Starting a business as a sole proprietor is relatively simple. There are no articles of incorporation, no separate corporate tax return and, in many cases, very little formal setup required before you begin.
But “simple” does not mean there are no tax or compliance requirements.
Here are the key things Canadian sole proprietors should understand when starting and operating their businesses.
What is a sole proprietorship?
A sole proprietorship is an unincorporated business owned by one individual. Unlike a corporation, there is no separate legal entity between you and your business. You receive the profits, claim the losses and are personally responsible for the obligations of the business.
For tax purposes, this also means the business does not file a separate corporate income tax return. Instead, you report your business income and expenses as part of your personal income tax return using Form T2125, Statement of Business or Professional Activities.
The CRA describes a sole proprietorship as the simplest form of business structure, but also notes that the owner assumes the risks of the business personally.
How does a sole proprietor pay income tax?
Your business revenue, less allowable business expenses, determines your net business income. That net income is included on your personal tax return and taxed at your applicable federal and provincial or territorial income tax rates.
The key word here is net.
You are not normally paying tax on every dollar you collect. Reasonable expenses incurred to earn business income can be deducted, while personal expenses cannot. Capital purchases, such as computers and equipment, have different tax treatment than ordinary operating expenses.
Good recordkeeping is therefore important from the beginning. A separate business bank account and credit card are not always legally required, but they can make it substantially easier to identify business income and expenses and support your tax filings.
Don’t forget about Canada Pension Plan (CPP)
One expense that sometimes surprises new sole proprietors is Canada Pension Plan contributions.
When you’re an employee, you pay the employee portion of CPP, and if applicable, higher earning staff also pay a second additional CPP contribution (CPP2). Employers additionally owe an equal employer portion of CPP (and CPP2). But, when you’re self-employed, you are generally responsible for both the employer and employee portions. This calculation is based on your self-employment income, up to the applicable annual limits. Note: Québec residents are subject to QPP instead.
And no, as a sole proprietor you don’t put yourself on payroll to avoid this. Money you withdraw from your business is an owner’s draw, not a paycheque with tax deductions taken from it. Salary or drawings paid to the owner of a sole proprietorship are not deductible wages of the business.
What about Employment Insurance (EI)?
Self-employed individuals generally don’t pay regular EI premiums simply because they operate a business.
However, eligible self-employed Canadians can voluntarily participate in the EI special benefits program. These benefits can include maternity, parental, sickness, compassionate care, and family caregiver benefits.
There is an important catch: you generally need to participate for at least 12 months before accessing benefits. You can withdraw from the program if you have never received benefits, but once you receive EI special benefits as a self-employed person, you must continue paying premiums while you remain self-employed.
Do sole proprietors need to register for GST/HST?
Maybe.
For most businesses, mandatory GST/HST registration is based on the $30,000 small-supplier threshold.
The timing matters. If you exceed $30,000 of taxable supplies in a single calendar quarter, you can lose small-supplier status immediately. If you exceed the threshold over four consecutive calendar quarters instead, different timing rules apply. Businesses below the threshold may also choose to register voluntarily.
Once registered, the CRA gives you a GST/HST program account. Your nine-digit Business Number is followed by RT0001 for your first GST/HST account — for example, 123456789 RT0001.
A common mistake is assuming that GST/HST is the only sales tax to think about. Depending on what you sell and where you make sales, you may also have provincial sales-tax obligations, such as PST, RST or QST. Those rules — including the current GST/HST and PST rates for each province — vary by jurisdiction and can change, so don’t assume that being a small business, or being located outside a particular province, automatically means its rules don’t apply to you.
If you’re late paying your taxes
Life happens, and sometimes a return or a payment is late. It’s worth knowing what that costs before it happens to you.
If you file your personal return after the deadline and owe tax, the CRA charges a late-filing penalty — a percentage of your balance owing, plus an additional amount for each full month it’s late, up to a maximum. That penalty is significantly higher if you’ve been charged a late-filing penalty in a recent prior year and were formally asked to file. Filing on time avoids this penalty entirely, even if you can’t pay everything you owe right away.
