The Problem with Using Shares as Compensation for Future Services
For growth companies, offering shares as compensation to employees and contractors can be effective early-stage strategy. This is especially true for companies still waiting to see revenues coming through the door. However, there are important considerations to keep in mind when using shares as compensation. This article will outline the issues with using shares as compensation for future services, and then discuss two possible solutions to this problem.
When can shares be used as compensation?
Both the Alberta Business Corporations Act and the Canada Business Corporations Act outline that shares cannot be issued until the consideration for the share is fully paid. This presents a problem when a corporation wishes to issue shares for future services. Based on the wording of these Acts, a share issuance given for future services would be an improper issuance.
What can happen if shares are improperly issued as compensation for future services?
There are currently two different views in the case law on what results when shares are improperly issued. The first line of cases has found that an improper issuance results in the shares being a nullity, while the second line of cases has instead used what is known as the "contextual" approach and allowed the courts to fashion the remedy to the situation.
According to the line of cases which follow Javelin International v Hillier, if shares are issued for inadequate consideration, the issuance is considered a nullity. This case, and the others which followed in its footsteps have noted that the legislation outlines that shares shall not be issued until consideration for the shares is fully paid. According to these cases, the use of the word "shall" signifies that without proper consideration, the issuance must be considered a nullity.
In Alberta, the nullity stream of cases appears to have been rejected by the Alberta Court of Appeal in favour of the contextual approach. In Pearson, The Court of Appeal highlighted that corporate legislation does not spell out what should result if an improper issuance occurs. The case expressly outlines that an improper issuance of shares under section 27 does not automatically make the shares void. Other courts have come to a similar conclusion as Pearson, and determined that in the absence of guidance from the legislation, it is up to the courts to determine the proper remedy in situations where shares are improperly issued. In this situation, courts have typically taken one of three positions:
(a) The shares are a nullification;
(b) The directors are liable for the improper issuance; or
(c) The shareholder is permitted to pay the subscription price to validate the issuance.
While this approach does offer the potential for an improper share issuance to be remedied, corporations will not want to rely on the discretion of the courts to validate their share issuances. Instead, two potential solutions are proposed below.
There are two potential avenues that a corporation may take that may allow it to issue shares as payment for future work.
One Canadian scholar has suggested that the shares may be issued as consideration for entering into an employment agreement with the corporation. However, if a corporation wishes to do this, it must keep in mind that section 27(3) of the Alberta Business Corporations Act requires that the consideration for the shares be "the fair equivalent of the money that the corporation would have received if the share had been issued for money." Therefore, the value of having the employee join the company must equal the fair market value of the shares being issued. This will typically only be possible in the early stages of a corporation's life.
The other strategy that a corporation may use requires further foresight. This strategy involves an existing shareholder transferring a portion of their shares to the contractor or employee. In this scenario the shares will have already been issued to the founder for good consideration. The founder is then free to deal with her shares as she sees fit.
In order to execute this type of plan, it can be wise for a corporation to issue a founder extra shares when the corporation is founded for the purpose of later transferring those shares to new employees or contractors. Alternatively, the founding shareholders may agree to transfer shares to a new employee or contractor on a pro-rata basis.
Granting shares to potential employees and contractors in exchange for future work may be something a growth company wishes to do in its early stages. If it does do this though, it must ensure it does not run afoul of corporate legislation. The shares should either be transferred from the holdings of a current shareholder, or the shares must be issued in consideration for entering into an agreement with the company.
 Business Corporations Act, RSA 2000, B-9, s 27(3); Canada Business Corporations Act, RSC 1985, c C-44, s 25(3).
 Javelin International Ltd. (Receiver of) v Hillier, 1988 CarswellQue 28, 40 BLR 249, para 24.
 Pearson Finance Group Ltd. v Takla Star Resources Ltd., 2002 ABCA 84, para 9.
 Ibid, para 22.
