Originally Published: June 22, 2022
Registering a Sole Proprietorship is the most common business entity for new business startups for a single business owner. It is the cheapest way to form a business ownership in almost all jurisdictions, but most affordable does not necessarily mean it’s the best option.
A Sole Proprietorship business structure is responsible for any decision making, revenues and any expenses from the business. More importantly, does not have a separate legal status from the business.
A Sole Proprietorship form of business also assumes all of the risk of the business personally which can include personal assets and property.
The fee difference between registering a Sole Proprietorship and Incorporating in Ontario with us is about $450.00. The additional fees associated with incorporation are not much when you consider the significant benefits and complete control you have with incorporation over registration.
Advantages and Disadvantages of Sole Proprietorship
Let’s look at the advantages of starting a Sole Proprietorship
- Easy to setup and easy to cancel
- One tax filing
- Simple ownership (one person)
A Sole Proprietorship is Easy to Set Up and Easy to Cancel
The Sole Proprietorship or Sole Proprietor is designed to make a straightforward form of starting a business in most jurisdictions. One individual owner can only establish it. The owner has full responsibility for all actions of the business. The Sole Proprietorship is as easy to cancel as it is to establish and can registered almost instantly.
One Tax Filing
With a Sole Proprietorship, the business and the individual are one entity and therefore, the taxation for the registration is to the individual person. A secondary tax filing is not required for the business.
Simple Ownership (One Person)
The single individual who owns the Sole Proprietorship has complete control of the business, its endeavours, risks, attributes and opportunities.
Let’s look at the disadvantages of registering a Sole Proprietorship under a number of categories
- No Business Name Protection
- Sole Proprietorship Tax disadvantages
- Limited access to change
- Limited access to credit
- Limited client potential
- Renewal obligations
- Liability risks
- Growth of business
- Sell Your Business
- Misconceptions about Incorporation
As you can see from just the categories listed, there are several reasons for you to pay very close attention to how to form your business from the start and whether you select to register a Sole Proprietorship or Incorporate.
No Business Name Protection
When you register a Sole Proprietorship, there is no business name protection. This means someone else can register or incorporate the exact same business name as you. They can register it, advertise it, and put it on social media, and you have no recourse to stop them from doing this. You don’t own the business name as a Sole Proprietorship, and therefore the name is up for grabs.
In Ontario alone, there are millions of registered businesses. Each and every day, hundreds of new registrations are established.
Sole Proprietorship Tax Disadvantages
Personal Income Tax
When a Sole Proprietorship is registered, all of the income generated becomes part of the taxable income under the T1 tax return filing. The T1 filing is for your personal tax return. This includes any revenue generated from the Sole Proprietorship, excluding the costs associated with running the business. In Canada, there are tiers of income and taxation from that income. According to The Revenue Canada Agency, the federal tax rate begins at 15% up to 33% of income depending on how much is earned. This does not take into account the other part of the tax implications, which are the provincial portion of the tax rate.
If you have another source of income such as a full or part time employment, spousal support, investment income or pension, the tax implications from the business could put you in a higher tax bracket where you receive the minimum tax benefit.
Corporate Income Tax
In contrast, if you open and operate a corporation, the corporation is its own entity, and therefore the income from the business is not attached to the individual taxation. The only time the business income becomes part of a personal tax return is if and when you draw revenues from the corporation to your personal bank account.
The corporation in Ontario has a tax rate of roughly 15%. This compares to the lowest personal tax rate available personally to those who earn under $50,000.00 a year.
The corporation also has the benefit of being its own investment entity. A corporation can borrow or lend money, purchase property, purchase stocks, mutual funds, ETF’s or bonds and can do this without the money being transferred and taxed to the individual who owns the business.
These two reasons can hold tremendous tax advantages and financial control to the corporate owner versus the Sole Proprietorship owner.
Taxation is one of the most expensive if not the most costly, elements of owning a business, and it’s best to look at your revenue streams earned prior to starting a business to determine the best business ownership for establishing the business. An accounting or financial adviser may provide taxation for each business model to assist you in deciding which is best for your personal scenario.
Limited Access to Change
The intention of every business owner is for the business to grow and provide more revenues over time from the business. Several diversions can happen over time to bring forward changes from the original setup of the business. With a Sole Proprietorship, you can change the address of the business or individual, change the activity or Naics code. This limits your ability to make changes that may be needed for your business to assist it in its path moving forward.
With a corporation, you can change the name of the business to a new name that may be better targeted for your business opportunities. You can also add another business owner or partner to the corporation. You can add a DBA or “doing business as” name under the corporation to enhance one particular part of your business or attract attention to a new business venture under the corporation.
Limited Access to Credit
As discussed, the Sole Proprietorship is attached to your personal assets for taxation. It is also attached to you with regards to gaining access to business credit. Under a business registration, including the Sole Proprietorship your personal income and assets are tied to the business revenues and it is challenging to complete an evaluation for your business under the Sole Proprietorship. Your personal assets, income and expenses need to be extracted from the business operations to obtain a better understanding of the business assets and liabilities to get a proper assessment for the value and worth of the business.