Instalments work similarly: pay them late or short, and the CRA charges daily-compounded interest, with a penalty layered on top once that interest passes a certain threshold. Because these rates and thresholds are reviewed regularly, check the CRA’s current pages before assuming last year’s numbers still apply.
Can a sole proprietor hire employees?
Absolutely.
You can’t employ yourself through your own sole proprietorship, but you can hire employees.
Before processing payroll, you’ll need to determine your employer obligations, collect the appropriate federal and provincial or territorial TD1 forms and set up a CRA payroll program account.
If you already have a Business Number, the same nine digits are used. Your first payroll account will generally end in RP0001 — for example, 123456789 RP0001.
From there, you’re responsible for properly calculating payroll, deducting income tax, CPP/QPP and EI where applicable, making employer contributions, remitting those amounts and completing year-end reporting — including the payroll deductions most new employers find unfamiliar at first. Learn more about Gross pay vs. net pay: what’s the difference?
This is one area where payroll software like Wagepoint can make running even a very small business much easier.
Do I need to register my business name or get a business licence?
These are two different questions.
If you’re operating under your exact legal name, you may not need to register a separate business name. If you’re operating under another name — even something as simple as adding “Consulting” to your name — registration may be required. Because business-name registration is provincial or territorial, the requirements may be different where you operate. Find out more about Registering a sole proprietorship or partnership – Canada.ca
Business licences are separate again. Depending on your municipality, industry and location, you may need municipal, provincial/territorial or federal permits and licences, including for a home-based business. Canada’s BizPaL service is a useful starting point for identifying what may apply. You can also go to your individual provincial and municipal websites for more information.
One final tax deadline to remember
Self-employed individuals generally have until June 15 to file their personal income tax return. However, any income tax balance owing is still due by April 30.
The gap between the payment and filing deadlines catches many first-time business owners. Since payment is still due April 30, many accountants suggest treating April 30 as your filing deadline, too. In practice, you can’t know what you owe until the return is prepared, so the later filing date rarely helps.
As your business grows, you may also become required to make income-tax instalments during the year. This becomes required once your net taxes owing is more than $3,000 (or $1,800 for Quebec residents) in the current year and in either of the two previous years. You can get more information on the CRA’s instalments page.
How should a sole proprietor keep their books?
There isn’t one bookkeeping system that’s right for every sole proprietor. The right approach depends on the size and complexity of your business and how much time you want to spend managing the records yourself.
Some business owners maintain their own bookkeeping throughout the year using accounting software or an Excel bookkeeping template. This can work well if you have relatively few transactions and are comfortable keeping the records up to date, but it can often lead to calculation errors.
Others choose to hire a bookkeeper. This may make sense as your business becomes more complex; particularly if you have employees, significant sales-tax obligations, receivable tracking, inventory, multiple accounts or a large volume of transactions. A good bookkeeper can keep the records current throughout the year and help identify issues before tax season.
There is also a middle ground. Some straightforward sole proprietors don’t need full monthly bookkeeping but still need to turn a year’s worth of bank and credit-card activity into organized records at tax time. As the owner of a CPA firm, I developed Heightly for this type of situation — it organizes bank and credit-card transactions into T2125-mapped records that can be reviewed and used for tax preparation.
Staying on the right side of the CRA
Running a sole proprietorship means wearing every hat, including the one that keeps you onside with the CRA. None of it is complicated on its own; it’s just a lot to track while you’re also running the business. Good recordkeeping, the right advisor, and staying current as rates and thresholds shift each year go a long way. And because every business situation is a little different, it’s worth confirming the specifics that apply to you with your accountant or bookkeeper before you file.
Related reading
- CRA: Sole proprietorship
- CRA: CPP for self-employed individuals
- CRA: EI for self-employed workers
- CRA: When to register for and start charging the GST/HST
- CRA: Paying your income tax by instalments
- Wagepoint: Common Canadian payroll deductions
The information in this post does not constitute or replace the need for professional bookkeeping, accounting, payroll or tax advice. As tax laws are constantly changing, it’s important to ensure that you have the most accurate and up-to-date information.