 Marshall Haughey, "Issuing Shares for a Promissory Note", (2014) 24:8 Can Current Tax 85, at 87.
 Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (LexisNexis Canada, 2018), at 154.
 Supra Note 1, s 27(3).
How to Protect your Billion-Dollar Idea: An Overview of Copyrights, Patents and Trademarks
Written by Skylar Caldwell
So you've finally thought of the next billion-dollar startup idea. Before you book the next available spot on Dragon's Den or let the Facebook, Amazon, and Apple shaped-stars in your eyes cloud your vision, you may be wondering what steps you can take to protect the information that is valuable to your future-unicorn company. Canadian legislation provides several options to protect intellectual property and other information that is valuable to a business. This blog post provides an overview of three of the most common ways businesses protect their information; copyright, patent, and trademark.
Copyright: For Creative Works
A copyright is the right a person holds in a creative work. Do you intend on building a literary empire à la Stephen King? If yes, copyright is for you. Copyright provides protection for literary, artistic, dramatic, musical works, computer programs, and other subject matter known as performer's performances, sound recordings, and communication signals. In general, copyright means the sole right to produce or reproduce a work or substantial part of a work in any form. In order to successfully apply for a copyright, a work must be original, creative, and recorded in some way. Creative, in the context of copyright, does not exclusively refer to artistic works. It simply means that the copyrighted work must be the product of knowledge and judgement.
Haven't been able to find a publisher willing to take on your literary masterpiece? Don't sweat it- unlike trademark protection, copyright protection under the Copyright Act applies to works that have not been published or otherwise made known. In fact, copyright includes the right to publish a work or a substantial part of a work.
Registering a copyright is not necessary. However, copyright gives the creator the presumption of ownership in any legal disputes that may arise surrounding the copyrighted material, as well as precludes a person who infringes on the copyright from claiming innocence. It should be noted that not every incidence of copying copyrighted material is considered to be a violation. For example, section 6 of the Copyright Act specifies that exceptions are made in instances of copying for the purpose of "research, private study, education, parody or satire". Additionally, the copyright must be monitored by the copyright holder. This means that the onus is on the holder of the copyright to recognize any infringements on their copyright and bring forth an action against the individual infringing on the copyright. A copyright is typically valid for the entire creator's life, and extends to 50 years beyond the year of the creator's death. Copyrights can be registered through the Canadian Intellectual Property Office (the "CIPO"). The process involves filling out an online form and paying a $50 fee.
Patents: For Inventions
Patents exist for the protection of inventions. Does your future-unicorn startup involve the invention of a product to protect dog's ears to solve the incessant problem of not being able to bring your pup along to concerts? I have bad news, Animal Ear Protectors have already been patented. If you have another invention, defined under the Patent Act as "any new and useful art, process, machine, manufacture or composition of matter, or any new and useful improvement in any art, process, machine, manufacture or composition of matter", a patent may be the right option for protecting your business.
Patentable inventions must be new, useful and not obvious to an individual working in the relevant field or industry. Unlike copyright, there is no automatic protection for creators of the patented material. In order to legally protect your invention, a patent must be granted. Patent protections are typically stronger than copyright protections, as they give the holder the right to exclude others from making, using or selling the invention, even in instances where another person developed the patented invention independently. Patents last for 20 years, and cannot be renewed.
The first step in obtaining a patent is to file an application. The patent application fee is $204 for small entities and $408 for other businesses. Once the application has been filed, the applicant must request an examination, which can take up to two years to occur. During the examination stage, an application may be granted, or the examiner may object to all or part of the application. In instances where there is an objection, the applicant must respond to the objection or else the application will be considered abandoned. If the applicant responds to an objection, there may be additional objections made by the examiner or the application may be denied in whole. If an application is rejected, the applicant can appeal the decision to the Commissioner of Patents. If an application is granted, the owner of the patent must pay maintenance fees every year to maintain the patent. The maintenance fee for the second, third, and fourth years following the filing date of the patent is $50 for small entities and $100 for other businesses. The maintenance fees increase the longer you hold the patent for. On the fifth, sixth, seventh, eighth and ninth years following the filing date of the patent, the maintenance fee is $100 for small entities and $204 for other businesses.
