There are two popular options for self-employment in Canada: independent contracting and sole proprietorship. Both options provide a certain level of work flexibility and the opportunity to work on a contract basis.
But what is the difference between an independent contractor vs a sole proprietor in Canada?
Indeed, both terms are not interchangeable and have distinct differences that can significantly impact your business operations, financial obligations, and legal liabilities. They are different business structures for self-employment and have varying set-up requirements and tax responsibilities.
Whether you are searching for financial independence, becoming a freelancer, or want to start a small business, it is good to know the differences between a sole proprietor vs an independent contractor in Canada before diving head first.
Let's explore the differences between independent contracting and sole proprietorship in Canada. This article aims to provide a comprehensive understanding of both to help you make an informed decision that aligns with your professional needs and aspirations as an independent contractor or sole proprietor.
What Is Self-Employment?
According to the Canada Revenue Agency, self-employed individuals are considered small business owners. These individuals are directly engaged in a business relationship with a payer or client.
Self-employed individuals must pay self-employment taxes and contribute to the Canada Pension Plan (CPP) and Employment Insurance (EI) independently. Both of these are important pillars of Canada's social security safety net.
Independent contractors can also opt in or out of employment insurance and are in charge of their benefit plans.
Employment Status: Employee vs Self-Employed
Every individual's employment status is determined by the province in which their contract was signed. The contract should define the working relationship and arrangement, stating clear intention.
Some factors determining whether an individual is self-employed or an employee include:
- Amount of control the payer has over their work
- Who supplies the tools and materials
- Can the worker subcontract the job?
- Financial risks
- Level of responsibility for investment and management
- Potential for profit
- Any other relevant aspects, such as written agreements
Why Do People Pursue Self-Employment?
There are many reasons people pursue self-employment.
Work flexibility, work-life balance, and greater control
A self-employed individual can choose the workspace that suits them best and make their schedule and workload. This route saves them both time and money and increases their effectiveness. A pleasant work atmosphere also keeps them from being sidetracked and enables them to get the job done.
Don't want to do it all on your own? You can outsource, too! Moreover, self-employed individuals can make their own decisions that will impact their business, career, and family.
Financial independence and job security
Going out on your own as a business owner can provide you with the chance to boost your earnings. You can determine your fees, so if your business is successful, there is no limit to how much you can make.
As opposed to working for someone else, your job security is in your own hands. That said, you may have to put in more effort to secure customers, develop a viable business, and maintain a steady business flow.
Growth and meaningful networks
When you're self-employed, you may face unfamiliar procedures, especially at first. Working on customer acquisition, marketing, finance, and other business matters can be an educational journey you can use in your future career.
Furthermore, you must network and build relationships on your own. This networking can lead to collaborations with other business owners and create chances to engage with people with the same mindset and experience who can help you expand your business. Additionally, you can make direct links with your customers and communicate with them more meaningfully.
Types of Self-Employment in Canada
There are various types of self-employment in Canada. You should know a few before diving into sole proprietorships and independent contractors in Canada.
- Freelancer: A freelancer works for multiple employers simultaneously on a project-to-project basis. This is a shorter-term form of self-employment. Freelancers must pay self-employment tax.
- Sole proprietors: A sole proprietor owns a business run solely by a single individual. Many sole proprietors own small businesses.
- Independent contractor: An independent contractor is similar to a freelancer but can work for a single employer longer term. Any skilled professional can be an independent contractor - from coding software to graphic design; there are many opportunities for contract work.
- Partnerships: A partnership is run by more than one person and governed by a partnership agreement. There is no division between the individual and the business; you and your partners are liable for any debts and obligations incurred.
- Corporation: This is a distinct legal organization separate from you as a person. All profits and losses are assigned to the business instead of being your own. In Canada, you may set up your firm federally or through the provincial or territorial governments. With this business structure, you will be responsible for payroll taxes, even if you are the only employee.
- Single-Member Limited Liability Company (LLC): Similar to sole proprietorships, single-member LLCs are run single-handedly but are incorporated businesses.
Under Canada's tax laws, both freelancers and independent contractors are classified as independent contractors.
What Is a Sole Proprietorship?
A sole proprietorship is the most inexpensive and basic form of business structure in Canada. It is an unincorporated business solely owned and operated by an individual.
A sole proprietorship is independent by nature. As a sole proprietor, you have absolute control over your business and its operations. You are the decision-maker, the manager, and the executor.
