Sole Proprietorship: An In-Depth Look
If you are planning to start a side hustle or even starting a business full time, this would be a great article for you to understand the various business structures that exist in Canada. Is there one that is better than the other for you? Find out below.
It’s important to consider the business structure as each has different tax implications, risk levels and regulatory requirements.
A business structure is also called a legal entity structure and you will have to select one before starting your side hustle or business.
There are 4 business structures in Canada but 3 of them are the most common:
Sole Proprietorship
What is the first most common business structure? Sole Proprietorship.
Let’s get started!
What is a Business Structure?
As mentioned above, a business structure is also known as a legal entity structure which in short means how the business is organized legally. You have to pick one before starting your business; it’s not optional. There are many considerations for Sole Proprietorship which we will go into more later.
How Many Businesses are Started Each Year?
According to the Key Small Business Statistics 2022 from the Government of Canada, in the 5 years between 2015 to 2019, approximately 101,324 businesses were created every year. They all had to pick a business structure to go with in order to legally form their business. You cannot operate your business if it’s not formed properly.
What is a Sole Proprietorship?
According to CRA, ‘a sole proprietorship is an unincorporated business that is owned by one individual’ An ‘individual’ means a human being and this structure is the least complex compared to the other two.
Why Sole Proprietorship? 👍
Here are some reasons to go with Sole Proprietorship:
You have the sole responsibility for making decisions since it’s just you
You receive all the profits or losses generated from your business
It has a very easy and low set up cost (this structure is the least complex compared to the other two)
Why Not Sole Proprietorship? 👎
Here are some reasons to avoid Sole Proprietorship:
There is unlimited liability (you are personally liable for the affairs of your business)
You cannot transfer ownership of your business to someone else
It may be difficult to raise capital for your business
How to Start a Sole Proprietorship?
If you like the pros and are okay with the cons of a sole proprietorship, here is how to start one:
1) Create a business plan
o What kind of products or services you will offer?
o Develop mission/vision statements
o Who will you cater your products or services to?
o Prepare a budget so you know how much to set aside
o Prepare a forecast to see if your business venture would be profitable
o Here is a guide from BDC How to write a business plan | BDC.ca
2) Determine a business name
o It can be your own name like John Smith or you can pick any business name
o Search for existing business names to see if someone is already using it (if you’re in Ontario, you can use Search the Registry (gov.on.ca))
3) If you selected a business name which is different than your own name, you need to register it with your province or territory
o Check it out here: Registering a sole proprietorship or partnership - Canada.ca
o You will receive a 9 digit Business Number from CRA
4) Open a business bank account
o You want to keep your business finances separate from your personal bank account
o It will be easier to track all your revenues and expenses
5) Check if you need any licenses or permits to run your business
o Each province or city may have different requirements
o Here is a link to BizPaL - Home Page (bizpal-perle.ca) outlining what you may need
6) Determine if you need to register for an HST account
o You can choose to register for it now or wait until you reach the requirement to register
o ie. Are you planning to have more than $30k in gross sales per year?
o Here is a link to CRA outlining when you need to register for HST: https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/gst-hst-businesses/when-register-charge.html
7) Determine if you need to register for a WSIB account
o This is only applicable if you have or planning to have employees
o Most businesses are not exempt from WSIB
o For example, under Ontario, Do you need to register with us? | WSIB
8) Create a website and branding
o More and more businesses rely on a website for marketing purposes
o Check out DIY websites like Squarespace, Wix or WordPress
9) Get financing
o If your business requires financing to get up and running, your financial institution may have some options
10) Get insurance
o Inquire with an insurance agent or broker on the types and amounts of coverage that you need to protect your business
11) Purchase an accounting software to track your revenue and expenses
o If you’re just starting your business, you can probably just use Excel
o As your business grows, it may be useful to purchase an accounting software like QuickBooks Online
Tax Considerations
Now that we went through how to start a sole proprietorship, it’s important to think about the tax considerations too.
Here are some areas that you need to consider:
Annual Taxes
The details of your business needs to be filed on T2125 Statement of Business or Professional Activities which is part of your T1 Personal Tax Return
Any income you generated will be taxed at your marginal tax rates
If you generated a loss, you can offset this against your income from other sources like employment income to reduce the overall tax burden
Any net business income is subject to CPP contributions (for an owner, this means paying both employer and employee part of CPP contributions)
Your business’ fiscal year end is January 1st to December 31st (you can’t choose)
You may need to pay tax installments throughout the year
If you used part of your home for your business activities, you may be eligible to claim a percentage as a deduction to your business income
GST/HST
You will have to start charging GST/HST to your customers and you can claim ITCs for the purchases you made
There are ongoing filings required depending on your reporting frequency
Any amounts owing on the GST/HST filings have to be paid before a certain time
Reporting frequency:
o Monthly (filings and payment are due end of following month)
o Quarterly (filings and payment are due end of the following month after the quarter)
o Annual (filings and payment are due by Mar 31st of the following year)
Payroll
On every employee pay stub, you are required to deduct Source Deductions (CPP, EI and Income Tax) and remit those deductions to CRA (along with employer’s portion of CPP and EI)
You must provide T4 and/or T4a to your employees by February 28th of the following year
If you have a WSIB or EHT account, there are filings and payments required at certain periods too
As the owner, you don’t pay yourself compensation because the net business income is deemed to be your compensation (that you’re paying taxes on)
Payroll burdens are tax deductible
If your employees experience an interruption of earnings, you are required to file a Record of Employment with Service Canada
Other
You must keep all receipts and income documentation for a period of 6 years plus current year (in case CRA asks for it)
Net business income is considered earned income so you can contribute more to your RRSPs which reduces your tax burden
You may need to register for other CRA program accounts depending on your business operations
Future Considerations
Starting a sole proprietorship is a good idea because of the low start up costs and ongoing regulatory requirements involved. Also, there are usually business losses which you can offset against your other income.
Once you start a sole proprietorship, are you stuck with it? The quick answer is no, you’re not stuck with it.
If you found some success in your business venture, it might be worth it to consider another business structure like a corporation to take advantage of the benefits it can provide. I don’t mean starting from scratch because you have built a brand that your customers trust.
You’re probably thinking ‘what do you mean?’.
There are 2 options available if you want to move the assets your business from sole proprietorship to corporation:
Sell the assets at fair market value to your corporation
Rollover the assets at cost to your corporation
It’s important to seek legal and accounting advice to ensure everything is done correctly.
Your Turn
Do you have a better understanding of why you would want to start a sole proprietorship or reasons to avoid this business structure? This blog went into detail of how to start a sole proprietorship and an in-depth look into some of the tax and future considerations you should think about.
If you’re not sure, make sure to contact us to find out the optimal business structure for you!
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At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: https://www.jtlaccounting.com.
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