Trademarks: For Business Names, Slogans and Logos
The word "Tesla" is inextricably associated with innovation and the quirky, visionary leadership of its founder Elon Musk. If you foresee your billion-dollar startup obtaining a similar type of powerful brand recognition, you should consider filing a federally registered trademark under the Trademarks Act. Trademarks can be any "combination of words, sounds, or designs used to distinguish the goods or services of one person or organization from those of others". Trademarks can include business names, logos, and slogans, and can be important components of ensuring continuity in brand recognition. After all, where would Nike be without its association with the intensely inspirational and instantly recognizable "Just Do It" slogan?
When registering a trademark, a person is granted "the sole right to use the mark across Canada for 10 years". The holder of a trademark is also provided the option to renew the trademark every ten years. A trademark is not required to be registered. This is because, if the use of a trademark has persisted for a certain length of time, the trademark may be protected under common law. 
The two most common types of trademarks in Canada are ordinary trademarks and certification marks. An ordinary trademark includes words, designs, tastes, textures, moving images, modes of packaging, holograms, sounds, scents, three-dimensional shapes, colours, or a combination of these used to distinguish foods or services of one person or organization from those of others.
A certification mark can be licensed to many people or companies for the purpose of showing that certain goods or services meet a defined standard with respect to: (a) the character or quality of the goods or services; (b) the conditions under which the goods have been produced or the services performed; (c) the class of persons by whom the goods have been produced or the services performed; or (d) the area within which the goods have been produced or other services performed. Certification marks are trademarks that serve as a guarantee that the goods or services with which the mark is associated conform to a particular standard. The owner of a certification mark is responsible for establishing the defined standard indicated by the mark. The owner may adopt the mark and register it with the Canadian Trademarks Office so long as it does not itself manufacture, sell, lease or hire the goods, or perform the services, in association with which the certification mark is to be used. Instead, the Trademarks Act provides for a licensing scheme under which the owner of the certification mark may license others to use to mark in association with their own goods and services, so long as those goods or services meet the owner's defined standard.
A trademark application may be filed on the CIPO website. There is a $336 base application fee if a business submits their application online through the CIPO website, and a $438 base application fee if a business submits through another channel. An application for a trademark may be refused if it is confusingly similar to a previously filed trademark. This is bad news for you if your billion-dollar idea involved a soft drink company called "doca dola". In order to expedite the process of filing a trademark, a business can search the Canadian Trademarks Database to look for similar trademarks before submitting their trademark application to determine whether their proposed trademark is confusingly similar to an existing one. The Trademarks Act deems a trademark to be adopted once it has been filed for registration in Canada. The filing date of an application is the date that the Registrar received an application meeting all its filing requirements.
Once you've taken all the necessary steps to protect the valuable information involved in your startup, you can start building your entrepreneurial empire. So get out there, maybe get a small loan of $1 million from your father, and use your copyrighted, patented, or trademarked billion-dollar idea to build your unicorn startup!
 Copyright Act, RSC 1985, c C-42 s 2. [“Copyright Act”]
 Ibid at section 53(2).
Ibid at section 29.
 Ibid at section 35(1).
 Ibid at section 6.
 Patent Act, RSC 1985, c P-4 [Patent Act].
 Ibid at section 44.
 Government of Canada, “Patent Fees” (1 February 2021), online: Canadian Intellectual Property Office <https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr00142.html>.
 Trademarks Act, RSC 1985, c T-13.
 Government of Canada, “What Are Trademarks?” (3 July 2019), online: Canadian Intellectual Property Office <https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr03718.html>.
 Government of Canada, “A Guide to Trademarks” (24 July 2020) online: Canadian Intellectual Property Office < https://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/h_wr02360.html?Open&wt_src=cipo-tm-main&wt_cxt=learn> [TM Guide].