However, this complete control also comes with complete responsibility. You are personally responsible for all aspects of the business, including any debts or liabilities that the business incurs. This means that if your business cannot pay its debts, your assets could be used to meet those obligations.
Is a Sole Proprietor the Same Thing as Being Self-Employed?
The short answer is yes. There are a few forms of self-employment and becoming a sole proprietor is one. As a sole proprietor, however, you have different legal and tax responsibilities than independent contractors. Both sole proprietors and independent contractors are self-employed.
Setting Up a Sole Proprietorship in Canada
Although setting up a sole proprietorship is straightforward, here are some things you should note.
- Choose a business name: You can run a sole proprietorship under your name or a business name. However, it is important to decide to ensure all invoices are billed to yourself or your business. This makes paperwork more manageable.
Skip to step three if you intend to run a sole proprietorship under your name instead of a business name.
- Register your business name: If you choose to run your sole proprietorship under a business name, you must conduct a legal name search, register your business name, and pay registration fees. This helps you register as a Canadian business. This may differ from province to province.
- Alberta (can’t be done online, $60)
- British Columbia (Name Reservation, Name Approval, and Business Name Registration, $40)
- Manitoba (Business Name Registration, $60)
- New Brunswick (Business Name Registration, $112)
- Northwest Territories (Business Name Registration)
- Nova Scotia (Business Name Reservation and Business Name Registration, $68.55)
- Nunavut (Business Name Registration)
- Ontario (Business Name Registration, $60)
- Prince Edward Island (Business Name Registration, $96.98)
- Quebec (Enterprise Registration, $38n)
- Saskatchewan (Name Reservation and Business Name Registration, $60)
- Yukon (Name Reservation)
- Get your business number: The Canada Revenue Agency assigns a nine-digit Business Number (BN) to every company's tax ID. This BN is one of a kind and is to be used when engaging with government entities (at the federal, provincial, or local levels).
Businesses that generate less than CA $30,000 in income annually from their business activities and are not incorporated are exempt from needing a BN. Others may require a BN to open accounts for programs such as the Canada sales tax (GST/HST), payroll deductions, and/or import/export privileges.
Businesses incorporated in British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario, Prince Edward Island, or Saskatchewan must have a BN to pay business taxes. - Open a bank account: Once you have set up your sole proprietorship in Canada, you may want to begin earning money. To do so, you need to open a bank account for your business. For this, you must present proof of registration and a photo ID.
It is also advisable to ask your bank pertinent questions about your business, obtain the needed checks/deposit books/business stationery, and ask for a banking, debit, interbranch card, or phone/internet access to the account. Additionally, you may apply for a credit card for company expenses. - Do your taxes: Any income you make from your Canadian sole proprietorship is considered your income for tax purposes, and so you will need to complete a T1 income tax and benefit return, as well as a Form T2125 Statement of Business and Professional Activities.
Additionally, you should also submit any necessary forms for provincial income taxes. You should file a return if you are seeking a refundable tax credit or a GST/HST credit. If you qualify as a “Small Supplier” and make less than CA $30,000 a year, you don’t need to register with the tax authorities for GST and QST purposes and can use your Social Insurance Number (SIN) instead of a Business Number.
What Is an Independent Contractor?
An independent contractor is an individual who provides services to clients on a contract basis. They can decide what contract work they want to take on. They are self-employed individuals who work independently for multiple clients. This means they have the freedom to choose who they work for and the projects they undertake.
However, they are not shielded from personal liability. Independent contractors are personally responsible for their actions and liabilities, which means they can be held accountable for any damages or losses caused by their negligence or misconduct.
Setting Up as an Independent Contractor
Unlike a sole proprietorship, an independent contractor is not considered a legal entity. Therefore, becoming an independent contractor is easier. While sole proprietors have to report business and personal income taxes, independent contractors only need to report personal income taxes. Independent contractors, however, can register as sole proprietors for tax purposes.
Do Independent Contractors Need a Business License?
In some cases, independent contractors do not have to register as businesses with federal or provincial authorities in Canada. This is as long as their revenues do not exceed CA $30,000 in the last four quarters. Otherwise, you must register for a sales tax account with the CRA. To set up a sales tax account, you need a business number, which requires business registration.
You may also need a business license depending on the service or goods you are selling. This varies among cities and provinces.
