The Independent Consultant's Guide to Selecting and Setting Up a Legal Entity in Canada
Please note that this information is for informational purposes only. Umbrex strongly recommends that you consult with an attorney and tax professional to select the entity type most appropriate for your situation.
Get help setting up an entity in Canada
The majority of independent consultants in Canada choose to operate either as a Sole Proprietorship or incorporate as a Corporation (either federally or provincially). Some may also consider forming a Partnership if collaborating with other consultants. Other entity types like Co-operatives are less commonly used by independent consultants due to their specific purposes and complexities.
Sole Proprietorship
Overview: A Sole Proprietorship is the simplest form of business structure, owned and operated by a single individual without forming a separate legal entity.
- Legal Implications: There is no legal distinction between you and your business. You have unlimited personal liability for all business debts, obligations, and legal actions.
- Tax Implications: Business income is reported on your personal income tax return (T1 General) using the Statement of Business or Professional Activities (Form T2125). You pay personal income tax on net business income. You are also responsible for remitting Goods and Services Tax/Harmonized Sales Tax (GST/HST) if your annual revenues exceed $30,000.
- Suitability: Ideal for independent consultants starting out or those with a low risk of significant liabilities. It offers simplicity and minimal administrative burdens.
Process to Set Up:
- Choose a Business Name:
- You can operate under your own name without registration. If you choose a different business name, you must register it.
- Register the Business Name (if applicable):
- Provincial Registration: Register the business name with the provincial or territorial government where you conduct business.
- Obtain Necessary Licenses and Permits:
- Depending on your province and industry, you may need specific licenses or permits.
- Register for GST/HST:
- Register with the Canada Revenue Agency (CRA) if you expect annual revenues over $30,000 or choose to register voluntarily.
- Open a Business Bank Account:
- Recommended to keep personal and business finances separate.
Partnership
Overview: A Partnership involves two or more individuals (or entities) conducting business together without forming a separate legal entity.
- Legal Implications:
- General Partnership: Partners share unlimited personal liability, jointly and severally, for business debts and obligations.
- Limited Partnership (LP): Consists of at least one general partner (with unlimited liability) and one or more limited partners (liable up to their investment).
- Limited Liability Partnership (LLP): Available only to certain professions (e.g., lawyers, accountants) in some provinces, providing limited liability protection to all partners.
- Tax Implications:
- The partnership itself is not taxed on income. Instead, profits and losses are allocated to partners according to the partnership agreement and reported on their personal or corporate tax returns.
- Partnerships must file an Information Return (Form T5013) with the CRA if certain criteria are met.
- Suitability: Suitable for consultants collaborating closely but willing to accept personal liability. LLPs offer liability protection but are limited to specific professions.
Process to Set Up:
- Draft a Partnership Agreement (strongly recommended):
- Outlines each partner’s contributions, profit-sharing ratios, decision-making processes, and dispute resolution mechanisms.
- Choose a Business Name:
- Must be registered if operating under a name other than the partners’ names.
- Register the Partnership:
- Provincial Registration: Register the business name and partnership with the provincial government.
- Obtain Necessary Licenses and Permits:
- Based on the business activities and provincial regulations.
- Register for GST/HST:
- Register with the CRA if required.
- Open a Business Bank Account:
- Recommended for managing partnership finances.
Corporation
Overview: A Corporation is a separate legal entity owned by shareholders and managed by directors and officers. It can be incorporated federally or provincially.
- Legal Implications:
- Provides limited liability; shareholders are generally only liable up to the amount of their investment.
- The corporation can own property, incur liabilities, and sue or be sued in its own name.
- Tax Implications:
- Corporations file a Corporate Income Tax Return (T2) and pay corporate income tax on net profits.
- Small Business Deduction: Canadian-controlled private corporations (CCPCs) may benefit from a reduced tax rate on active business income up to a certain limit ($500,000 federally).
- Shareholders are taxed on any salary, bonuses, or dividends received from the corporation.
- Corporations must register for GST/HST if revenues exceed $30,000 or voluntarily choose to register.
- Suitability: Preferred by consultants seeking liability protection, potential tax advantages, and enhanced professional credibility. Suitable for those expecting higher profits or planning to reinvest earnings.
Process to Set Up:
- Choose Federal or Provincial Incorporation:
- Federal Incorporation: Allows you to operate under the same name in all provinces and territories.
- Provincial Incorporation: Limits the name protection and operation to the incorporating province.
- Choose a Corporate Name:
- Must be unique and meet specific naming requirements.
- Name Search: Conduct a NUANS (Newly Upgraded Automated Name Search) report for federal and some provincial incorporations to ensure name availability.
- Prepare Articles of Incorporation:
- Define the structure of the corporation, including share classes, restrictions, and business activities.
- File Incorporation Documents:
- Federal Incorporation: File with Corporations Canada.
- Provincial Incorporation: File with the provincial corporate registry office.
- Create Corporate Bylaws and Organizational Resolutions:
- Establish internal governance rules and document initial resolutions (e.g., appointing directors, officers).
- Register for CRA Business Number and Program Accounts:
- Obtain a Business Number (BN) from the CRA for corporate income tax, payroll (if applicable), and GST/HST accounts.
- Register in Provinces/Territories (if required):
- If incorporated federally, you may need to register as an extra-provincial corporation in provinces where you conduct business.
- Obtain Necessary Licenses and Permits:
- Based on business activities and provincial regulations.
- Open a Corporate Bank Account:
- Required for managing corporate finances.
Considerations for Independent Consultants
Selecting the appropriate business entity is a significant decision that impacts your consulting practice’s legal protection, tax obligations, administrative workload, and professional image in Canada. While operating as a Sole Proprietorship offers simplicity and ease of setup, incorporating as a Corporation provides liability protection and potential tax advantages, especially as your business grows and profits increase.
If collaborating with other consultants, forming a Partnership is straightforward but exposes all partners to unlimited liability. Alternatively, incorporating and sharing ownership through shares can provide both liability protection and collaborative flexibility.
- Liability Protection:
- Corporation: Offers limited liability, protecting personal assets from business debts and legal actions.
- Sole Proprietorship/Partnership: No liability protection; personal assets are at risk.
- Tax Efficiency:
- Corporation: Potential tax deferral opportunities by retaining earnings within the corporation at lower tax rates.
- Sole Proprietorship: Income is taxed at personal marginal tax rates, which may be higher at higher income levels.
- Administrative Responsibilities:
- Sole Proprietorship/Partnership: Simplified bookkeeping and fewer reporting requirements.
- Corporation: More complex administration, including maintaining corporate records, filing annual returns, and preparing separate tax filings.
- Costs and Time to Establish:
- Sole Proprietorship/Partnership: Quick and inexpensive to set up.
- Corporation: Higher setup costs due to incorporation fees, potential legal fees, and ongoing compliance costs.
- Professional Image:
- Operating as a corporation may enhance credibility with clients and partners.
- Future Growth and Investment:
- Corporation: Easier to transfer ownership, bring in investors, or sell the business.
- Sole Proprietorship/Partnership: Business is tied to the individual(s), making transfers more complicated.
- Provincial Differences:
- Be aware that incorporation fees, annual filing requirements, and business registration processes vary by province.