Chapter 1: Setting Up Your Business

• Sole proprietorship
• Partnership
• Corporation
• The Business Number (BN)
• Keeping records
• Bringing assets into a business

A business is an activity that you conduct for profit and there is evidence to support that initiative. There are three types of business structure: sole proprietorship, partnership, and corporation. The way your business is taxed has a lot to do with the way your business is set up.

Sole proprietorship

A sole proprietorship is an unincorporated business that is owned by one person. It's the simplest kind of business structure.

The owner of a sole proprietorship has sole responsibility for making decisions, receives all the profits, claims all losses, and does not have separate legal status from the business.

If you're a sole proprietor, you pay personal income tax on all revenue generated by your business. You also assume all the risks of the business. The risks extend even to your personal property and assets.

As a sole proprietor, you have to register for the goods and services tax/harmonized sales tax (GST/HST) if your worldwide annual taxable revenues are more than $30,000.

It's easy to set up a sole proprietorship. Simply operate as an individual or as a registered, unincorporated business. If you operate as an individual, just bill your customers or clients in your own name. If you operate under a registered business name, bill your clients and customers in the business's name. If your business has a name other than your own, you'll need a separate bank account to process cheques payable to your business.

How does a sole proprietor pay taxes?

A sole proprietor pays taxes by reporting income (or loss) on a personal income tax and benefit return (T1). The income (or loss) forms part of the sole proprietor's overall income for the year.

If you're a sole proprietor, you must file a personal income tax and benefit return if you:

• have to pay tax for the year;
• disposed of a capital property or had a taxable capital gain in the year;
• are required to make Canada Pension Plan/Quebec Pension Plan (CPP/QPP) payments on self-employed earnings or pensionable earnings for the year; or
• received a demand from us to file a return.

The list above does not include every situation where you may be required to file. If you're unsure, call us at 1-800-959-5525.

• Form T2124, Statement of Business Activities;
• Form T2032, Statement of Professional Activities;
• Form T2042, Statement of Farming Activities;
• Form T1163, Statement A - CAIS Program Information and Statement of Farming Activities for Individuals;
• Form T1164, Statement B - CAIS Program Information and Statement of Farming Activities for Additional Farming Operations; or
• Form T2121, Statement of Fishing Activities.

We will also accept a computer-generated version of the applicable form.

For GST/HST, sole proprietors have reporting periods for which they have to file a return. For more information, see the section "Reporting periods".

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Partnership

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 in the business. The business profits (or losses) are usually divided among the partners based on the partnership agreement.

Like a sole proprietorship, a partnership is easy to form. In fact, a simple verbal agreement is enough to form a partnership. However, if money and property are at stake, we recommend that you have a written agreement.

The partnership is bound by the actions of any member of the partnership, as long as these are within the usual scope of the operations.

How does a partnership pay taxes?

A partnership by itself does not pay income tax on its operating results and does not file an annual income tax return. Instead, each partner includes a share of the partnership income (or loss) on a personal, corporate, or trust income tax return. You do this whether or not you actually received your share in money or in credit to your partnership's capital account.

Each partner also has to file either financial statements or one of the forms referred to in the section on sole proprietorship or a computer-generated version of one of these forms:

• Form T2124, Statement of Business Activities;
• Form T2032, Statement of Professional Activities;
• Form T2042, Statement of Farming Activities; and
• Form T2121, Statement of Fishing Activities;
• Form T1163, Statement A - CAIS Program Information and Statement of Farming Activities for Individuals.

A partnership has to file a partnership information return if, throughout the fiscal period, it has six or more members or if one of its members is a member of another partnership. For more information, see the T4068, Guide for the Partnership Information Return and Information Circular IC89-5, Partnership Information Return, and its Special Release.

For GST/HST purposes, a partnership is considered to be a separate person and must file a GST/HST return and remit tax where applicable.

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Corporation

A corporation is a separate legal entity. It can enter into contracts and own property in its own name, separately and distinctly from its owners.

Since a corporation has a separate legal existence, it has to pay tax on its income, and therefore must file its own income tax return. It must also register for the GST/HST if its taxable worldwide annual revenues (including those of associates) are more than $30,000.

You set up a corporation by completing articles of incorporation, and filing them with the appropriate provincial, territorial, or federal authorities.

How does a corporation pay taxes?

