Is sole proprietorship the right business structure for your new venture in Alberta?

Jean Chung

Jean Chung

MBA, CGA, CPA

When you start in business, one of the most important decisions that you have to make is to choose the business structure. Registering your business is part of your legal obligations. Should you register your venture as a sole proprietorship or another form of business? A sole proprietorship is the simplest form of business that you can operate under. 

However, such a type of business has its own benefits and inconveniences compared to a corporation, another type of legal structure. You need to be aware of them to choose the right type of structure for your business. There are a few factors that you have to be aware of when deciding whether a sole proprietorship is the right form of structure for your business.

What is a sole proprietorship?

A sole proprietorship, or sole trader, is an unincorporated business that is owned by one individual. It is the simplest form of business structure to start, and it is probably the easiest to operate. Sole proprietorships are important to the Canadian economy. In Canada, they employ 15% of all workers according to Stats Canada. Because of its simplicity, it is also one of the most popular types of business ownership.

In order to determine whether a sole proprietorship is the right business structure for you, we are going to look at its working mechanism, benefits, and inconveniences. Right off the bat, it is important to note that there is not a unique factor to decide in favor of or against a sole proprietorship. There is no one-size-fits-all answer. It depends on your unique situation including your specific industry, operational risks, expected growth rate, risk aversion, and risk tolerance, etc.

If your business involves a high level of operational risk, a sole proprietorship is probably not suitable for business. For example, if you are in construction where the risk of injury is high, then a sole proprietorship is probably not the best structure for you. 

How does a sole proprietorship work?

There are three types of business structures: sole proprietorship, partnership, and corporation. The sole proprietorship’s distinctive feature from the other two forms of business structures is that there is no legal separation between the business and the owner. The owner and the business are one. The business is just an extension of the owner. The owner is responsible to decide on behalf of the sole proprietorship, receive profits, claim losses, and enter into agreements for the ‘business.’

Unlike corporations, sole proprietors are not required to have shareholder meetings or take votes to make decisions. You manage your own schedule and hours of operation, depending on the customers’ needs and requirements.

The owner is personally responsible for any debts or liabilities incurred by the business. If the owner gets sued for a debt that the ‘business’ owes to its creditors and bank, the owner is personally liable. That means the owner’s personal assets are on the hook. For example, the owner can have their personal assets such as their house or their car seized. In technical terms, it means that the owner has unlimited liability, in the sense that the liability is not restricted to the business.

Are you operating a sole proprietorship?

If you are not employed by another business, then you are considered to be self-employed if you are generating income from selling a product or providing a service going forward. Self-employment simply means that you are your own boss, you do not report to anybody. If you do not have a corporation or a partnership (the other two business structures), then most likely you are operating as a sole proprietor.

If you are a digital marketing consultant working from home on Fiverr, a website designer offering your services on Upwork, or a tutor on a teaching platform, and you have not registered your business, then most likely you are a sole proprietor. If you know that you operate as a sole proprietor, then you have to register your business at your local registry if you decide to operate under a name other than your own first name and last name. This is the case in most provinces, except for Newfoundland and Labrador. 

In order to register a sole proprietorship at a local business registry, in Alberta, you will need a business name, a NUANS (optional), a completed application form, an ID, and pay the registration fee. Check here for more info on registering a sole proprietorship. The requirements are fairly similar to those of a corporation. Other provinces have their own requirements, and they are similar to those in Alberta. The cost of registration can vary across provinces, but in most cases, registering is fairly quick. In most provinces, registering a business is a two-step process, but in Alberta, it is only one step.  

What are the benefits?

As we have seen above, a sole proprietorship is the easiest form of business structure to set up. It is also the cheapest business structure to set up and operate. The cost to register a sole proprietorship in Alberta is $30 compared to $500 for a corporation.

You can operate your business under your own first name and last name, in which case you are not required to register your business as a sole proprietorship. This is very convenient if you have just started operating your business as a freelancer, independent contractor, self-employed, or consultant. All these terms are used interchangeably with a sole proprietorship. However, if you decide to do business under a business name that is not your first name and last name, you have to register a tradename.

Another benefit of a sole proprietorship is that you own your business 100% and all the profits are yours. The tax reporting for a sole proprietor is also fairly straightforward compared to that of a corporation. In Canada, a sole proprietor has to file a T2125 (Statement of Business or Professional Activities) form, which is part of the personal tax return (T1 form). The gains and losses of the sole proprietorship are reported on the owner’s personal income tax return.

If your business incurs a business loss, you can apply the loss against other sources of income if you have any and reduce your tax payable amount. You cannot do that with a corporation. Losses under a corporation cannot apply to other sources of income at the individual level because the corporation and the individual are separate legal entities. However, if you are a sole proprietor, you can deduct a bunch of business-related expenses.

Common office expenses for a self-employed working from home are rent, utilities, insurance, maintenance, office expenses, etc. These expenses have to be prorated, based on the working office space in your home. However, personal expenses that are non-business-related are not eligible for deductions.

The simplicity of a sole proprietorship also means that the ongoing administrative costs (legal and accounting fees)  are lower compared to those of a corporation. 

What are the inconveniences?

As we have seen above, the major issue with a sole proprietorship is that there is no separation between the owner and the business. The owner handles the debt of the business. That means your personal assets could be seized to discharge the liabilities. If you are sued for damages caused by accident or negligence in your businesses, your personal assets can be seized. With a corporation, your liabilities are limited to what you have invested in the business; you are not personally liable for the debt and obligations of your business.

The sole proprietorship also ceases to operate upon the death of the owner. Therefore, it is not possible to engage in any sort of long-term planning with a sole proprietorship. On the other hand, a corporation continues to exist even after the passing of the owner. So it is much easier to transfer the assets to the owner’s children by using estate planning.

We have seen that it is easier to have a sole proprietor for tax reporting purposes. You can use your business losses and apply them against your other sources of income such as employment income. However, they all have to be reported in the same income year that they were earned. There is no possibility for you to carry forward or backward a ‘business’ loss as is the case with a corporation.

If you register as a sole proprietorship, it may seem less professional than a corporation. Some businesses and government agencies will not deal with sole proprietorship because it is seen as not having the level of professionalism and legitimacy as a corporation or partnership.

Another major drawback with a sole proprietorship is that it does not allow the owner to benefit from the lifetime capital gain exemption (LCGE) upon the selling of their business. This exemption dispenses business owners from paying taxes on capital gains when they sell their businesses, up to the amount of $884K. Capital gains are taxed on 50% of the gain amount based on the tax bracket of the individual, except for the LCGE.

The last drawback with a sole proprietorship is that the owner has to double pay for Canada Pensions Premiums (CPP), for both the employee’s and employer’s shares. 

So to conclude, a sole proprietorship can work to your advantage or your disadvantage. The answer to our original question is: it depends. I know, it is frustrating! It all depends on your unique situation. It is better that you consult with a legal advisor or a certified accountant in order to make the determination whether a sole proprietorship is the best form of business structure for your new venture. 

Registering a business is easy, however, you have to be aware of your legal and tax obligations. We have compiled a list of the top 12 business tips that every aspiring entrepreneur should be aware of, including the legal and tax ones. Check it out here.

Disclaimer:

The information in this blog is not intended to provide legal, accounting, or tax advice. It is intended for informational purposes only. You should obtain professional advice from your accountant or lawyer before acting on any information in this blog.