Main article

1. Introduction
2. Unincorporated and incorporated sectors
3. Key differences between the unincorporated and incorporated sectors
4. Overview of methodology
5. Contribution of the unincorporated sector to the gross domestic product in 2002
6. Conclusion

1   Introduction

Self-employment in the unincorporated sector accounted for over 40% of all job growth in Canada between 1990 and 1998. ¹  Employment in the sector increased by 387,000 during this period according to Statistics Canada’s Labour Force Survey. This growth caused the sector’s share of total employment to peak at 11.7% in 1998, well above 9% seen during the 1980s, a period of much slower growth for the sector. However, during the late 1990s and early 2000s, its share has fallen back to that observed during the 1980s.

Self-employed owners of unincorporated enterprises hire paid help, unpaid workers, including family members, or work without paid help. They are typically small-sized enterprises that play an integral role in the small-business sector.

The importance of the sector’s employment has been well documented, but other measures of economic activity are lacking. Gross domestic product (GDP) ² produced by industry provides a useful tool to monitor economic performance as it measures the value added generated by an industry. This study provides a measure of Canadian GDP generated by self-employed owners in the unincorporated sector.

This study divides the GDP of the business sector into the unincorporated sector and the remainder which represents the incorporated sector. The key legal and organizational differences between the unincorporated and incorporated sectors are described. An overview of the methodology used in the study follows. Then estimates of GDP by industry are generated for the two sectors for the period from 1997 to 2002. Finally, the paper compares the relative contribution of the unincorporated business sector to the Canadian economy across industries.

2   Unincorporated and incorporated sectors

The System of National Accounts (SNA) manual (1993) defines “unincorporated enterprises” as “producer units within the household sector” that “are not incorporated as a separate legal entity from the household itself” (1993 SNA, paragraph 4.140). Furthermore, “the owner of a household enterprise usually plays a dual role: first, as the entrepreneur who is responsible for the creation and management of the enterprise; and second, as a worker who contributes labour inputs of a kind which could be provided by paid employees” (1993 SNA, paragraph 4.142). The operating surplus paid to the owner of an unincorporated business represents two kinds of income, referred to as mixed income: return to entrepreneurship and remuneration for work done (1993 SNA, paragraph 4.143).

The unincorporated sector is comprised of self-employed owners of unincorporated farms, businesses or professional practices. Unincorporated enterprises are typically small in size, but often hire workers. They are typically single establishments ³  that are operating in a single province. They usually have relatively low start-up costs and require less working capital compared to larger businesses. ⁴ 

Individuals create unincorporated enterprises for many reasons. Often, they do so because of a desire for the independence associated with running a business. At times, particularly during poor economic times, they are pushed into entrepreneurship for lack of full time jobs. ⁵  Finally, some professions are required by their governing bodies to adopt this form of business (for example, physicians, lawyers, etc.). These individuals create unincorporated enterprises in various industries. This includes physicians and dentists in the Health Industry; lawyers, accountants and consultants in the Professional Services Industry; landlords, insurance and stock brokers in the Finance Industry; contractors who build or renovate houses in the Construction Industry; farmers in the Agriculture Industry; owners of retail stores and individuals selling goods directly to customers in the Retail Trade Industry; truck drivers in the Transportation Industry; and barbers, hair stylists and housecleaners in the Other Service Industry. Many organize their business as sole proprietorships, while others form partnerships.

The 1993 SNA defines a corporation as “a legal entity, created for the purpose of producing goods and services for the market, that may be a source of profit or other financial gain to its owner(s); it is collectively owned by shareholders who have the authority to appoint directors responsible for its general management” (1993 SNA, paragraph 4.23).

The incorporated sector is comprised predominantly of larger companies, including multinationals, operating in many regions across Canada. The sector covers public corporations, national privately controlled corporations, foreign controlled corporations as well as government business enterprises (SNA, paragraphs 4.71 and 4.84). ⁶  The incorporated sector also includes self-employed persons who organize their business as corporations. The sector crosses all industries, both service-based and goods-producing, making up the greater part of the business sector of the economy producing the bulk of the nation’s output of goods and services. They tend to hire larger numbers of paid workers, and require more substantial investments in buildings and machinery and equipment. They tend to use larger amounts of capital per worker compared to the unincorporated sector.