Raising capital for financing expansion is part of most business plans. With a Sole Proprietorship, borrowing is only available to the individual business owner where your personal assets are required instead of gaining business loans through the business assets. With a Sole Proprietorship, you will be borrowing personally for the business. The business and you as a sole owner are the same entity when it comes to raising money.
A corporation is a separate entity from the individual owner, and therefore, it is much easier to value the business’s worth and to provide business financing and business credit to the entity. This has the potential to limit your personal risk for the business. The corporation has its own financials and tax filings, making it easier for an evaluator to appraise the business’s worth. There are financial institutions, private lenders and government bodies who are willing to provide money to corporations with financial history.
Limited Client Potential
If your business is solely providing services or products to individuals on an item-by-item sale, a Sole Proprietorship may be very marketable.
If the business is looking at selling in bulk to individuals or other businesses or desires to form contracts with existing businesses, having a corporation with limited liability protection is much more enticing. The business to business industries at large request and often demand that a business that wishes to do business with them is an incorporated entity. A Sole Proprietorship is frowned upon.
A Sole Proprietorship, General Partnership or Firm Name For a Corporation all require to be renewed every 5 years. This carries the same expense if not higher of the original registration, and if a renewal is missed, the Sole Proprietorship automatically expires. If the renewal date is missed and you wish to carry on the business further, a new registration is required. This means that you have the loss of the original registration date, the history of the name of the registration and the overall longevity of the business operation.
An Incorporated business never requires renewal. The corporation continues indefinitely and does not require additional renewal fees such as the registration.
As provided earlier, a Sole Proprietorship has implications both to your taxable income and access to business credit. Another issue related to operating a Sole Proprietorship is the liability risk of the business and how that relates to you personally as the owner. Starting the business as a Sole Proprietorship brings you business risk and liability that you weren’t exposed to before starting your business. If the business has debts, they are your debts, if the business causes personal injury or property loss, it is as if you personally did this, if the business is sued, you are personally sued. Since there is no distinction between you and your business, what happens for the business happens for you when it comes to liability. Unless you obtain separate business insurance, your personal assets are exposed to anything that happens for the business.
A corporation is a separate entity from you as an individual and therefore, there is a separation between the liability of the business and you as a person and your personal assets. The debts of the business are the debts of the business, and unless you personally support the obligations of the business, the business can flounder without it affecting you personally. The corporation may cause injury or property loss but that is separate from you as an individual and if the business is sued for liability, it will be the corporation who is named and not you personally.
Growth of Business
Registering a Sole Proprietorship limits your ability for expansion. The registration may be considered a good option when the revenues of the business are small, the risk is limited and expansion is a consideration down the road. With a Sole Proprietorship, you will most likely be self financing any expansion you wish to do including buying equipment, property, bankrolling ideas, staffing and technology.
A corporation as discussed has separate financial criteria and tax filings. It may be very viable for you to have the corporation take on the debts of new equipment and technology for the business, as well as having the credit to be able to take loans to purchase property or investment in new employees.
Sell Your Business
Every business owner dreams that the business will have value and be marketable down the road to either pass on to others as a succession plan to children or employees or to be sellable to a third party to reap the financial rewards of hard work and labour.
Succession for a registered business as a Sole Proprietorship is very limited. You cannot pass the existing business to another. As a Sole Proprietorship, you can not take your name from the registration and add another person’s name. A completely new registration or incorporation will be required if someone is to take over the business.
The taxation can be very significant where capital gains tax would be applicable and can be as high as 49% to the business owner with no access to tax benefit savings offered to the counterpart Incorporation.
A corporation as discussed, is a separate entity from the individual when it comes to taxation, access to credit, liability and now to the sale of a business. The corporate financial records are on their own very separate from the individual owner and, therefore much easier for anyone looking to purchase the business to understand the business assets.
A corporation provides several ways for succession, share or asset purchase where taxation is minimized in comparison to the Sole Proprietorship.
Misconceptions about Incorporation
There are so many misconceptions about incorporating including the following
It’s expensive to incorporate
This is not true. The average incorporation is somewhere between $500 and $600.
It would be best if you had a lot of capital to incorporate
This is not true. You don’t need any capital and can start a corporation with zero investment
A corporation is complicated
A corporation is less complicated than a Sole Proprietorship because the personal and business assets are completely separate.
A corporation is messy at tax time.
The corporate tax return can be filed at any time during the year and doesn’t require filing at the same time as a personal tax return filing.
Its harder to keep track of money.
It’s much easier with a corporation as it has its own bank account so therefore, its easier to track revenues and expenses instead of trying to track your personal expenses as well.
Only large corporations can incorporate.
This is absolutely not true. Most incorporations have one director with minimal investment.
At Ontario Business Central we offer a wide variety of business structures including:
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Ontario Business Central Inc. is not a law firm and cannot provide a legal opinion or advice. This information is to assist you in understanding the requirements of registration within the chosen jurisdiction. It is always recommended, when you have legal or accounting questions that you speak to a qualified professional.