Sole proprietorships and partnerships are often times the simplest and most cost-effective entities in which to operate a new business. Furthermore, there are some attractive tax benefits that may be available by choosing one of these business organizations.
Several factors need to be considered when deciding which form of business organization is suitable for your new business. These considerations include:
- Need for limited liability;
- Number of owners/participants in the new business;
- Financing requirements and availability;
- Type of new business being considered; and
- Business and tax objectives of owner.
Consideration of the above factors may lead one to prefer operating a sole proprietorship. The sole proprietorship is the least expensive and simplest form of business vehicle. Essentially, a sole proprietorship exists when an individual commences business on their own account. However, unlike a corporation where the owners (shareholders) enjoy limited liability, a sole proprietor is liable for all of the debts, obligations and any claims against the business; both the sole proprietor’s personal and business assets are at exposed to such risks. However, the problem of unlimited liability can often be addressed by securing liability insurance or “creditor-proofing” the proprietor.
There is no requirement to register a sole proprietorship; however, if the individual is not operating the business in their own name, the individual must register a name under the Business Names Act. Additionally, if the sole proprietor has employees, they must register for a business number with the Canada Revenue Agency (“CRA”) and are responsible for payroll deductions. The sole proprietor must comply with provincial payroll requirements such as the Employer Health Tax and the Ontario Health Premium, and must comply with all withholding, remitting and reporting obligations in respect of its employees.
Depending on the type of business the sole proprietor is engaged in and the amount of sales generated, the sole proprietor might also have to register under the Excise Tax Act for collection and remittance of HST. In general, if the business is generating annual taxable sales in excess of $30,000, collection and remittance of HST is required. If the business does not exceed the $30,000 threshold amount, it is classified as a small supplier. The business does not have to register for an HST program account; however, it may do so voluntarily and claim input tax credits (ITCs).
It is important to note that some sole proprietorships may need a licence to carry on business. For example, a municipal licence is required for electricians, plumbers, restaurants, and driving schools; a provincial licence is required for employment agencies, motor vehicle dealers, and real estate brokers; and, Government of Canada licences are required for inter-provincial carriers and businesses using aircraft, etc.
Lastly, sole proprietorships and partnerships are often attractive because of the flow-through quality of the income or loss generated through the sole proprietorship or partnership for income tax purposes. The Income Tax Act (“ITA”) requires either the partner in a partnership or the proprietor in the sole proprietorship to report all the business income or loss on his or her own personal income tax return. New businesses can take advantage of this flow-through quality if, as many new businesses experience, they incur start-up losses. These losses can then be deducted against any other income earned by the proprietor or partner in determining income taxes payable. Businesses that have only one owner and expect losses in the first few years should consider a sole proprietorship. Subsequently, when the sole proprietorship becomes profitable, it is possible to convert the sole proprietorship to a corporation or a partnership on a tax deferred basis. There are a number of reasons to transfer the assets of a sole proprietorship into a corporation; for example, to take advantage of the capital gains exemption for the sale of “qualifying small business corporation shares”, or to take advantage of the lower corporate tax rates for Canadian controlled private corporations.
For more information on the operation of sole proprietorships, contact Adnan D. Chahbar at 519-660-7804.
Adnan D. Chahbar is a business lawyer at Siskinds LLP. Kristen King assisted with the preparation of this article.