 Ibid at "Understanding Trademarks".
 Canadian Intellectual Property Office, “Complete list of fees for trademarks” (28 April 2017) online: Canadian Intellectual Property Office <http://www.ic.gc.ca/eic/site/cipointernet-internetopic.nsf/eng/wr04194.html>.
The Default StructuresSo, you want to start a business and can’t wait to build that new prototype of your ground-breaking, market-disrupting product. Maybe this is a joint effort, and you get together with some tech savvy friends, and borrow some seed money from yet more friends to get started. So, what’s the problem here?
When you start a business by yourself (a Sole Proprietorship), there is no distinction in the eyes of the law between yourself and the business. Taxes are filed together, money earned is considered personal income, and most importantly, obligations of the business are your personal obligations. You are personally on the hook for everything the business does or does not do. This is the first default way of doing business.
When you get together with others to “carry on a business in common with a view to profit” you’ve triggered the second default way of doing business, by entering into a Partnership. Like the previous default structure, there is no distinction made between the business and the partners. Partnership income is the same as the partner’s income, but with the added catch that if no agreement is made between the partners, that income (or loss) is to be divided equally among the partners. The Partnership Act governs some of the key elements, but the interpretation of the above underlined terms is found in the case law.
In addition, partners owe to each other stringent fiduciary duties that compels them to act in the best interests of the partnership. In practice this includes: not competing with the partnership, the sharing of any benefits accrued from the partnership, full disclosure of information pertaining to the partnership, and confidentiality, among others. Liability incurred by the partnership for wrongs committed against a third party is also joint and severable between the partners. This means that an injured third party may claim against any partner for the full quantum of damages.
There surely are some benefits for using these default structures but that is a topic for another time. However, one of the biggest risks is the personal exposure to liability.
The Corporate Form
A popular alternative to the above default structures is the corporate form. This is not a default way of doing business because it requires positive procedural steps to trigger its formation. A corporation does not arise automatically from indirect actions of the involved parties. To start a corporation, you must follow procedures in a Business Corporations Act. There is both a federal and provincial version of this act with a large degree of similarly (albeit there are some differences too). Incorporation can be done under either of them, but not both simultaneously.
The main benefit of the corporate form is that it effectively splits ownership from management in the eyes of the law. This gives the corporation “legal personhood”, sometimes also called a “juridical person”. A corporation therefore is considered a separate entity that files taxes, declares income, borrows money, and incurs liability on its own, separate from the true owners. The owners in this case are the “shareholders”, and the management of the corporation is led by the “board of directors”. The trick here is that the owners are protected from liability above the amount they have invested in the corporation. This protection is known as the “corporate veil”. Only on very limited and extreme occasions is the corporate veil breached by a Court to hold the owners personally liable for an action of the corporation.
Ownership of a corporation is therefore comparatively less risky, which facilitates activities such as obtaining new investment from people looking to buy shares or from institutions looking to lend capital. Another benefit is that ownership does not preclude the individual from also being a manager or employee. However, unlike the owners, individuals acting as managers do have to contend with other legal duties and potential liability.
The shareholders maintain control over the board of directors by using statutory mechanisms in the Business Corporations Act and also through provisions in the “articles of incorporation”. The articles are akin to a corporate constitution, and it will govern the relationship between the owners and managers. It does this through restrictions on what the company can and cannot do, and through the rights associated with the shares that a company can issue.
The distribution of liability between the managers depend on the scope of their relationship to the company. The board of directors will carry the largest burden because they are ultimately responsible and in charge of making strategic decisions for the corporation. In addition, they owe a fiduciary duty of loyalty and care to the corporation itself. In practice, this often means that they attempt to maximize benefits for the shareholders. To attract and retain competent directors, a corporation will typically indemnify directors for liability that they could personally incur so long as they were acting in good faith and did not breach their fiduciary duties.
