What is a business and types of ownership - Segment 2
Host: Welcome to the segment called What is a business? And types of ownership, part of the Starting Your Business video.
I'm your host Janice Novak.
With me is Diane Rice who will share with us, in this segment, information that she has obtained from the CRA to help you identify the type of ownership structure for your new business.
Welcome Diane. Can you tell us what the definition of a business is for income tax purposes?
Subject matter expert: Thank you Janice.
For income tax purposes, a business is an activity that you intend to carry on for profit and there is evidence to support that intention.
A business can include a profession, a calling, a trade, or an undertaking of any kind.
Host: Where can I find more information on this subject?
Subject matter expert: For more information on the definition of a business, go to the CRA's What is a Business webpage. The link is included in the Related links for this segment.
Host: Now assuming that I have met the definition of a business for tax purposes, what would my next step be?
Subject matter expert: Well, you would choose the type of ownership structure that suits your business.
Host: Why is it so important to know the type of ownership structure?
Subject matter expert: The type of ownership you choose has a significant impact on the way you report your income, and on the type of returns you file each year.
One of the most important concerns will be your liability for business debt.
Host: What are some of the different kinds of ownership?
Subject matter expert: The three most common types of ownership are sole proprietorship, partnership, and incorporated.
A sole proprietorship is an unincorporated business that is owned by one person.
It's the simplest kind of business ownership.
The owner of a sole proprietorship has sole responsibility for making decisions, gets all the profits, and claims all the losses. Also, the owner does not have separate legal status from the business.
Host: How does a sole proprietor pay taxes on the business income?
Subject matter expert: As a sole proprietor, you pay taxes by reporting your income, or loss, on an individual income tax and benefit return, referred to as a T1 return.
The income, or loss, forms part of your overall income for the year.
You have to file financial statements or Form T2125, Statement of Business or Professional Activities, with your T1 return.
Host: How does the income, or loss, form part of your overall income?
Subject matter expert: Well, your net business income will be added to all your other sources of income; for example if you received interest income, it will be added to your net business income on your T1 return, and if you have a net business loss, it will reduce your income from other sources.
Host: The second ownership structure you mentioned was a partnership. What is a partnership?
Subject matter expert: A partnership is an association or relationship between two or more individuals, corporations, trusts, or partnerships that join together to carry on a trade or business.
Each partner contributes money, labour, property, or skills to the partnership. In return, each partner is entitled to a share of the profits or losses of the business.
The business profits or losses are usually divided among the partners based on the partnership agreement.
Host: Is it difficult to setup a partnership?
Subject matter expert: Not at all. Like a sole proprietorship, a partnership is easy to form.
In fact, a simple verbal agreement is often enough to form a partnership. However, if money and property are at stake, you should probably have a written agreement.
Host: If a person is in a business partnership, is that person responsible for the partners' decisions relating to the business?
Subject matter expert: The partnership is bound by the actions of any member of the partnership, as long as these are within the normal scope of the partnership's operations.
Host: How does a partnership pay taxes?
Subject matter expert: A partnership itself does not pay income tax on its operating results and, with a few exceptions, does not file an annual income tax return.
Instead, each partner includes a share of the partnership income or loss on their T1 return by including financial statements or Form T2125.
They do this whether or not they actually received their share in money or as a credit to the partnership's capital account.
To determine if your partnership has to file a Partnership Information Return, go to the CRA's Partnership webpage. The link is included in the Related links for this segment.
Host: Now, you said there were three types of ownership. What is the third type?
Subject matter expert: The third type of ownership is incorporated.
The difference with a corporation is that it's a separate legal entity. It can enter into contracts and own property in its own name, separately and distinctly from its owners.
Host: An entity separate from its owners, what does that mean exactly?
Subject matter expert: A corporation may have some of the following features:
- It's a separate legal entity with a perpetual existence; and its shares are passed on upon the death of the owner.
- It can generally raise larger amounts of capital more easily than a sole proprietorship or a partnership, and
- The shareholders can't claim any loss the corporation sustains.
Host: If a business's owner or owners decide to form a corporation and if they have money, property or services to transfer to the corporation, how would it work?
Subject matter expert: Basically, when forming a corporation, the owners transfer money, property, or services to the corporation in exchange for shares. The owners are referred to as shareholders.
Host: Makes sense. Now, how does a corporation pay taxes?
Subject matter expert: Well, since a corporation has a separate legal existence, it has to pay tax on its income, and therefore, it must file its own income tax return, the T2 Corporation Income Tax Return.
Host: Thank you Diane.
This concludes the segment on what a business is and types of ownership for your business, part of the CRA's Starting Your Business video. Thank you for watching.
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