BU111 Study Guide - Final Guide: Sole Proprietorship, Privately Held Company, Tax Advantage

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Published on 16 Oct 2011
School
WLU
Department
Business
Course
BU111
Forms of business ownership
Unincorporated versus incorporated
businesses
o Legalistic distinction
o Implications for liability of owners
Taxation of different forms of ownership
o Taxation of unincorporated
businesses
Profits taxed on
progressive personal tax
rates
o Taxation of corporations
Profits taxed on fixed
corporate rates
Regular corporate
tax rates
Small business
rates
When to incorporate from
a tax perspective
Sole proprietorship
o Advantages and disadvantages
Partnerships
o The partnership agreement
o Advantages and disadvantages
o Types of partners
General and limited
partners
Corporations: definition
o Formation of a corporation
Approaches
Articles of incorporation
Required content
Federal versus
provincial
corporation
o Public corporation vs. private
Advantages and
disadvantages
o Private corporation
Restrictions
Advantages and
disadvantages
Legal forms of business ownership
2 forms of business ownership
Corporation an entity created by law that possesses all the rights of the individual but has a legal
status that is separate and distinct from that of its owners (shareholders)
o can do all the things individually that WE can do, has its own name
Unincorporated businesses
o Sole proprietorship an unincorporated business that is owned and run by one individual for
his or her private profit (most popular form)
o Partnership
unincorporated business that is owned and run by more than one person for
their private profit (not limited to just two people)
Incorporated businesses
o Public corporation legally entitled to sell its shares to the general public
o Private corporation legally is not entitled to sell its shares to the general public (has not
gone through process to get approval to sell shares to the general public)
Distinction between unincorporated and incorporated businesses is legalistic in nature
o Its legalistic distinction will affect the personal liability of the owners
o Will also affect the taxation of the business
These 2 factors are the most crucial factors to consider which form of business an owner/owners will
want to adopt
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Unincorporated businesses
o In the eyes of the law in Canada, the law does not distinguish between the owners of the
business and the business itself, and because of this lack of distinction, it gives rises to
significant ramifications when it comes to personal liability and taxation
o Huge disadvantage: law does not distinguish between the business and the owners: thus,
businesses will have an unlimited liability
o Ex. Joe has a business, can easily differentiate between his personal assets (house, car) and his
business assets (store, equipment). If Joe’s business in trouble and insufficient to pay the
claims of creditors, Joe has to pay creditors by selling off his personal assets such as house, car
etc. This is called unlimited liability
Corporations
o A legal entity that is created by law that possess all the rights of an individual but has a legal
status that is separate from the individual
o Corporate veil separates the personal assets and business assets
o Therefore, creditors can only look at the assets of the business to satisfy their claims, creditors
has no right to his personal assets, you have protected your personal assets
Taxation
Unincorporated business
o Business’s profits are taxed under personal tax law (graduated/progressive system)
o Business profits equals owner profits
o Profits of business is just added to the personal taxable income
Incorporated business
o Taxed on the basis of corporate tax system (FIXED rate system, NOT progressive)
o Federal (19%) and Ontario tax (14%), thus fixed corporate rate is 33%
o (calculation is online)
Tax comparison: large public corporation versus proprietorship
Assume $750 000 in profit, pubic corporation = $247 500 in tax
Whereas sole proprietorship, taxed on progressive system will pay 331 360
The tax differential is 83 860, however they made the same profit
Private corporation tax rates 2009 small business rate on first 500 000
o Federal government gives 17% reduction on the 28% federal tax and provincial gives 8.5
reduction, total is 16.50% tax rate
Small business tax rates RULES
o Must be Canadian controlled private corporation (50% of stock outstanding must be held by
Canadians) in order to be eligible for the reductions
o In order to be eligible for the 16.5% rate, must retain earnings to retain savings
Rates changes for income above 500 000
Once go above 500 000, then federal rate jumps to normal 19% and provincial 14%
Once go above 500 000, they take back the 42 500 benefit they gave you if you made
less than 500 000, they will now add a surtax of 4.250% on every dollar after 500 000,
until they have recaptured their 42 500 (this means once you get to 1.5 million dollars
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in profit, they have gained back their 42 500 (33% + 4.250%), then once you get PAST
1.5 millions, tax rates go back to normal less the surtax)
Traditional forms of business ownership
Businesses often start off as a sole prop. Or a partnership, then they start to realize the drawbacks
unlimited liability and taxation problems
Begin to consider moving business to private corporation
Then once get to a certain point in private corporation where you are restricted to the ability to create
capital because you cannot sell your shares, then you move towards public corporation, in order to
sell shares to the general public
You do not incorporate a business until they are profitable, and will be profitable for future years
o Any losses that you suffer in an unincorporated business can be written off other sources of
taxable income
o Ex. Income from other sources, $50 000, if sole prop generates a loss of 5000, then that loss
can be written off as a direct expense against any other sources of income that you are
producing, therefore, your taxable income will now be 45 000 tax deduction
o These loses can actual finance the business itself
If you incorporate a business, if it suffers loss of 5000, the 5000 loss can NOT be written off, tax for the
year would be 0%, however you can take the 5000 loss, and write it off for future years (ex. Next year
20 000, 5000 will reduce taxable income to 15 000)
o Can carry a loss forward for a max of seven years, or you can write the loss off in past years
(max of 3 years, thus you redo your taxes) just not your current year
Most common form of ownership is sole proprietorships (74%)... but which has the largest sales?
o Sole prop only account for 9% of total sales, partnerships (4%), corporations (87%)
Sole Proprietorships - Advantages (4)
Easiest form to establish and dissolve because there are no legal restrictions to establish a sole prop,
only requirement is that business is legal and in some cases, get a business license
Owner has sole claim on all profits and must bear all losses max level of incentive, freedom and
personal satisfaction, speed of decision making (no need to get approval from others etc)
Tax advantage losses can be written off against other sources of personal income
Max levels of secrecy, no need to public disclose financial statements (balance sheets, income
statements)
Disadvantages (5)
Unlimited liability of owner personal assets are at risk, creditors can seek your personal assets
Lack of continuity in the event of the death or long term illness of the owner
Difficulty of raising capitals can’t sell shares, difficult to get bank loans unless you have collateral
o No capital to expand
Severe management limitations contribute to keeping sole prop small lack of knowledge in finance,
taxation, business etc.
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Document Summary

Unincorporated versus incorporated businesses: legalistic distinction. Taxation of different forms of ownership: taxation of unincorporated businesses. Profits taxed on progressive personal tax rates: taxation of corporations. When to incorporate from a tax perspective. Partnerships: the partnership agreement, advantages and disadvantages, types of partners. Corporations: definition: formation of a corporation. Federal versus provincial corporation: public corporation vs. private. Distinction between unincorporated and incorporated businesses is legalistic in nature. Its legalistic distinction will affect the personal liability of the owners: will also affect the taxation of the business. These 2 factors are the most crucial factors to consider which form of business an owner/owners will want to adopt. Joe has a business, can easily differentiate between his personal assets (house, car) and his business assets (store, equipment). If joe"s business in trouble and insufficient to pay the claims of creditors, joe has to pay creditors by selling off his personal assets such as house, car etc.