Senior officers include managers that are hired and appointed directly by the board of directors. Officers owe a fiduciary duty to the corporation because their influence over the affairs of the company are analogous to that of the directors, and because they are included alongside directors under the fiduciary provision in the Business Corporations Act. Other managers of a corporation may also owe a fiduciary duty to the company, but the scope of the duty will be circumscribed by: 1) the degree of influence they exert over the daily operations, and 2) the terms in their employment contract. As a general rule, the more senior and influential a manager is, the more likely they will owe a fiduciary duty and the greater the scope of that duty.
Finally, the employees of a corporation generally do not owe any additional duties to the corporation beyond those that arise from general principles under the common law, and through their employment contract. This often means that any non-competition, non-solicitation, and confidentiality restrictions on an employee are spelled out in a contract.
 Partnership Act s.15
 Alberta Business Corporations Act [“ABCA”] and Canada Business Corporations Act [“CBCA”]
 Salomon v Salomon & Co.
 Lee v Lee’s Air Farming Ltd.
 ABCA s.122
 International Corona Resources v Lac Minerals
 ABCA s.122
Shareholder Agreements vs Unanimous Shareholder Agreements
When incorporating, the question of whether or not to establish a shareholder agreement, or a unanimous shareholder agreement for that matter, should be considered. This blog will cover the major benefits and drawbacks of each while attempting to clarify in what situation each type of agreement is most suitable.
Shareholder agreements outline the expectations and guidelines on how to resolve specific problems that may arise between shareholders. Essentially, these agreements allow shareholders to address any situation in the manner in which they choose. Often, the agreements will establish how corporations make decisions, and how shareholders dispose of or acquire additional ownership interests.
In small, closely held corporations, shareholder agreements are paramount as any change in ownership is typically of great interest to the company and its remaining shareholders. Change in ownership could even result in a material event. Without any such agreement, provincial or federal statute will govern shareholder relationships. Applicable laws tend not to be the most comprehensive and often leave unforeseen situations wanting.
Shareholder Agreement vs. Unanimous Shareholder Agreement
In Canada, there are two types of shareholder agreements, regular shareholder agreements (“SA”) and unanimous shareholder agreements (“USA”).
SAs will only be applicable or bind those who sign it. In order for the agreement to apply to a specific shareholder, that shareholder must be a party or a signatory to the agreement. Note, that shareholders can become a party to the SA at any time. Conversely, USAs bind all shareholders provided that notice is given. No signature required. The USA will apply to any shareholder regardless of when the shares are acquired.
SAs are a form of commercial contract. It may provide rights and obligations to shareholders, resolutions to specific disputes and good management or governance practices. A USA is a combination of a commercial contract and a constitutional document similar to the articles of incorporation. A USA can override the common law rule against fettering the discretion of the directors. This means that it can withdraw or restrict a director’s power and transfer it to the shareholders.
Important Points of Distinction
USAs involve withdrawing or restricting decision-making power from the director and placing that power onto the shareholders. By doing so, directors can no longer be held liable for the rights or liabilities that have been fettered by the USA. Additionally, USAs should be flexible enough to allow minority shareholders to have a say in the direction of the company, but it should also permit the majority of shareholders to make corporate decisions without being blocked or restricted by the minority.
Choosing the Right Structure
Prior to incorporation, one must first characterize the venture. Consider a growth company and a small privately-owned corporation. A growth company is defined by its rate of change. Rapid growth inevitably leads to instability in the corporation’s composition including the number of investors and frequent management changes among other things. Such changes lead to varying corporate and legal needs that are difficult to anticipate. As a result, greater flexibility is needed to avoid impeding growth and development. Small privately-owned corporations have different needs. This type of company opts for stable growth with the ultimate goal of remaining small and closely held. Predictability is key in these organizations.
