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Entrepreneur Law – The Sole Proprietor: How to Tell If You Have Become One

January 1st, 2014 by

So, you’ve got a great business idea that you are about to launch. Your business planning is finished, the funding is lined up and your test-marketing tells you that it’s sure to be a hit. Have you thought about your business structure? Likely not, and this is where most people’s eyes will glaze over and minds tune out, ahhh, the legal stuff… but wait, it doesn’t have to be that way.

A key to being a successful entrepreneur is of course being informed, and this includes having a basic understanding of the fundamental business law concepts that will affect your business, and that should affect the business decisions you make on a daily basis.

Different business structures come with their own pros and cons. The goal of this article is to discuss some the key aspects of the sole proprietorship in order that the entrepreneurs reading it will gain an essential, basic understanding of the legal consequences to being in business.

This will be a general overview of the sole proprietorship and the examples draw on Nova Scotia (Canada) law. There may be similar concepts according to the law in your area, but you should verify with a lawyer in your jurisdiction (state, province, or country, etc).

What is a Sole Proprietorship?

A sole proprietorship is a solely owned, unincorporated business. It is often the structure chosen by new small business entrepreneurs for several reasons. These include the ease of set up due to minimal registration requirements, relatively low cost to begin operating, and few, if any, annual reporting obligations.

If you simply started operating a business today, without having registered anything at all, you are more than likely a sole proprietor.

No Legal Entity

A sole proprietorship is not a separate legal entity. This means that the “business” cannot own any property or hold any assets in its own name. A sole proprietorship business is really just an extension of the business owner him or herself. Any assets or property used in the business are legally owned by the sole proprietor (you) (unless owned by someone else).

Because the business owner and the business are one in the same, the sole proprietor cannot be employed by the business. An employment relationship is a contractual relationship and it is impossible for a person to be in contract with him or herself. Money made in the business therefore can’t be taken out and expensed as salary against the income of the business. In fact, sole proprietorship business income will be computed as, and considered to be personal income to the business owner by the tax authority (CRA in Canada), normally called “Self Employment Income”.

As such, if a sole proprietor turns a profit; the profit will be taxed at the higher personal income tax rate in addition to any other taxable income the sole proprietor may have. However, if losses are incurred, which is often the case in the early years of the business, those losses could be used to offset other taxable income such as employment wages from a day job (we know that it is common for entrepreneurs to have a day job while trying to get their business off the ground). This could lead to a lower amount of taxable income payable on your annual taxes.
Liability of the Sole Proprietor.

The exposure to unlimited liability is a disadvantage to having no separate legal entity as a sole proprietor. This means that the owner’s personal assets may be accessible to creditors to satisfy the obligations and liabilities of the business. Should the business not make enough money to cover such liability, the owner’s personal belongings and other assets such as savings accounts, property, or anything of value could be available in such circumstances. One potential way to limit liability could be through business insurance. This would however, only be within the limits and coverage of the policy, anything in excess of that would still be a personal exposure of the sole proprietor.

Business Name Registration

If a sole proprietor wants to use a business name which is something other than his or her own personal name, business name searches will have to be done and, if the desired name qualifies, it will have to be registered as required in Nova Scotia by the Partnerships and Business Names Registration Act.

The reasoning for this is, among other things, to avoid duplicate business names from being used, which would confuse the public. It also serves to provide protection from potential later registrants using or trying to make use of your business name in the same jurisdiction in which you are registered. There is also the notion that it will serve to protect the public by providing transparency in the form of a notice to customers of who you are, and thus who they are in business with (i.e. who they are purchasing a product or service from). It is noteworthy however to make it clear that mere business name registration, however, does not provide the same level of protection afforded by trademark legislation, and it is limited, generally, to the jurisdiction in which the name was registered.

Keep in mind that just because a business name has been registered, and is being used in a sole proprietorship, the nature of the sole proprietorship legally, as discussed above, has not changed. It is common to describe a sole proprietorship as the sole proprietor “carrying on business as”, or as abbreviated “cba”, followed by the registered business name. Therefore you may see for example, Ronald Duck, carrying on business as Duck Consulting. In such a case, Ronald Duck would be the sole proprietor, and Duck Consulting the registered business name of the sole proprietorship.

There are potential monetary and legal consequences to operating a business under an unregistered business name which fines, along with a restricted ability to bring or defend legal proceedings.

Sole proprietorships may be the most practical option many entrepreneurs when starting out. However, this decision depends on several important factors including the potential risk involved in operating the particular business or industry you are in. If the industry is a higher risk one, it may be best to invest the extra money and incorporate the venture. The benefits of this should be discussed in detail with your lawyer when planning your business.

On a final note, should you decide to begin a sole proprietorship to see how things go before deciding to invest the money and commitment into incorporating a company, you may be able utilize what is referred to as a s. 85 Rollover pursuant to the Income Tax Act (Canada). If your business qualifies, you’d be able to transfer the business assets to the incorporated company on a tax deferred basis.

Garnet Brooks is an experienced entrepreneur, and is a practising business lawyer in Halifax, Canada. His law practise involves advising and representing businesses and entrepreneurs in various matters including the set-up and incorporation of businesses, transactions, drafting and negotiation of contracts, as well as preparation and registration of security in various commercial financing transactions. Garnet also represents clients in enforcing their legal and contractual rights and particular has represented clients in proceedings before the Federal Court of Canada, Nova Scotia Supreme Court, and the Small Claims Court of Nova Scotia. Garnet has an active financial recovery & collections practise where he represents clients in the enforcement, negotiation and recovery of secured and unsecured loans, credit facilities and other debts.