A corporation must file a corporation income tax return (T2) within six months of the end of every taxation year, even if it doesn't owe taxes. It also has to attach complete financial statements and the necessary schedules to the T2 return. A corporation pays its taxes in monthly instalments. For more details on instalment payments and the filing requirements for corporations, see the T4012, T2 Corporation - Income Tax Guide.

For GST/HST, corporations have reporting periods for which they have to file a return. For more information on reporting periods, see the section "Reporting periods".

The taxation year for a corporation is its fiscal period. For more information on fiscal periods, see the section "Fiscal period".

For more details, visit our Corporations Web page.

Are you responsible for your corporation's debts?

As a shareholder of your corporation, you have limited liability. In the strict sense, this means you and the other shareholders are not responsible for the corporation's debts. However, limited liability may not always protect you from creditors. For example, if a smaller, more closely held corporation wants to borrow money from a bank or other creditor, the creditor may ask for the shareholder's guarantee that the debt will be repaid. If you agree to this condition, you'll be personally liable for that debt if the corporation does not pay it back.

This applies to taxes owing as well. If your corporation owes taxes, and you have personally guaranteed any loan on behalf of your corporation, we will claim the amount of the taxes owing up to the limit of the loan guarantee.

Directors may also be liable to pay amounts owed by the corporation if it has failed to deduct, withhold, remit or pay amounts as required by the Income Tax Act, Employment Insurance Act, Canada Pension Plan and Excise Tax Act.

For more information on the subject of Director's Liability, see Information Circular IC89-2, Directors' Liability - Section 227.1 of the Income Tax Act and Section 323 of the Excise Tax Act.

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The Business Number (BN)

Your first step to doing business with the CRA

The BN is a numbering system that simplifies and streamlines the way businesses deal with us. It is based on the idea of "one business, one number." This helps businesses reduce costs and be more competitive. It also increases government efficiency. You get your BN the first time you register to do business with us. Eventually, businesses will be able to use their BN for other government programs.

The BN consists of two parts: the registration number and the account identifier.

The four major Canada Revenue Agency (CRA) business accounts and the account identifiers are as follows:

• RC - corporate income tax
• RM - import/export
• RP - payroll deductions
• RT - GST/HST

The BN number has 15 digits:

• 9 numbers to identify the business;
• 2 letters for the type of account; and
• 4 numbers for the account reference.

For example, your BN might look like this:

Businesses that register for the BN will get one-stop business services from us, including integrated new business registration, a consolidated approach for updating account information, and integrated business account enquiries.

Your BN, and all information relating to it, are confidential.

You can register for a BN by Internet, telephone, fax or mail. Business Registration Online is a one-stop, self-serve application that allows you to register for a new business number as well as the four major CRA programs, namely corporate income tax, GST/HST, payroll deductions and import/export. At the same time you can register online for Ontario, Nova Scotia, New Brunswick and British Columbia programs.

If the business's mailing address is in Québec, we will offer the option to be directed to the Revenu Québec Website.

Business Registration Online is easy to use, convenient and secure.

Are you doing business in Quebec?

For businesses in Quebec, the BN does not include GST/HST accounts. Revenu Québec administers the GST/HST on behalf of the CRA. If you plan to register for the GST/HST in Quebec, please contact Revenu Québec for more information at this address:

Revenu Québec
3800, rue de Marly
Ste-Foy QC G1X 4A5

Telephone: 1-800-567-4692
Outside Canada: (418) 659-4692

Do you need a BN?

If you need at least one of the four CRA business accounts listed before, you will need a BN.

However, before you register for the BN, you need to know a few things about the business you plan to operate. For instance, you should know the name of the business, its location, its legal structure (sole proprietorship, partnership, or corporation), and its fiscal period end. You should also have some idea of what the sales of your business will be. Without this information, you won't be able to complete the BN registration form.

For more information on the BN, see pamphlet RC2, The Business Number and Your Canada Revenue Agency Accounts, call us at 1-800-959-5525 or visit our Business Number (BN) registration Web page.

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Keeping records

Five reasons why keeping records can benefit you

1. Good records can help you identify the sources of your income.

You may receive cash or property from many different places. If you don't have records showing your income sources, you may not be able to prove that some sources are non-business or non-taxable.

