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SOLE PROPRIETORSHIP, PARTNERSHIP OR INCORPORATION?  THE DOLLAR AND SENSE OF CONTRACTING

By George H. Wall

At the end of the day, the number of dollars a contract consultant has in his or her pocket is, to a large extent, affected by how well they organise, manage and run their consultancy. Professional legal and accounting advice, and effective record keeping, can have a substantial effect on that bottom line.

BUSINESS STRUCTURE
Each of the three types of business structures, sole proprietorship, partnership, and corporation carries with it certain financial considerations.

SOLE PROPRIETORSHIP

Advantage
  • Inexpensive to start and comply with regulations.
Disadvantages
  • Owner is subject to unlimited liability.
  • Contracting agencies must deduct CPP and EI, placing both the agency and consultant at a financial disadvantage.
  • Tax deduction for some expenses (e.g. office in home and car) are restricted.
  • All income is not subject to personal tax rates.
  • February 95 budget requires accrual of non December 31 year ends with more accounting effort and cost.

PARTNERSHIP

Advantages

  • Inexpensive to start and comply with regulations.
  • Agencies need not deduct CPP or EI.
Disadvantages
  • Owners are subject to unlimited liability.
  • All income is subject not personal tax rates.
  • Each partner can be bound by errors or omissions of the other partner(s).
  • A partnership agreement should be completed.
  • February 95 budget requires accrual of non December 31 year ends with more accounting effort and cost.

CORPORATION

Advantages

  • The liability of the owner(s) is limited.
  • Corporate structure makes it easier to sell the business and facilitate estate planning.
  • Assets of an existing business can be transferred to a new corporation tax free.
  • Capital can be raised by selling shares.
  • Alternative financing can be arranged through accounts payable without putting personal assets at risk.
  • Government assistance and tax incentives are available to corporations.
  • Personal taxes can be reduced through the use of the dividend tax credits.
  • The corporation can issue shareholder’s loans on better terms that are otherwise available.
Disadvantages
  • The cost of incorporation can range from $700 to $1,500.
  • There is considerable extra paperwork (minutes, registers, income tax returns, etc.).
  • The annual accounting fees for compliance with accounting regulations is about $850.
SELECTING PROFESSIONAL ADVISORS
The quality of the accounting, legal, banking and insurance advice you receive can make a significant difference to your professional practice. In choosing advisors, the recommendations of peers and business associates are an excellent indicator. However, be sure to check out the advisor to ensure that you feel comfortable with them.

A minimum indicator of the appropriate business advisor is their credentials. Legal advisors should have an L.L.B. designation and your accountant should be a C.A. There is also a correlation between the degree of expertise and length of time in practice. Don’t be afraid to ask how many years of experience you advisor has in your area of need.

The size of firm you deal with can also make a difference. You are more likely to find a suitable advisor in a firm whose size is comparable to yours. Large firms tend to have higher fees and lack a small business orientation in their marketing and service priorities. Often, large firms will pass small business clients to junior associates or trainees to free more senior advisors to handle larger clients.

You should seek out advisors who have a good client base of firms the same size and industry as you. It is important that your advisors have a good understanding of the environment in which you operate.

A critical factor in the selection of advisors is style. An advisor who takes the initiative and offers advice before you request it can provide significant value to your business. This style indicates an initiator rather than a reactor, a person who anticipates and performs before the matter becomes serious. This kind of advisor is more likely to come up with creative solutions to problems, to complement your planning function and be a true part of your management team.

Another important issue is compatibility. If there is a poor fit between you and your advisors, you might find yourself rejecting advice based on personality alone. You should feel a sense of confidence when relating to your advisor, both in the general sense and in dealing with specific issues. At the same time, you should consider your advisors as equals who offer specialized knowledge in the same way you offer services to your clients.

Finally, an advisor should be there for you when you need them. If they are frequently out of town, or in the case of a lawyer, in court on a regular basis you may not have the immediate access you require. Of course, if the advisor is of exceptional quality and ideally suited to your type of practice, some allowances should be made.

RECORD KEEPING
The general definition of a business expense is any money that is spent that has a reasonable chance of producing income some time in the future. The contract consultant should keep track of all money spent whether or not he or she construes it as a business expense. If your financial advisor is aware of all expenditures, they can assess the deductibility for tax purposes.

A receipt should be kept whenever possible for any expense. If, however, a disbursement is made and a receipt is not obtained, a record should be made of the expenditure. The accountants have accepted expenses without receipts when they have been judged to be reasonable for the circumstances.

SUMMARY
Selecting the most appropriate business structure, finding suitable advisors, and keeping complete records are important steps along the road to success in your business. However, space here allows only a cursory look at the business issues you face. Build a good working relationship with your advisors, they can help ensure that your next steps are the more profitable ones.

© 2000 Canada Business Service Centres, All Rights Reserved

If you are required to remit C.P.P. and E.I. premiums, the costs of C.P.P. are payable whether you are incorporated or not, but E.I. premiums are generally not payable for the consultant or his spouse if the consultant is incorporated. Since most consultants, due to the demand for their service and the E.I. rules, are seldom able to collect E.I. benefits, the cost of E.I. premiums required to be paid (maximum of approximately $3,000 per annum) is an expense which is seldom justified.

EXPENSE TREATMENT CAN VARY WITH THE FORM OF ORGANIZATION
Revenue Canada has interpreted the deductibility of certain expenses differently depending on the form of business organization for car expenses and office-in-home expenses.

In the case of car expenses, if the business is not incorporated, the car expenses must be calculated on the basis of actual expenses incurred and receipts must be provided to substantiate these costs. In the case of an incorporated entity, the corporation can elect to use a mileage rate of $0.31 per km for the first 5,000 kilometers and $0.25 per kilometer thereafter. In situations where a car is used for more than 24,000 kilometers of business driving, it is likely that the mileage rate will yield a higher expense against the business than the compilation of actual expenses.

Regarding office-in-home expense, a sole proprietor is only entitled to deduct this expense if he uses the office in his home as his primary place of business and/or he sees clients in his home office on a regular basis. With a corporation, there are no such restrictions.

WHAT IS A VALID EXPENSE?
The general criterion for a business is that it must be money spent that has a reasonable chance of resulting in income sometime in the future. This is a grey area and is open to numerous interpretations. If you were to ask an entrepreneur what portion of his lifestyle expenditures would be a business expense, he would probably tell you somewhere between 90% and 100%. If you were to ask a new computer consultant the same question, he would probably tell you that he might have a few expenses to deduct. We are constantly striving to encourage our clients to see themselves as entrepreneurs.

In order to encourage our clients to maximize their after tax income, we ask them to give us all the information regarding all the money that they have spent. This gives our office the maximum opportunity to determine that deductibility of an expense and also allows the clients to understand more about where their money goes so that they can make decisions that involve lifestyle changes based on facts.

We believe that a large percentage of consultants are paying higher taxes than they should and could benefit from reviewing their situation. In general, if you are paying more than 18% of gross income in taxes, we believe you may need a financial check-up.

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