A proprietorship is the simplest form of business. The owner and the business are the same legal person. A corporation (a limited company) is a separate legal entity that owns its own contracts, debts, and obligations. Each has advantages. Each has costs.
Formation
Starting a proprietorship is straightforward. Pick a business name, register it (in Alberta, through a registry agent), and start operating.
Starting a corporation is more involved. You file articles of incorporation, set up share classes, name directors, and on government approval the corporation becomes its own legal entity that can enter into contracts and own property in its name. See Steps to Incorporate for the full sequence.
Cost of maintaining
Both forms incur legal and accounting costs from contracts, sales agreements, and routine bookkeeping. A corporation adds annual filings, corporate income tax returns, company resolutions, and directors’ meeting minutes. More formal records have to be kept because the corporation is a separate legal entity. Plan for higher ongoing cost.
Liability of owners
A proprietorship is not a separate legal entity. The owner is personally liable, to the full extent of their personal assets, for every debt and obligation the business takes on.
A corporation is a separate legal person. Shareholders are only liable for company debts up to the amount of their share capital and any loans they have personally made to the company. In practice, banks often require small business owners to give a personal guarantee before lending to the corporation, which weakens that shield.
Limited liability is real, though, and protects personal assets from trade creditors if the business runs into trouble. Directors and major shareholders can still be held personally liable for unremitted employee wages, unpaid corporate tax, improperly declared dividends, and improper shareholder loans.
If you are taking on a venture with meaningful liability exposure, a corporation should be on the table. Insurance helps too. In many cases, only the combination of insurance plus incorporation provides adequate protection.
Continuity of existence
A proprietorship ends when the owner dies. A corporation continues legally regardless. In practice, a small closely-held corporation may not be able to keep operating if its sole owner dies, but the legal shell continues, which simplifies the wind-up.
Tax considerations
Rates of tax
Proprietorship income is taxed in the hands of the proprietor at graduated personal rates. As the business earns more, the effective rate climbs.
A corporation is taxed at a relatively flat rate. Most Canadian controlled private corporations qualify for the small business deduction on the first $500,000 of active business income. In Alberta that combined federal and provincial rate is in the low double digits. Above the $500,000 threshold, the rate steps up.
Wages paid by the corporation to an active owner are deductible as an operating expense for the corporation. The remaining corporate income is taxed at the corporate rate. The owner then chooses the most tax-efficient mix of wages and dividends to draw out for personal use. We model that mix per client. See the Owner-Manager Remuneration Mix calculator for an illustrative version.
Tax deferral
A corporation can declare wages owed in one fiscal year and pay them in the next. The corporation gets the deduction the year it accrues; the individual is taxed in the year they receive the cash. That can produce a one-year deferral. A proprietorship is taxed on earnings in the fiscal year the income is earned, no matter when cash moves.
Application of losses
If a proprietor has a business loss, it can usually be applied against other personal income that year. Corporate losses can be carried back three years or forward twenty, but only against the corporation’s own income, not the owner’s. That makes the proprietorship form more useful in early unprofitable years. A common pattern is to operate as a proprietor while losses are likely, then incorporate once the business turns profitable.
Employee participation
A corporation can reward employees with profit-sharing through non-voting shares without diluting control. A proprietor who wants to do the same has to admit the employee to a partnership, which usually gives away more control than intended.
Summary
A corporation has more advantages than a proprietorship. It also has higher initial and ongoing costs. The right choice is whether the advantages, in your situation, are worth the extra cost. We run that cost-benefit analysis with you before you commit.