3   Key differences between the unincorporated and incorporated sectors

3.1  Tax regime

Canada Revenue Agency (CRA) defines various types of business structures. A corporation is a separate legal entity that can enter into contracts and own property in its own name, separately and distinctly from its owners. A corporation is created by completing articles of incorporation, and filing them with the appropriate provincial, territorial, or federal authorities. It must file a corporate income tax return (T2). These corporations make up the incorporated sector.

All other businesses, of which there are two main types, make up the unincorporated sector. The first type is a sole proprietorship, which is a business that is not incorporated and is owned by one person. The owner has sole responsibility for decision-making and receives all profits, is responsible for all losses and reports business income on a T1 Individual income tax return. ⁷ 

The second type is a partnership which is “usually the relationship between persons who carry on a business in common with the belief they will make a profit” (Canada Revenue Agency). ⁸  Each partner contributes money, labour, p roperty, or skills to the partnership. In return, each partner is entitled to a share of the profits or losses in the business. The business profits (or losses) are usually divided among the partners based on a partnership agreement.

One of the largest groups in terms of gross domestic product (GDP) in the unincorporated sector consists of various professionals, including physicians, dentists, lawyers and consultants. CRA defines professional income as including all fees received for goods and services. Many of these professionals are involved in partnerships.

The Department of Finance (September 2005) outlines the integration concept of income earned and the effective tax rate among different business structures. ⁹ Table 1 shows the effective tax rates for business income earned through an unincorporated enterprise, income earned and distributed by a public corporation and the same by a small Canadian-controlled private corporation (CCPC) that is subject to the small business tax rate.

The effective income tax rate for a small CCPC (37.1%) is comparable to the unincorporated business rate of 38.0%. ¹⁰  Dividends received from corporations are subject to a higher corporate and personal income tax rate of 49.6%. However, if the income is retained within the corporation to allow the business to grow, the corporation is able to defer tax to the extent that the earnings are not distributed to the shareholder. There are some possible tax advantages for CCPC, including the small business tax rate and $500,000 capital gains exemption. However, corporations require extensive record keeping and are closely regulated (e.g., corporations must file an annual report). ¹¹ 

3.2  Limited liability

Shareholders in corporations have limited liability. This means that shareholders are not responsible for the corporation’s debts. However, limited liability may not always protect shareholders from creditors. For example, if a smaller, more closely held corporation wants to borrow money from a creditor, the creditor may ask for the shareholder’s guarantee that the debt will be repaid. This means that the shareholders can in some circumstances be personally liable for that debt if the corporation does not pay it back.

An unincorporated enterprise does not have a separate legal status from the business owners. They are personally liable for all debts and obligations (known as unlimited liability) and the continuity of the business depends on their presence.

In some provinces, professionals such as doctors and lawyers were not permitted to incorporate during the study period. ¹²  These professions are self-regulatory with their respective governing bodies overseeing their actions.

In a general partnership, the owners of the company share in the management of the company and are bound by the actions of any member of the partnership, as long as these are within the usual scope of its operations. A general partner has unlimited liability for debts of the partnership. Limited partnerships can also be formed under provincial laws. These require that the partnership have one or more general partners who are involved in management, but they also involve limited partners who are not involved in management of the company. The responsibilities of the latter are similar to those of shareholders of a corporation, so that liability is limited, and they cannot be liable for more than the amount of capital they have contributed to the business.

3.3  Number of incorporated and unincorporated entities

Ideally, we would like to measure the number of business entities. ¹³  Since this information does not exist for the unincorporated sector at this time in the Business Register, ¹⁴  this paper will choose to define the business entity by the number of self-employed owners of unincorporated enterprises. ¹⁵ 

The Labour Force Survey (LFS) is a source of the number of unincorporated entities. It provides data on the number of self-employed owners of unincorporated enterprises with paid help, without paid help and unpaid family workers. As for corporations, the Corporations ReturnsAct mandates data collection on the number of Canadian and foreign-controlled incorporated enterprises. ¹⁶ 

For 1999, the LFS reports that there were 1.6 million self-employed owners of unincorporated enterprises (Table 2). However, by 2002 this type of business had declined substantially, both in absolute and relative terms. On the other hand, data collected under the Corporations ReturnsAct shows that the number of corporations had increased from 1.0 million in 1999 to 1.2 million in 2002. The total number of entities (2.6 million) did not change throughout the period, but the percent that were unincorporated fell from 61% to 56% over the period. ¹⁷ 

