In Ontario, the three most common types of business entities are sole proprietorships, partnerships, and corporations. To begin 2017, we will provide a short description of each type of entity and their advantages and disadvantages. In this blog post, I will focus on corporations.
A corporation is a separate legal entity from the individuals who manage it. It owns the assets (not the shareholders or the directors) and has the liabilities. A corporation may own property in its own name, and it may sue and be sued in its own name. It is the corporation who owns the business, not the shareholders or the directors.
Shareholders, Directors and Officers
There are three main components of a typical corporation: the shareholders, the directors, and the officers.
The shareholders of a corporation own shares. Shares are a bundle of legal rights in a corporation. The rights of the shareholders are limited to the legal rights against the corporation, but they have no right to the assets of the corporation.
In a corporation, the managers are the directors and officers. The shareholders elect the directors. The directors have the power and legal authority to manage or supervise the management of the corporation. The shareholders, directors and officers of a corporation have specific roles and specific legal rights, duties and obligations. It is important to understand this distinction, particularly in a small corporation where the shareholders, officers and directors are all the same people (e.g. in a family-run businesses).
For example, John and Mary want to operate a business to carry on a website hosting business. They each want to be the directors, officers and shareholders as they will running the business together. At the beginning, they will work out of Mary’s house and will not have any employees; that is, they will do everything themselves. They file articles of incorporation with the government and then each purchase 50 common shares in the corporation. As the first directors named in the articles of incorporation, John and Mary also have to pass a corporate authorizing resolution approving the issuance of shares to themselves and to certify that the corporation has received payment for those shares. As shareholders, they then elect themselves as “permanent” directors. As directors, they appoint John as the President and Mary as the Secretary-Treasurer, among many other things. As you can see, there are two people performing three or four different functions within the corporation.
In a small corporation such as this, the lines between shareholder, director, and officer often become blurred; however, it is important to remember that each position or component of the corporation (director, officer and shareholder) has a specific function and purpose. While it may seem inefficient to adhere strictly to the differences between the roles, it is vitally important to do so, as not strictly complying with the legal requirements may result in negative legal consequences.
Below are the advantages and disadvantages of a corporation:
|· Limited liability for shareholders, except where a personal guarantee is given
· Lower income taxes for income retained in the corporation
· Possible income splitting with spouse and children (who are over the age of 18)
· Corporate pension plans can be established
· Can establish a year end other than December 31st
· A corporation does not die even when its shareholders die (perpetual existence)
· The issuance of shares allow silent partners
· Ownership of shares is easily transferred (but corporate rules have to be followed)
· Estate planning potential
· Enhanced capital gains exemption
|· The initial expense of incorporation
· The additional cost of roll-over of assets
· Maintaining corporate records
· Maintaining separate financial records
· Cumbersome technical requirements for small businesses with few individuals involved
· Directors may be faced with personal liability
· Personal liability may occur from improper use of corporate name
· Losses in the corporation remain in the corporation
Business names and the requirement to register under the Business Names Act (Ontario)
If a corporation carries on business under a name other than the corporation’s name, it must register the business name under Ontario’s Business Names Act. A business name registration under the act is valid for five years. The responsibility to renew the business name before the expiry date rests with the corporation – the Ontario government will not remind the corporation that the business name needs to be renewed.
Going back to our earlier example, the corporation that John and Mary incorporate for their website hosting business is called “Ottawa Valley WebHosting Inc.”. If the corporation uses “Ottawa Valley WebHosting Inc.”, it does not have to register under the Business Names Act. However, if the corporation decides to use “WebHosting by John and Mary”, this name must be registered by the corporation as the corporation is carrying on business in a name other than its corporate name.