What is the difference between a sole proprietorship and a corporation?

Looking to start a business but don't know what entity structure to implement? 

There are in fact 4 different types of entity structures you may choose to trade under (not including non profit organisations or clubs).

They are:

• Sole Proprietorship
• Partnership
• Corporation
• Trust

Sole Proprietorship

A sole proprietorship is a business owned and operated by an individual. There is no legal distinction between the owner and the business, meaning the owner is personally liable for all debts and obligations.

The benefits are simplicity and control: setup and running costs are low, the owner keeps all profits, and decision-making is entirely in their hands.

Sole proprietors report business income on their personal tax return (T1) and pay personal income tax at federal and provincial rates. Canada also provides a basic personal amount that is tax-free ($15,000 federally for 2024). Profits above this threshold are taxed according to progressive tax rates, varying by province.

Partnership

A partnership is a business run by two or more people. Like a sole proprietorship, a general partnership is not a separate legal entity, so partners are jointly and personally liable for business debts.

Partnerships allow owners to pool skills and resources, and profits are taxed in the hands of each partner, avoiding corporate taxation.

While there is no legal requirement for a written partnership agreement, it is strongly recommended. An agreement should outline partners’ contributions, how profits are shared, and what happens if a partner leaves or the partnership dissolves.

Setup costs are generally low but slightly higher than a sole proprietorship. Each partner reports their share of profits on their personal tax return.

Corporation

A corporation is a separate legal entity from its owners. Ownership is determined through the issuance of shares, and shareholders’ liability is generally limited to the amount unpaid on their shares, protecting personal assets beyond their investment.

Corporations can be federally or provincially incorporated, with registration required with Corporations Canada or the relevant provincial authority. Companies must file annual returns and corporate tax filings.

Corporations pay corporate income tax on profits. The federal general corporate tax rate is 15%, with additional provincial taxes depending on the province. Canadian-controlled private corporations (CCPCs) may qualify for the small business deduction, reducing the federal tax rate on the first $500,000 of active business income to 9%.

One of the advantages of corporations is that ownership can be transferred easily by selling or assigning shares, without affecting ongoing operations. This structure is suitable for raising capital, attracting investors, or planning for succession.

Trust

A trust is a legal arrangement where a trustee holds property or assets for the benefit of beneficiaries, under a trust agreement. While not a separate legal entity, trusts are considered taxable entities in Canada and must usually file a T3 Trust Income Tax Return.

Trustees can be individuals or corporations. Trusts are commonly used for estate planning, family businesses, and asset protection. Types include testamentary trusts, inter vivos (living) trusts, and unit trusts, each with specific rules and tax implications.

Trust income is either taxed within the trust or allocated to beneficiaries, who then report it on their personal tax returns. Properly managed trusts can help minimize tax liability and facilitate wealth distribution.

Trusts can be complex and costly to establish and maintain, and professional legal and tax advice is usually necessary.