Key Differences Between a Sole Proprietorship and an Independent Contractor
Legal Status
One of the most significant differences between a sole proprietorship and an independent contractor is their legal status. A sole proprietorship is considered a legal entity, while an independent contractor is not. This distinction has profound implications for liability.
As a sole proprietor, you are personally liable for any debts or liabilities of your business. This means that your assets, such as your home or car, could be at risk if your business cannot pay its debts.
On the other hand, as an independent contractor, you are personally responsible for your actions and liabilities, but not for the debts or liabilities of your clients.
Tax Implications
The tax implications for sole proprietors and independent contractors are also markedly different. As a sole proprietor, you are required to report your business income and expenses on your tax return. Your business profits are taxed at your income tax rate. Additionally, you are responsible for collecting GST or HST if you make more than 30K in revenue in a single calendar quarter and paying both the employer and employee portions of the CPP contributions. Sole proprietors are also eligible for tax refunds on goods and services they purchase for their business.
In contrast, as an independent contractor, you are responsible only for paying your own CPP contributions and are not eligible for those refunds. Similar to a sole proprietor, you can deduct certain business expenses from your income, reducing your taxable income, and should collect GST/HST if you make more than 30K in revenue in a single calendar quarter.
It's important to note that the CRA has strict guidelines on what can be considered a legitimate business expense, so it's advisable to consult with a tax professional to ensure you comply with these rules.
Control and Independence
Both sole proprietors and independent contractors enjoy a high degree of control and independence in their work. However, the extent and nature of this control can vary. Sole proprietors have complete control over their business and its operations. They make all the decisions for the business. While they still take on clients and may have less control over these contracts, they are in total control of their own business and have more administration work to do.
Independent contractors also have control and independence. They are typically hired to complete a specific project or task, and the client may have more control over the scope and direction of the work. Independent contractors can choose who they work for. However, unlike a sole proprietor, they don’t have a business to take care of – being an independent contractor isn’t a business structure.
Liability
As mentioned earlier, sole proprietors are personally liable for any debts or liabilities of their business. If the business fails or incurs debts, the owner's assets may be at risk. On the other hand, independent contractors are generally not personally liable for the debts or liabilities of their clients. However, they may still be held responsible for any damage or loss caused by their negligence or misconduct.
Benefits and Protections
In terms of benefits and protections, both sole proprietors and independent contractors are at a disadvantage compared to employees. Sole proprietors and independent contractors are eligible for a degree of EI or workers' compensation coverage if they decide to pay into it.
Which Option Is Right for You?
The decision between operating as a sole proprietorship or an independent contractor depends on your circumstances, preferences, and risk tolerance. If you value complete control over your business, make over 30K in revenue, and are willing to accept the risks and responsibilities that come with it, a sole proprietorship may be the right choice for you.
On the other hand, if you prefer more flexibility and independence in your work, and are comfortable working on a contract basis with multiple clients, being an independent contractor may be a better fit.
When making this decision, it's crucial to consider factors such as the nature of your work, your financial situation, and your long-term goals.
Consulting with a legal or tax professional can provide valuable guidance and help you make an informed choice.
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Are You an Employer Hiring an Independent Contractor?
Whether you are hiring an independent contractor for the first time, hiring an employee as a contractor, or rehiring your employee as a contractor, you need to be aware of the risks of misclassification.
There are differences between a contractor and an employee in Canada. There are differences in provinces, such as in Alberta and Ontario.
Other things you should keep in mind include benefits and protections, tax requirements, legal implications, paid vacation, and length of contract.
While there are many advantages to hiring independent contractors, here’s a checklist to make sure you do so compliantly:
- Build a foolproof contractor agreement
- Get tax forms in order
- Pay independent contractors on time
Make Business Easier with Borderless
Both independent sole proprietorship and contractor offer unique opportunities for individuals to work independently and on a contract basis in Canada. However, they come with their challenges and considerations, particularly regarding legal status, tax implications, control, independence, liability, and benefits and protections.
By understanding these differences and considering your circumstances and goals, you can make an informed decision that best supports your business and career aspirations.
Whether you're a sole proprietor or an independent contractor, you can use Borderless to make and receive international payments from all over the world and access localized contracts for clients worldwide.
Save all your documentation in our all-in-one platform that simplifies taxes. Speak to us today.
Disclaimer: Borderless does not provide legal services or legal advice to anyone. This includes customers, contractors, employees, partners, and the general public. We are not lawyers or paralegals. Please read our full disclaimer here.