A SA suits a growth company’s need for flexibility. SAs allow for effective management while the number of passive shareholders tends to increase. USAs are inappropriate for companies that seek rapid growth and anticipate a larger number of investors or shareholders. Essentially, a SA will protect the company from a wide range of shareholders while staying attractive to investment as it doesn’t transfer a disproportionate amount of power to founders as is typical of USAs.
The distinctive characteristics of the USA present challenges to growth companies should a disgruntled founder or shareholder aim to hold up the business’ activities. Further, passive investors won’t want to bear the risk of liability resulting from the transfer of rights and obligations from the directors onto the shareholders. Finally, USAs are part of the constating documents. As such, a growth company is likely to quickly outgrow an agreement written at incorporation. The ability to amend or withdraw a USA requires a unanimous vote as per the Alberta Business Corporations Act, which could be difficult to acquire with a large number of shareholders.
Small Privately-Owned Corporation
USAs are ideal for small, privately-owned corporations. The distribution of shares can be controlled. Shares can therefore remain closely held. For corporations that intend to stay small, USAs can control shareholders and founders in the event of diverging opinions. The agreements allow for all shareholders to have a say in how the business is run. A USA can be drafted to include provisions ensuring the continued operation of the company regardless of founder or shareholder disagreements.
Application to a New Venture
Provisions that are appropriate for a small, privately-owned company may be harmful for a growth company. In particular, USAs are generally inappropriate for growth companies whereas SAs are well-suited for such companies. Prior to incorporation, founders should consider which type of venture is anticipated. Early consideration of the nature of the venture will inform the breadth of desired legal agreements.
 Mihai Gheorghe Cioc, Why should you have a shareholders’ agreement in Canada? Online: LexStart <https://lexstart.ca/en/legal-articles/why-should-you-have-a-shareholders-agreement-in-canada/>.
 Brian Graves, Shareholder Agreements (2005) online: McCarthy Tetrault LLP <https://marcomm.mccarthy.ca/pubs/insight_paper_ver_two.pdf>.
 Mihai Gheorghe Cioc, Why should you have a shareholders’ agreement in Canada? Online: Lex Start <https://lexstart.ca/en/legal-articles/why-should-you-have-a-shareholders-agreement-in-canada/>.
 Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 2nd ed (LexisNexis Canada, 2013) at 2 [Tingle].
 Ibid at 4.
 Ibid at 107.
 Ibid at 106.
 Business Corporations Act, RSA 2000, c B-9, at 146(8).
Sole Proprietor to Incorporation & Section 85 Rollovers
Frequently, small business owners will initially operate as a sole proprietorship in the early stages of business development. This can be beneficial as it facilitates the deduction of business losses against other personal income and reduces legal, accounting, and administrative costs until the business’ viability has been demonstrated. As a business grows, however, the desire to limit liability, facilitate raising funds through the sale of shares and the ability to defer taxes by retaining corporate profits within the corporation and pay dividends in lieu of salary often make incorporation preferable.
Unfortunately, the sole proprietor learns that if an asset has gained in value and then is transferred it attracts capital gains tax. Fortunately, the Government recognized it would be unfair to not encourage businesses to grow properly. Thus, when a sole proprietor incorporates his or her business, section 85(1) of the Income Tax Act (the “Act”) allows the business owner to transfer business assets out of the sole proprietorship and into a corporation without triggering tax liabilities due to a disposition of property. This is known as a Section 85 rollover.
Section 85 Conditions:
There are 5 primary conditions for determining the applicability of a section 85 rollover, these include:
4.Consideration consists of at least one share of capital stock; and
5.A joint election must be filed by the prescribed deadline.
An eligible transferor includes individuals (i.e. a sole proprietor), trusts and corporations. An eligible transferee must be a taxable Canadian corporation (i.e. the newly incorporated business) A corporation is a taxable Canadian corporation if it was incorporated in Canada (and therefore deemed to be a resident of Canada by section 250(4) of the Act) or a resident of Canada from June 18, 1971and is not tax exempt under the Act.