2. Well-kept records can mean tax savings.

Good records serve as a reminder of deductible expenses and input tax credits. If you don't record your transactions, you may forget some of your expenses or input tax credits when you prepare your income tax or GST/HST returns.

3. Well-kept records can prevent most of the problems you might encounter if we audit your income tax or GST/HST returns.

If your records are so incomplete that auditors cannot determine your income from them, the auditors will have to use other methods to establish your income. This will cost you time. If your records do not support your claims, they could be disallowed.

4. Your records will keep you better informed about the financial position of your business.

You need good records to establish your profit or loss, and the value of your business. Information from good records can also tell you what is happening in your business and why. The successful use of records can show you trends in your business, let you compare performance in different years, and help you prepare budgets and forecasts.

5. Proper records may help you get loans from banks and other creditors.

Creditors need accurate information about your current financial position before they give you a loan. You can't give them this information if you don't keep organized records. Also, good records show potential creditors that you know what's going on with your business.

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Legal requirements for keeping records

All records such as paper documents, as well as those stored in an electronic medium (e.g., on computer disk), must be kept in Canada or made available in Canada at our request. The records must be in English or French. Today many kinds of records are kept in electronic formats. Information on keeping these type of records is available in the guide RC4409, Keeping Records.

You can keep these documents outside Canada if you get written permission from your tax services office.

What records should you keep?

Make sure you keep orderly records of all income you receive. Also, keep all receipts, invoices, vouchers, and cancelled cheques indicating outlays of money. Such outlays include:

• salaries and wages;
• operating expenses such as rent and advertising, and capital expenditures; and
• miscellaneous items, such as charitable donations.

If you import goods into Canada, your records must substantiate the price you paid for imported goods, and list their origin and description. They must also include any documentation about the reporting, release, and accounting of the goods, as well as the payment of duties and taxes.

You should keep these records at your place of business or residence in Canada (unless you get written permission from us to keep them elsewhere). You have to make them available to us if you're asked to do so.

Your records must be permanent

Whichever accounting or record-keeping method you use, your records must be permanent. They must contain a systematic account of your income, deductions, credits, and other information you need to report on your income tax and GST/HST returns.

What information should your records contain?

It's not hard to keep records that meet the requirements of the law. However, sketchy or incomplete records that use approximates instead of exact amounts, are not acceptable.

Your records must:

• allow you to determine how much tax you owe, or the tax, duties, or other amounts to be collected, withheld, or deducted, or any refund or rebate you may claim; and
• be supported by vouchers or other necessary source documents. If you do not keep your receipts or other vouchers to support your expenses or claims, and there is no other evidence available, we may reduce the expenses or claims you have made.

Retaining and destroying records

The six-year requirement

You must retain records (other than certain documents for which there are special rules) for six years from the end of the last taxation year to which they relate for income tax, for six years from the end of the year to which they relate for GST/HST purposes or for six years after the goods are imported or exported.

If you filed your income tax return late, keep your records and supporting documents for six years from the date you filed the late return.

The minimum period for keeping records is usually measured from the last year you used the records, not the year the transaction occurred or the record was created.

You have to keep every record necessary for dealing with an objection or appeal until it is resolved and the time for filing any further appeal has expired, or until the six-year period mentioned above has expired, whichever is later.

Request for early destruction

If you want to destroy your records before the six years are up, you must apply in writing to the director of the tax services office in your area to obtain written permission from the Canada Revenue Agency. To do this, either use Form T137, Request for Destruction of Books and Records, or prepare your own written request. In addition to our requirements, there are other federal, provincial, and municipal laws that require you to keep records. We have no authority to approve destruction of records that these other laws require you to keep.

For more information, see Guide RC4409, Keeping Records.

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Bringing assets into a business

Fair market value

You may find yourself in a situation where you would like to take assets that belong to you personally and transfer them to your business.

If you are operating a sole proprietorship, this is a reasonably simple process. The Income Tax Act requires that you transfer these assets to the business at their fair market value (FMV). This means that we consider you to have sold these assets at a price equal to their FMV at that time. If the FMV at the time of the transfer to the business is greater than your original purchase price, you must report the difference as a capital gain on your income tax and benefit return.

You can claim a GST/HST input tax credit based on the basic tax content of the assets you transfer to your business. For more information visit our Basic tax content formula Web page or call us at 1-800-959-5525.

