ownership interest in property used in the joint venture. received by corporate shareholders can be received tax- Therefore, if a joint venturer sells property (even to the free (via the inter-corporate dividend deduction in joint venture), there is no rollover available, and a gain or s. 112(1) of the ITA) and, in other circumstances, may be loss on the sale (as well as recapture or a terminal loss for subject to income tax under other Parts of the ITA depreciable capital property) of the property would be (including Part IV). recognized. Similarly, joint venturers (like co-owners) The income taxation of corporations and other available would claim and deduct CCA on their separate property tax incentives depends on used in the joint venture. Therefore, unlike a partnership, ▪ the type of corporation (e.g., public, private, joint venturers compute their net income separately. Canadian-controlled private corporation (CCPC), Whether a joint venture exists is a question to be decided not-for-profit, and registered charity); and based upon all the facts and circumstances. 146 LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION METHODS OF CARRYING ON BUSINESS CHAPTER 16 6. Franchises and licences of retrieving confidential information, regaining control over the business location, repurchasing stock, and 6.1 What is the parties’ relationship? honouring trade debts, as well as the usual conveyancing Both franchise and licence agreements are contractual problems involved in purchasing a business. relationships whereby information or industrial or A franchise is attractive to a franchisee because the intellectual property rights are transferred from one franchisee immediately obtains the benefit of the person to another to enable the transferee to engage in a reputation or goodwill associated with the franchisor and commercial activity. its products. A franchise or licence agreement may be made between Disadvantages to a franchisee may include the degree of business entities of any sort. control exercised by the franchisor and the amount of A franchise is an arrangement established by contract compensation that must be paid by the franchisee while whereby one person (the franchisor) grants to another carrying on the new business. person (the franchisee) a right to use a distinguishing The Arthur Wishart Act (Franchise Disclosure), 2000 trademark or trade name in connection with the supply of (AWA), Ontario’s franchise legislation, came into effect on goods and services by the franchisee. This arrangement January 31, 2001. The primary focus of the AWA is requires the franchisee to conduct its business in “disclosure.” Prior to the franchisee making an investment accordance with prescribed operating methods and in the franchise, franchisors are required to provide procedures developed and typically controlled by the prospective franchisees with relevant and meaningful franchisor. Generally, an up-front fee is payable by the information concerning the franchisor, its principals, the franchisee upon the initial grant of the franchise, and the franchise organization, and the franchise system. franchisee’s business makes extensive use of the franchisor’s know-how, expertise, and established The disclosure document must be accurate, clear, and business goodwill. The franchisor maintains a continuing concise and contain a certificate signed by the franchisor interest in the franchisee’s business by advising and as to the truth and completeness of the document. The providing ongoing assistance and expertise and by AWA contains various penalties, including rescission and monitoring the franchisee’s compliance with common damages where non-compliance occurs. standards and operating techniques required by the In addition to the existing case law on the relationship franchisor. The franchisor has a continuing right to between a franchisor and its franchisee, s. 3 of the AWA receive compensation from the franchisee through fees, imposes a duty of “fair dealing” on each party whereby lease payments, or the sale of products to the franchisee they must act in good faith and in accordance with for resale. reasonable commercial standards. Use of a franchise permits a franchisor to expand It has been held that there is normally no fiduciary duty operations more rapidly than it could if it used its own owed by a franchisor to a franchisee, although the financial resources to establish its own business outlets. franchisor establishes controls over the franchisee’s Franchisees use their capital and borrowing capacity to business for the protection of the franchisor’s goodwill, establish the franchised outlets. integrity of its products, trade techniques, trademarks, Franchising arrangements can take many different forms, and marketing methods. from master franchising relationships, where a person or Restrictions on a franchisee in a franchise agreement may corporation is granted the right to carry on the franchised be challenged on the ground that they are in restraint of business and operate multiple outlets within a designated trade. Such challenges are determined on a case-by-case territory, to simple franchise agreements, where the right basis. to operate a single outlet at a designated location is granted. A franchisee may also have an action for damages against a franchisor and may also be able to obtain an injunction Disadvantages to the franchisor arise from the difficulty of if a franchisor exercises or attempts to exercise predetermining