3.4  Employment

Employment in unincorporated enterprises consists of self-employed owners who work for themselves and paid employees. ¹⁸  The employment of the first group is obtained directly from data in the LFS on self-employment of working owners of unincorporated farms, businesses or professional practices. The employment estimates of the second group (paid employees of unincorporated enterprises) was estimated by applying the unincorporated share of labour income to the LFS data on private sector employment of paid employees. ¹⁹  The self-employment of owners of unincorporated enterprises (first group) was added to employment estimates of the second group to arrive at the employment for the unincorporated sector.

Similarly, the estimate for the incorporated sector includes both those that are self-employed owners of corporations and those that are paid employees of corporations. The first group (self-employment owners of corporations) were obtained directly from the LFS. The second group (the estimates for paid employees) were derived residually by subtracting the estimate of the unincorporated sector (estimated above) from the private sector employment of paid employees from the LFS. They were then summed to arrive at the total employment for corporations.

Employment for unincorporated enterprises peaked in 1998 at 1.9 million workers representing a share of 16.9% of total employment in the private sector (Table 3). This share marginally declined to 14.3% by 2002.

The average size of corporate businesses (measured in terms of employment) is about eight times the size of the average in the unincorporated sector (Table 4). The larger number for corporations reflects that they hire many more paid employees compared to the unincorporated sector which is typically owner operated and employ a smaller number of employees. Large businesses dominate the incorporated sector with a few hundred accounting for the majority of GDP. The very largest corporations that dominate the sector tend to have thousands of employees.

3.5  Capital intensity

The incorporated sector is dominated by larger corporations that make substantial capital investments. They often require factory-type investment in the form of buildings, machinery and equipment, employing large amounts of capital per worker. Unincorporated enterprises are smaller in size and operate mainly in service-based industries using smaller amounts of capital per worker.

This study estimated the depreciation (capital consumption) per worker used by the two sectors. Depreciation is an indication of the capital intensity: the larger the depreciation, the more capital is employed in the industry. Table 5 shows the depreciation by worker for unincorporated enterprises and corporations across various industries. The average depreciation per worker in 2002 was 1.7 times larger for corporations than for unincorporated enterprises.

The differences between the two sectors are quite noticeable across industries. ²⁰  The incorporated sector had much larger depreciation per worker in the highly capital intensive goods-producing industries ($13,273 per worker in 2002) compared to service-based industries ($5,833 per worker in 2002). As for the unincorporated sector, they also exhibited much larger depreciation per worker in the goods-producing industries ($8,120 per worker in 2002) compared to the service producing industries ($3,803 per worker in 2002). However, their depreciation per worker is much lower than the corporate sector in both the goods-producing industries and service-based industries.

The major exception is the finance sector where the depreciation per worker was larger for the unincorporated sector. A large component of the unincorporated sector was Lessors of Real Estate industry (i.e. landlords), which represented about 95% of all of the depreciation within the sector for finance. On the other hand, the incorporated sector is composed of banks, insurance, automotive equipment rentals, other rental and leasing and non-depository credit intermediation. In accommodation and food services, capital intensity is about the same in the unincorporated and incorporated sectors.

Finally, there is a large difference in the information, culture and recreation industry between the two sectors. Many of the corporations here are part of the telecommunications, broadcasting, cable and data processing industries, which are very capital intensive. The unincorporated sector, on the other hand, is mainly involved in culture industries (i.e. independent artists and movie producers, writers and performers), which are less capital intensive.

4   Overview of methodology

At present, the Canadian Input-Output Accounts combine the values of the unincorporated enterprises and corporations in its estimates of industry gross domestic product (GDP). This study separates the aggregate business GDP (including its components of labour income and other operating surplus), into the unincorporated and incorporated sectors. It also expands the estimate of other operating surplus for both sectors to include the various components (such as interest and depreciation) which are not reported separately in the Canadian Input-Output Accounts (see Appendix A for a detailed description of the methodology).