Eligible property is defined in Section 85(1.1) of the Act and includes:
Section 85(1) transfer requires that, in exchange for the eligible property, the eligible transferor must receive at least some share consideration. The eligible transferor may also receive a non-share compensation in exchange for the eligible property, but the total compensation package must include shares in the corporation and must not exceed the fair market value of the property transferred.
The joint election is a filing that must be made with the Canada Revenue Agency using the prescribed form (T2057) in order for Section 85(1) to apply to a disposition of property.
Section 85 Elected Amounts:
When filing a joint election, the transferor and transferee must choose an elected amount, which represents the proceeds of disposition for the transferor and the cost to the transferee corporation. The actual value exchanged must be FMV (i.e., the corporation must pay the sole proprietor FMV for the transfer) but the elected amount is the deemed value for the tax purpose of avoiding capital gains tax. The Act prescribes the following upper and lower limits on the elected amount:
If a Section 85 rollover is warranted, it is common to transfer assets from the sole proprietorship to the corporation at FMV (but elect at cost and take back shares equal to FMV). The individual (shareholder) takes back shares from the corporation equivalent to the FMV of the assets transferred into the corporation. So, for example, if an individual transfers $50,000 worth of assets, they would take back $50,000 worth of shares (preferred or common shares).
It’s important to have a valuation done or at least a reasonable attempt made to understand the value of assets transferred, including intangible assets such as ‘goodwill’ (brand, customer lists, etc.). More often than not, goodwill is an asset that is transferred.
In this scenario, there is no immediate tax consequences. If the shares or assets of the corporation are sold at a future date, tax is paid then (if the transaction includes a gain on the sale of shares or assets).
It is important for business owners to take note that a Section 85 rollover provides only a deferral or postponement of tax. It does not amount to tax avoidance. Any increase in value of the assets that was not realized when the transfer occurred will be taxed at the time the assets are sold or otherwise disposed of by the newly incorporated business. The Section 86 rollover can be an important election that can help small businesses lower their tax burden when they want to expand or make changes in their business structure. Use this if you want to convert your sole proprietorship business into a corporation but ensure you seek qualified advice from a lawyer and your accountant before doing so.
 Income Tax Act, RSC 1985, c 1 (5th Supp). [ITA].
 Ibid at s 85(1).
 Ibid at s 89(1).
 ITA, supra note 1.
 Ibid at s 85(1)(f).
 Ibid at s 85(6).
 Ibid at ss 85(1) (a), (b), (c).
Sole Proprietorships – A Closer Look
Sole proprietorship is the simplest form of business organization. It is also by far the most popular structure amongst business founders, as 64% of new Canadian businesses chose to register the onset of their business in the form of sole proprietorship. This blog post aims to take a deeper dive into sole proprietorships in Alberta by providing 1) an overview of sole proprietorships, 2) legal requirements of operating a sole proprietorship, as well as 3) briefly evaluate its advantages and disadvantages.
Sole proprietorships come into existence when an entrepreneur start to carry on business for his or her own account without taking the steps necessary to adopt other form of organization, such as a corporation.
A sole proprietor has sole ownership of the business and there is no separation between the sole proprietor, as the individual owner, and its business. This means that the individual owner of the sole proprietor assumes total responsibility over the management and the business’s assets, profits, and losses. The sole proprietor is also exclusively responsible for all torts committed by him or her personally in connection with the business and will be vicarious liable for all torts committed by employees in the course of their employment. Most crucially, a sole proprietor bears unlimited personal liability. As a result of this unlimited liability, the sole proprietor’s personal assets, as well as assets contributed to the business, may be sized in fulfillment of the obligations of the sole proprietor’s business.
2. Legal Requirements and Registration Process
There are two main legal requirements associated with the use of a sole proprietorship: 1) trade name registration and 2) licensing requirements.