the method and amount of the unauthorized control over the franchisee’s business. franchisor’s compensation and the negative effect it may have on the franchisee’s cash flow. It is often very difficult A licence is a contractual arrangement where the owner of to maintain common standards among the various a patent, trademark, copyright, know-how, or technical franchises, and the transfer of know-how may create data grants (i.e., licenses) to another the right to use such potential competitors. Terminating a franchise as opposed property for an up-front fee and/or an ongoing royalty fee. to firing a manager is fraught with the practical difficulties LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION 147 CHAPTER 16 BUSINESS LAW Licensees and franchisees are independent contractors. A Considerations in determining the appropriate form of key distinction between a franchisee and a licensee is the organization include the following: greater ongoing involvement and control exercised by a ▪ Duration of the activity: Corporations are a franchisor in the business of a franchisee, compared to more permanent vehicle; trusts are used for that exercised by a licensor in the business of a licensee. activities being carried on for a limited time. 6.2 What are the tax consequences? ▪ Liability: Members of an unincorporated association or trust are personally liable. Individual The income tax consequences of a franchise or licence members of a corporation generally do not incur arrangement will depend upon the business vehicle personal liability. chosen by the taxpayer (e.g., sole proprietorship, ▪ Type of property held or owned: partnership, and corporation) to carry out the rights and Unincorporated associations cannot hold real estate obligations under the franchise or licence arrangement. In in their own name but only in the name of a trustee addition, there are special tax rules related to a franchise, or a member, a situation that can give rise to trustee/member succession issues. concession, licence, and similar property. ▪ Procedures: Corporations have greater statutorily Generally speaking, a franchise, concession, licence, imposed compliance obligations. patent, and similar property are granted for a limited ▪ Delegation: Trustees have limited rights to period of time (i.e., the grant is for a fixed period or has a delegate responsibility, apart from administrative limited useful life). There are specific tax rules under the matters, compared with corporate directors. ITA dealing with each type of interest, which require If incorporation is decided upon, the first consideration careful consideration before finalizing any agreement. In should be whether to incorporate under Ontario or federal this case, a franchise, concession, licence, patent, and legislation. The new Canada Not-for-Profit Corporations similar property are considered Class 14 property, and Act establishes a new set of rules for federally their cost is expensed under the CCA rules on a straight- incorporated NFP corporations in Canada. These new line basis over this fixed period. rules replaced Part II of the Canada Corporations Act. 7. Not-for-profit organizations and In Ontario, NFP corporations are now governed by the charities Not-for-Profit Corporations Act, 2010 (ONCA), in force as A not-for-profit (NFP) organization (or “non-profit of October 19, 2021. It will automatically apply to all organization” (NPO), as it is commonly referred to in the Ontario NFP corporations and charities governed by ITA and tax community) and a charity are not necessarily Part III of Ontario’s Corporations Act. Those corporations the same type of entity. Typically, a NFP organization will have a three-year transition period (commencing on refers to social clubs, professional groups, recreation or October 19, 2021) to make any changes to their letters sporting clubs, fraternal organizations, and trade groups. patent/supplementary letters patent, by-laws, and special Subject to compliance with s. 149(1)(l) of the ITA, the resolutions to ensure that such documents do not conflict income of a NFP organization is not subject to income tax. with the new legislation. After the three-year transition period, any provisions in letters patent/supplementary By contrast, to qualify as a charity, an organization is letters patent, by-laws, or special resolutions that are required to register under the ITA and must satisfy the inconsistent with the ONCA (with a few limited definition of “registered charity” contained in s. 248(1) of exceptions) will be deemed to be amended to comply with the ITA. For an entity to be considered a charity, it must the ONCA. satisfy three criteria: In general, the operations of a NFP corporation must be ▪ It must have a charitable object or purpose. carried on without monetary gain to its participants, who ▪ Such object(s) or purpose(s) must be exclusively are called members rather than shareholders. charitable. ▪ It must promote a public benefit recognized by the NFP corporations are entitled to be incorporated upon the courts and not a private benefit. submission of articles of incorporation, any documents that may be required by the regulations under the Both NFP organizations and charities can be organized as applicable statute, and the requisite fee. Such unincorporated associations of individuals, trusts, or corporations are given the capacity rights, powers, and corporations with or without share capital. However, most privileges of a natural person, subject to any limitation in are organized as non-share capital corporations. If the governing legislation. NFP corporations may have any organized as a non-share capital corporation, the NFP purpose that is within the governing legislative authority; organization or charity enjoys all the benefits and however, they may only have commercial purposes to liabilities of a corporation discussed earlier. 