Sole Proprietorship (Self-Employment)

Catherine Yeulet / iStock / Thinkstock

Where one person decides to set up a business, there are not many options about the legal structure to use. There are really only two: a sole proprietorship or a business corporation, also called a company.

The sole proprietorship is a very simple legal structure that is inexpensive to set up and operate. This makes it a very attractive option for self-employed workers in Québec.

In this article, Éducaloi explains the advantages and disadvantages of a sole proprietorship as the legal structure for a person starting business alone.

Definition of Sole Proprietorship

As the name suggests, a sole proprietorship is a business operated by one person working alone. This person is often called a "self-employed worker" or an "independent operator"

The self-employed worker and the sole proprietorship are one and the same. In other words, this worker operates the business and the business is the product of this worker's labour.

But because we can't say that the self-employed person is the legal structure, we say that this person is running a business with only one owner  - him or herself. And we call this business structure with one owner a "sole proprietorship".  

Self-employed workers can carry on their activities in various ways. Here are some examples:

  • act as a consultant or freelancer for one or more clients
  • open their own offices  to practice their professions (a lawyer, for example)
  • work on commission (door-to-door selling for example)  
  • operate a business from home
  • work part-time, full-time or on specific projects

So if a person runs a sole proprietorship, we say that they work for themselves. They are not under anyone else's authority and have maximum freedom in managing their  affairs and doing their work.

Also, because they are the sole owner of their businesses, they earn all the profits of that business and must absorb all the losses, if there are any.

Careful! Sometimes it is hard to tell the difference between self-employed workers and employees.

Advantages of Sole Proprietorship

Being your Own Boss

  • Self-employed workers work for themselves. They offer their services or products to clients with whom they can sign service contracts. They can also hire employees to help perform their contracts. They then become the person in charge of the business.

 Low Start-up and Operating Costs

  • A sole proprietorship is the least expensive legal structure to create and operate (low government fees, minimal lawyers', notaries' or accounting fees, etc.).

Simple Operation

  • A sole proprietorship is the simplest legal structure to set up for doing business. Also, because business owners operate their businesses alone, they can run it as they see fit.
  • Subject to few exceptions, people who operate a sole proprietorship under their family names and first names are not required to register their businesses in the Registre des entrerpises (register of businesses). This means that they do not have to follow all the rules involved in registering (filing an initial declaration, name search and name reservation, updating declaration, etc.).
  • A "small supplier" - a self-employed person whose total billings in a year for sales and services is $30,000 or less - is not required to register with the tax authorities for the purposes of collecting and paying sales tax (GST and QST). The finances of the business are therefore much simpler to manage.

 Certain Tax Advantages

  • From a tax point of view, self-employed people are entitled to certain advantages because the money the business makes is seen as personal income. This means that they are entitled to the tax credits reserved for individuals. For example, individuals can get a tax credit based on the "basic personal amount" set by the government. This amount gives individuals a credit to reduce income taxes owed to the government.
  • They can use the expenses paid to run their businesses to reduce the amount of taxes that they must pay (for example, they  can deduct travel and accommodation expenses and the cost purchase of supplies).

 Profits

  • All the profits earned by the business belong to the owner. They do not have to share them with anyone else.

Disadvantages of Sole Proprietorship

 Not Entitled to Benefits Employees Usually Get

  • Self-employed workers are not the employees of their clients. This means that
     
    • they  do not receive the employment benefits usually offered by employers (such as paid vacation, sick leave, a pension fund and supplementary group insurance (life and medical, dental or disability),
       
    • they must get insurance required for operating their businesses ("civil liability" and professional negligence insurance), and
       
    • they must put money aside for retirement, even though they participate in various government-run plans, such as the Quebec Pension Plan. They can put money aside by, for example, signing up for a voluntary retirement savings plan (VRSP).

Run Their Businesses Alone

  • This means that they do not have access to the financial resources, knowledge and work provided by a business partner to help run and grow the business. Also, they are solely responsible for debts of their businesses.
     
  • However, self-employed workers can hire employees to help with the work. If they have employees, they must respect all the normal obligations of employers, Self-employed workers can also hire other self-employed workers.
     

Greater Difficulty Getting Financing

  • Because they run their businesses alone, financial institutions are more hesitant to lend them  money.

Higher Taxes

  • A sole proprietorship pays the same taxes as an individual. Therefore, if the business generates a lot of money, a sole proprietorship could be a disadvantage from a taxation point of view. When a business makes a lot of money, using a business corporation structure can save taxes. This is because business corporations pay taxes at a much lower rate than an individual with the same level of income.

Personally Responsible

  •  Self-employed workers are personally responsible for their actions in operating their businesses. In some situations (especially for professionals and self-employed workers whose services or products have specific risks), it is necessary, if not required, to buy insurance to reduce the risks of potential lawsuits.

Risks in the Event of Bankruptcy

  • If the business goes bankrupt, people owed money can seize not only the money and equipment used to operate the business, but also the self-employed person's personal money and property.

    This is because self-employed workers and their businesses are one and the same. In other words, self-employed workers must declare personal bankruptcy when the business can no longer pay its debts.

Business Ends at Death of the Owner

  • A sole proprietorship ceases to exist when its owner dies.

The Decision to Incorporate

Self-employed workers who set up as a sole proprietorship to do business can later change their minds. They can choose the other legal option: the business corporation (also called a company). To pick this option, they must "incorporate".

To make incorporating worthwhile, the business usually has to be making a certain amount of money. When the business is making more money, the advantages of operating as a business corporation (such as earning more profits and reducing the self-employed worker's personal risks) outweigh the disadvantages (especially the cost and complexity).

To make it easier to move from a sole proprietorship to a business corporation, a "tax rollover" is possible. This allows everything owned by the sole proprietorship to be transferred to the corporation with minimal or even no taxes.

Important !
This article explains in a general way the law that applies in Quebec. This article is not a legal opinion or legal advice. To find out the specific rules for your situation, consult a lawyer or notary.