The sole proprietor may either use the sole proprietor’s given name or trade name as their business names. Carrying on business under the sole proprietor’s given name does not require registration, unlike operating under a trade name. Under the Alberta Partnerships Act, using a trade name to run a sole proprietorship does require registration. According to Partnerships Act section 110, “[e]ach person who...
(a) is engaged in business for trading, manufacturing, contracting or mining purposes,
(b) is not associated in partnership with any other person or persons, and
(c) uses as the person’s business name
(i) some name or designation other than the person’s own, or
(ii) the person’s own name with the addition of “and company” or some other word or phrase indicating a plurality of members in the firm, shall sign and file with the Registrar a declaration in writing of the fact.”
Trade name registration is a straightforward process. All that the sole proprietor has to complete a Declaration of Trade Name Form (found here) and file it at one of the Alberta Corporate Registry service providers. Note that despite the requirement in Partnerships Act section 110(2)(d) that the Declaration be “filed within 6 months after the time when the business name is first used,” section 110(3) suggests that no penalty will be imposed if the sole proprietor were to file the Declaration over the 6-months limit.
Unlike a corporation, a sole proprietorship does not have perpetual existence. A sole proprietor who wishes to cease carrying on business of the trade name can do so by filing a Cancellation Declaration (found here).
The other requirement for sole proprietorships, which applies equally to all forms of business organizations, is licensing. Licensing requirements will vary from different business types and the levels of government, whether it be federal, provincial, or municipal. The BizPal permit/licensing finder filter can be found here.
3. Advantages & Disadvantages
As mentioned earlier, one of the main characteristic that makes a sole proprietorship attractive to business founders is its simplicity. Unlike incorporation, which comes with certain paperwork requirements, such as filing of articles of incorporation pre-incorporation and bylaws and minute books post-incorporation as well as annual returns in subsequent years, sole proprietorships has virtually no paperwork that needs to be done save for a trade name registration.
Sole proprietors may also be attractive if the businesses incur losses in its early start-up years. This loss may be applied against the income received by the entrepreneur from other sources. If the losses cannot be used in the current year, it can be carried back for three years to recover taxes previously paid or it can be carried forward 20 years to offset future earnings.
On the flip side, a chief disadvantage of the sole proprietorship is unlimited personal liability. All of the sole proprietor’s personal assets may be taken by third parties in satisfaction of obligations of the business. As the scale of the business and related liabilities increase, this exposure to personal liability makes sole proprietorships increasingly less attractive. By comparison, incorporation provides protection against personal liability. While it is true that a sole proprietorship could manage liability risks through insurances or contractual provisions, incorporation is cheaper and in most cases, more effective.
Another problem with sole proprietorship is raising capital. As a business grows, it will require additional investment. Since it is impossible to divide ownership of the sole proprietorship, the only financing option available is debt. Not only that, non-friends and family investors will also be interested in acquiring an ownership interest in the business without being exposed to the venture’s liabilities. In that case, a sole proprietorship could provide neither the liability protection or the equity mechanism.
To conclude, it is the legal nature of the sole proprietorship as an unlimited liability and unincorporated entity that is determinative of its relative advantages and disadvantages as compared to a corporation. While sole proprietorships have its simplicity and loss-offsetting tax advantages to boast at the beginning of a venture, incorporation may provide further capital raising avenues and better protection against liabilities as the business matures and develops. For more information on the registration process of a sole proprietorship or how it compares to a corporation, contact the BLG Venture Clinic for further details.
 Bryce C. Tingle, Start-up and Growth Companies in Canada 4th ed (Lexis Canada Inc, 2018) at page 36.
 Anthony J. VanDuzer, The Law of Partnerships and Corporations, 3rd ed (Toronto: Irwin Law Inc., 2018) at page 6.
 Ibid at page 8.
 Partnership Act, RSA 2000, c P-3 [Partnership Act], s 110.
 Partnership Act, s (110)(2)(d).
 Business Corporations Act, RSA 2000, c B-9, s 21.
 Income Tax Act, s. 111(1)(a).
 Supra note 1 at page 36.
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