Your business will show a purchase of these assets, with a cost equal to the FMV at the time of the transfer. This is the value that you will add to the capital cost allowance schedule for income tax purposes.

For income tax purposes, when you transfer the property to a Canadian partnership or a Canadian corporation, you may transfer the property to the partnership or the corporation for an elected amount. This amount may be different from the FMV, as long as you meet certain conditions. The elected amount then becomes your proceeds for the property transferred, as well as the cost of the property to the corporation or partnership.

The rules regarding these transfers of property are technical in nature. For more information, see Interpretation Bulletin IT-291, Transfer of Property to a Corporation under Subsection 85(1), Information Circular IC76-19, Transfer of Property to a Corporation under Section 85, and Interpretation Bulletin IT-413, Election by Members of a Partnership under Subsection 97(2).

Buying an existing business

When you are considering becoming a business owner, you will find that you have the option of either buying an existing business or starting up a new business. The option you choose will have a significant effect on how you account for the purchase of the business assets for income tax purposes.

When you buy an existing business, you generally pay a set amount for the entire business. In some cases, the sale agreement sets out a price for each asset, a value for the inventory of the company and, if applicable, an amount that you can attribute to goodwill. If the individual asset prices are set out in the sale agreement, and the prices are reasonable, then you should use these prices to claim capital cost allowance. If the individual asset prices are not set out in the contract, you have to determine how much of the purchase price you should attribute to each asset, how much to inventory, and how much, if any, to goodwill. These amounts should coincide with the amounts the vendor determined when reporting the sale.

The amount you allocate to each asset should be the fair market value (FMV) of the asset. You should allocate to goodwill the balance of the purchase price that remains after you allocate the FMV to each asset and to inventory.

Once you have determined the values for the assets and the goodwill, add the fixed assets (e.g., buildings and equipment) into the appropriate classes for the purpose of claiming the capital cost allowance. The goodwill is considered to be an eligible capital expenditure, which is treated in a manner similar to assets eligible for capital cost allowance.

Treat the value of the inventory as a purchase of goods for resale, and include it in the cost of goods sold in your income statement at the end of the year. For GST/HST purposes, if you buy a business or part of a business and acquire all or substantially all of the property that can reasonably be regarded as necessary to carry on the business, you and the vendor may be able to jointly elect to have no GST/HST payable on the sale by completing Form GST44, Election Concerning the Acquisition of a Business or Part of a Business. You must be GST/HST registrants, and you both have to agree that the sale will not be subject to GST/HST. In addition, you must buy all or substantially all of the property, and not only individual assets.

Usually, for the election to apply to the sale, you have to be able to continue to operate the business with the property acquired under the sale agreement. You have to file Form GST44, on or before the day you have to file the GST/HST return for the first reporting period in which you would have otherwise had to pay GST/HST on the purchase.

Another way of buying an existing business is to buy the shares of an incorporated business. This does not affect the cost base of the assets of the business. As explained previously, a corporation is a separate legal entity and can own property in its own name. A change in the ownership of the shares will not affect the tax values of the assets the corporation owns.

For more information visit our Buying a business Web page.

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Why it pays to plan ahead

In considering when to register for your BN, keep several things in mind.

Remember your legal obligations. For example, you become a registrant who must register for GST/HST when your taxable worldwide revenues (including those of your associates) exceed $30,000 over four consecutive calendar quarters, or in one calendar quarter. This threshold is $50,000 if you are a public service body. If you think your sales will exceed $30,000 (or $50,000 if you are a public service body), it's probably wise to register for the GST/HST sooner rather than later. Remember, registering for the GST/HST is the same as registering for the BN.

Registering early gives you certain advantages, such as the right to claim the GST/HST you pay on your business's start-up expenses from the time you register. For more information, see the section "Input tax credits" in the chapter on GST/HST. Also see the section "Can you deduct business start-up costs?".

If you intend to import goods into Canada, you should open an import/export account before you import the goods. This will avoid delays at the port of entry.

You should open a payroll deductions account as soon as you know when you will have employees. This account will allow you to make regular payroll deductions for your employees and make remittances on time. For information on how to make payroll deductions, see the chapter called "Payroll Deductions and Remittances".

If you decide to incorporate, you will need a BN to pay your corporate income taxes and to make instalment payments to your corporate account.

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