148 LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION METHODS OF CARRYING ON BUSINESS CHAPTER 16 advance or support their non-profit purposes. The affairs businesses, whereas a shareholder’s liability to creditors of of such a corporation are managed by a board of directors the corporation is limited to the amount of the consisting of a minimum of three directors. shareholder’s investment. Therefore, if a substantial uninsurable risk is possible, a corporation is the preferable The qualifications for membership are outlined in the vehicle to limit a proprietor’s (or partner’s) liability. legislation. Members are generally admitted into the corporation by a resolution passed by the directors. If the 8.3 Desirability of perpetual existence articles or by-laws so provide, membership may be divided Unless the partnership agreement provides to the into different classes such as honorary members, life contrary, death or disagreement among the partners can members, and ordinary members. Different voting rights result in the dissolution of the partnership. A corporation may attach to different classes of membership. continues notwithstanding the death or withdrawal of a In the case of a NFP corporation that is a charitable shareholder or director. A corporation with perpetual corporation, upon dissolution and after the payment of all existence may be preferable to a partnership or sole debts and liabilities, the remaining property, or part proprietorship that relies for its existence on the survival thereof, shall be distributed or disposed of to charitable of individuals. organizations whose objects are of a similar nature. If the venture is for a single project or a limited number of The ITA exempts the income of registered charities and commercial transactions, consideration should be given to NPOs that meet the requirements of the ITA from income the partnership or limited partnership form since they can tax (ITA, ss. 149(1)(f) and (l), respectively). In order to be dissolved more easily and expeditiously than a maintain such tax-exempt status, care must be taken to corporation. comply with the statutory requirements. Several amendments were recently made to s. 149.1 of the ITA, 8.4 Estate planning including updating the definitions of charitable activities, It may be preferable to use a method that will provide purposes, and devotion of resources. Importantly, financial benefits to family members while keeping the charitable activities can now include, without limitation, business under the proprietor’s control and direction. public policy dialogue and development activities carried Such an objective can be achieved by carrying on the on in furtherance of a charitable purpose, whereas business through a corporation. A well-designed share previously, charities were limited to devoting only 10 per structure can enable the proprietor to control the business cent of their resources to non-partisan political activities. while permitting the equity growth to be owned by Larger NFP organizations are required to file an successive generations. In addition, passing on an interest information return six months after the organization’s in a business under a will to one or more legatees is best fiscal year-end, and all incorporated NFP organizations done through shares in a corporation. must also file information returns (ITA, s. 149(12)). Every 8.5 Number of proposed proprietors registered charity is required to file both an information return and a public information return for the year (CRA Where there will be a large number of owners, Form T3010, Registered Charity Information Return) incorporation is preferable since the responsibility of one with the MNR within six months of the end of its tax year shareholder for the acts of the other shareholders is (ITA, s. 149.1(14)). absent. Moreover, incorporation provides established and accepted rules for control of the business and permits 8. Choosing the best method greater flexibility in financing. In addition, it may be When advising a client as to the most appropriate method simpler to transfer shares in a corporation than to either of carrying on business, care should be taken since no one execute new partnership agreements or amend existing method is best in every case. agreements upon the admission of new partners. 8.1 What is legally possible 8.6 Relationship of proposed proprietors Not all legal arrangements are possible in each case. For A significant consideration is whether it is intended that instance, the number of potential owners and the nature each proprietor take an active role in the affairs of the of the activity being carried on may influence the form of business. In a partnership, one partner can bind the business organization used. partnership, whereas typically one shareholder alone cannot subject the corporation to obligations. 