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Business Structures: Sole Proprietorships

Introduction to Sole Proprietorships

One of the first decisions to make in establishing a business is what organizational structure will be used. This article is part of our Website series on business organizations and discusses the use of sole proprietorships as a specialized structure for carrying out a specific business purpose.

In the strictest sense, a proprietorship is not an organization at all since it exists only where a single individual is conducting business by himself, without any partners and without the use of a limited corporation. It is not possible for more than one individual to act together in a proprietorship, as a proprietorship is by definition a single individual. It is possible for an individual to own more than one proprietorship, and operate each one under different business names.

While there are many considerations involved in choosing the form of organization, they usually fall into the general categories of income taxation, administration and cost, and limitations on liability.

Income Taxation

The income tax treatment of proprietorships is administratively simple as the income or loss from the business is reported directly on the individual owner’s income tax return. The individual proprietor may set up different accounting structures for different proprietorships, if they happen to operate more than one proprietorship.

While the simplicity of the income taxation for proprietorships is an advantage, it can also be a disadvantage. The individual must declare the income or the profit in the year that it occurs, meaning that there is little opportunity for the individual to carry out any tax planning to defer income to years where the individual’s marginal tax rate might be lower.

Administration and Cost

The start up of a business as a sole proprietorship is very easy and the costs are minimal. An individual usually only needs to register a business name and pay any provincial or municipal licence fees charged for the right to operate a business. As there are no specific statutes that govern the structuring of proprietorships, there are very few rules to follow about establishing or maintaining the structure. There is also no continuing requirement to make administrative filings to maintain the proper status of the proprietorship with any government department, as there is with some of the other structures.

Similarly, the accounting records and income tax filings of the business are easier to maintain than some of the more complex structures. This may be minimal, simply remitting source deductions to Canada Revenue Agency, including E.I., C.P.P., and federal income taxes withheld for any employees. The costs associated with tax compliance for a proprietorship are usually the lowest of any of the various business structures.

Limitations on Liability

The most obvious disadvantage to a proprietorship is that there is no limited liability protection for the individual owner. The individual owner is liable to the full extent of their personal assets for all debts and obligations incurred during the course of operating the proprietorship.

This would include specific debts incurred in the proprietorship, but would also include claims by third parties that might arise from a wrong suffered in the conduct of the business operations.

Additionally, most individuals are not aware that if the proprietorship has employees, the proprietor is also liable for the actions and conduct of these employees in the course of their employment.

We always advise that it is important for all business owners to carry sufficient liability insurance to cover claims that may inadvertently arise in the course of business. With a proprietorship, it is very important to make sure the insurance is adequate to cover the risks because of the exposure of the owner’s personal assets.

As you can see from the headings we have discussed, the sole proprietorship structure is a relatively simple and cost effective organization to use. Unfortunately that simplicity can also be its biggest disadvantage as it exposes the individual owner of the proprietorship to liabilities of the business. Ultimately the choice of which structure to use to carry on a business involves a careful understanding of how the business will operate in the future, the various risks that the business will face, and what benefits each structure will provide to the operator of the business. We recommend you speak with our lawyers to discuss the relative merits of the different structures before you commence carrying on business.

The opinions set out in this article reflect generally on this area of law. The impact of the law on any given situation depends upon each individual’s circumstances and the opinions contained in this article should not be relied on for assessing anyone’s legal position. Advice should be obtained directly from our business law lawyers regarding your particular situation.