8.2 Limited liability If some proprietors wish to limit their risk or have greater Sole proprietors and most partners are liable to the full security for their investment than others or if there are to extent of their personal assets for the liabilities of their LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION 149 CHAPTER 16 BUSINESS LAW be several degrees of control and risk taking (some and willing to accept the citizenship requirements for bordering on the status of lenders), a limited partnership directors, it may be necessary either to proceed by way of or incorporation utilizing the varying classes of shares and partnership or to incorporate in a province without such share conditions available to a corporation may be requirements. An alternative solution is incorporation preferable. under the CBCA with the appointment of nominee directors with the proper citizenship qualifications, and One disadvantage of incorporation to note is that minority the assumption by the shareholders of all the powers and shareholders are subject to the will of the majority, and duties normally exercised by directors by means of a their shares are not very marketable in the absence of a unanimous shareholder agreement (USA). compulsory buy-sell agreement on the withdrawal of a shareholder. By contrast, if a partner wishes to withdraw As of July 5, 2021, Ontario’s Business Corporations Act and the majority will not buy the partner out, the (OBCA) was amended to remove Canadian residency partnership can normally be dissolved and the assets requirements by repealing s. 118(3). However, the Ontario liquidated. Business Registry still requires OBCA corporations to include the residency status of directors in their current 8.7 Employees filings including, for example, their articles of If the owners want to allow employees to participate in the incorporation (Form 1) and the initial and annual returns growth and profits of the business without giving them the under the Corporations Information Act. management rights of a partner, incorporation or a 8.10 Flexibility of structure limited partnership should be used. It should be noted that a limited partnership is not available if it is intended While the Partnerships Act provides various rules for the to give the employees an interest as a limited partner in partnership structure, many may be negated by return for the employees’ services. A corporation must be agreement. As a consequence, one is left with considerable used if the employees are also to be owners, since latitude to structure the arrangement between the parties. employees may not be general partners. By contrast, many of the rules governing the relationship among shareholders are mandatory. Nevertheless, the 8.8 Costs ability to include in the articles of incorporation The cost of creating and maintaining a corporation will provisions that may be contained in by-laws and the often exceed that of a partnership or limited partnership availability of a USA can provide considerable flexibility and almost always exceed the costs associated with for structuring arrangements among shareholders. carrying on business as a sole proprietorship. 8.11 Income tax Preparation of or amendments to a carefully drawn Although the foregoing considerations are significant partnership agreement may cost as much in legal fees as when determining which form of carrying on business to the incorporation of a corporation or the execution of select, unquestionably a most important and often the corporate amendments. Government fees associated with determining factor will be the impact of income tax the creation of partnerships are less than those associated directly and indirectly on the proprietor. The following with the creation of corporations. discussion is not exhaustive and merely highlights some of Corporations must also keep records specified by statute, the points that should be considered before deciding comply with certain formalities respecting the which business form to choose. maintenance of records and procedures to withdraw An important difference between partnerships and capital, and qualify to carry on business in other corporations is that while the income or loss of the jurisdictions. These are continuing and additional costs business carried on by a partnership is determined at the not required to the same extent by the law governing sole partnership level, that income is taxed in the hands of the proprietorships or partnerships. As a result, a corporation partners, not at the partnership level. Conversely, each may incur higher recurring legal and accounting costs partner may, subject to certain rules, use the partner’s than a partnership or a sole proprietorship. share of losses of the partnership to reduce income from 8.9 Citizenship requirements other sources. The Canada Business Corporations Act (CBCA) imposes The income or loss of a business carried on by a Canadian residency requirements on the composition of corporation is both computed and subject to tax at the the board of directors. Under the CBCA, at least 25% of the level of the corporation. When a corporation’s after-tax directors of a corporation must be resident Canadians. income is distributed to its shareholders by the payment Unless businesses owned by foreign shareholders are able 150 LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION METHODS OF CARRYING ON BUSINESS CHAPTER 16 of dividends, these dividends are generally taxed again in marginal tax rate of 53.35%. Here again, the the hands of the shareholders. tax savings for a CCPC qualifying for the SBD would result from a 41.33% tax rate differential In order to minimize taxes, people who are going to carry (53.53% − 12.2%) on the income in excess of on business in common with a view to profit may prefer to $235,675. There is a significant tax savings do so in a partnership rather than through a corporation. even at very low levels of income by carrying on business in a CCPC that qualifies for the This is so if they expect the business to lose money in its SBD; in 2023, the personal marginal tax rate early years and the partners have income from other on income over $49,231 is 24.15%, resulting in sources, such as investments. If the proprietors are a tax rate differential of 11.95%, and this tax partners, each can deduct the partner’s share of non- rate differential continues to increase until the capital losses (i.e., business losses) from the partnership top marginal tax rate applies on income over against other income in the current year, the three $235,675. preceding years, and the next 20 years. ▪ If a corporation is not eligible for the SBD, there is still an advantage from a tax standpoint to carrying If the business is incorporated, the losses are the on the business through a corporation rather than corporation’s and may be applied only against the as a sole proprietorship or partnership: the lower corporation’s profits for the same carryover periods for tax rate of tax (i.e., the 26.5% regular corporate tax purposes, not against its shareholders’ income. In rate) and deferral of personal tax (on dividends or addition, if the corporation has losses or little profit for other corporate distributions) while the after-tax business earnings are retained inside the several years, some of the losses carried forward may corporation. In 2023, the top combined (federal and expire. provincial) marginal tax rate applicable to an If an individual is going to carry on business alone, expects individual resident in Ontario earning more than $235,675 is 53.53%. Accordingly, the maximum tax the business to lose money in its early years, and has other deferral achieved is the difference between the income, it may be preferable to carry on the business as a general corporate tax rate of 26.5% and the top sole proprietor rather than through a corporation in order personal tax rate of 53.53%; i.e., there is a 27.03% to use losses from the business to reduce income from tax deferral in 2023 and later years. other sources and, therefore, the amount of income tax ▪ If the corporation earns investment income instead that must be paid. of business income, such as portfolio dividends (i.e., as in a holding company that owns a stock In terms of immediate tax consequences associated with portfolio), generally speaking, there is no tax earning either business or investment income in a deferral. In addition, when the corporation’s after- corporation versus personally, the following is a summary tax investment income is paid out as a dividend to of key matters to be considered (see Chapter 18 of these an individual shareholder, there is an overall higher Study Materials for more information): total tax cost paid, such that more tax is paid than if the same investment income had been earned by the ▪ Less immediate tax will be paid if a business is shareholder directly. carried on through a corporation by a CCPC (defined in s. 125(7) of the ITA) that earns active Lastly, the ITA contains provisions to address tax- business income (ABI) qualifying for the small planning strategies involving private corporations that the business deduction (SBD) rather than on an government views as inappropriately reducing the unincorporated basis. personal taxes of high-income earners (see Chapter 18 of — In 2023, a CCPC in Ontario that qualifies for these Study Materials for more information): the SBD is taxed at 12.2% (9% federal tax + ▪ The use of private corporations to “sprinkle” or 3.2% Ontario tax) on the first $500,000 of ABI income split (e.g., via dividends and capital gains) in each year (assuming there are no changes to with family members who are subject to lower the federal and Ontario small business tax personal tax rates was addressed by expanding the rates). Note a CCPC that earns more than tax on split income (also known as “TOSI”) rules as $500,000 of ABI and corporations that do not of January 1, 2018. qualify for the SBD are taxed at the regular corporate tax rate of 26.5% (15% federal tax + ▪ Some taxpayers, taking advantage of the fact that 11.5% Ontario tax). A CCPC qualifying for the corporate income tax rates on business income are SBD would therefore enjoy tax savings because generally lower than personal tax rates, were of this 14.3% tax rate differential accumulating earnings from passive investment (26.5% − 12.2%). portfolios inside a private corporation. But, effective for 2019 and future years, there are two changes: — On the other hand, if the business were carried (1) reducing and then eliminating the SBD for a on as an unincorporated business (i.e., sole corporation once its investment income reaches and proprietorship), any income earned above then exceeds a certain dollar limit (i.e., between $235,675 would be taxable at the top personal LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION 151 CHAPTER 16 BUSINESS LAW $50,000 and $150,000), and (2) significantly “refundable dividend tax on hand” accounts when restricting the ability of a private corporation to paying dividends to shareholders. receive a refund of refundable dividend tax from its 152 LAW SOCIETY OF ONTARIO: NOT TO BE USED OR REPRODUCED WITHOUT PERMISSION