No attempt has yet been made to estimate the GDP generated by the unincorporated sector on a regular basis. Baldwin and Chowhan (2003) mainly utilized the net income component of GDP for the unincorporated sector to study growth rates of income. Siddiqi (2004) estimated GDP, along with its components, of the unincorporated business sector for 2000 in order to provide precise estimates of its levels. This study uses the methodology developed by Siddiqi and expands the study period from 1997 to 2002.

The GDP estimates include labour income of employed workers in the unincorporated and incorporated sectors, mixed income of unincorporated owners, ²¹  net indirect taxes and operating surplus of both sectors where the latter includes interest, depreciation, and resource rents while the incorporated sector also includes profits. The profits and wages earned by owners in the unincorporated sector are reflected in mixed income.

Table 6 illustrates the components of GDP in the unincorporated and incorporated sectors. The unincorporated sector generated most of its GDP through mixed income (57.6% in 2002) which represents profits and implicit wages earned by owners. This is followed by other operating surplus (18.7%) which is comprised of mainly depreciation and interest payments, while labour income represented about 15.4%. As for the incorporated sector, it generated most of its GDP through labour income representing 59.0% of the total in 2002. Operating surplus was much larger for the incorporated sector since it included corporate profits (representing about 20.8% of total GDP).

The data were processed at the S-level of aggregation for all industries in the business sector while some industries were processed at the W level. ²²  The data sources used for the study are the same as the ones used to produce the Canadian Input-Output Accounts. All estimates of the unincorporated sector were done in conjunction with the corporate one.

For the unincorporated sector, data sources for labour income, other operating surplus and gross output were drawn primarily from the Statistics Canada Tax Estimate Program, the T1 portion of Statistics Canada surveys; as well as worksheets of System of National Accounts analysts. Mixed income was used ‘as is’ from the Canadian Input-Output Accounts.

As for the corporate sector, labour income, operating surplus and gross output were estimated residually by subtracting the unincorporated portion from the respective estimates in the Canadian Input-Output Accounts. Data on the components of other operating surplus were drawn from the T2 portion of Statistics Canada surveys, the Generalized Index of Financial Information (GIFI) and the Annual Financial and Taxation Statistics (AFTS). For example, the interest and depreciation components of operating surplus for the incorporated sector were derived from GIFI and from the AFTS. Corporation profits were derived residually by subtracting the corporate estimates of the various components of other operating surplus (i.e. interest, depreciation, resource rents and surplus adjustments) from the corporate portion of other operating surplus.

Trends in the ratio of GDP (including components) to gross output were analyzed by industry for each sector and between the two sectors. It is assumed that these ratios were consistent over the period of the study. The underlying difference in the ratios between the two sectors was determined based on ratios obtained from the various data sources (for example by analyzing the T1 and T2 portions of Statistic Canada surveys).

5   Contribution of the unincorporated sector to the gross domestic product in 2002

The unincorporated enterprises in the business sector accounted for $82.2 billion of gross domestic product (GDP) in 2002 representing 10.1% of total aggregate business sector GDP (Table 7). ²³  Service-based industries contributed most of the activity ($64.4 billion).

In order of importance by share of GDP, the Finance Industry ranks at the top (at the S-level of aggregation) contributing about $18.2 billion where Lessors of Real Estate (landlords) accounted for about 80% of the industry, making it the largest W-level industry in the unincorporated sector (Table 7 and Table 8). Next, the Health Industry was estimated to be $15.5 billion in 2002 representing about one fifth of the total GDP of the unincorporated sector. Physicians accounted for over 50% of the industry, while dentists made up another 20%. Professional Services generated about $10.3 billion where lawyers and accountants represented over 60% of the industry. ²⁴  Others services include for example engineering, computer system design, and administrative management and general management consulting. Next, the unincorporated enterprises in the Construction Industry generated about $8.6 billion of new construction, repairs and renovations to existing buildings. This industry consists of unincorporated enterprises engaged in construction of residential buildings and the specialty trade contractors who work on finished carpentry, painting, dry wall, plumbing, electrical, flooring, site preparation, framing and masonry.

The Agriculture Industry’s unincorporated GDP was estimated to be about $6.5 billion. A number of factors have affected this industry. The shift towards larger and fewer farms has been ongoing since the 1940s. ²⁵  Rising farm productivity has led to large declines in farm employment. More farming activity is being conducted as second jobs, as farmers and their spouses take advantage of better non-farm employment opportunities. ²⁶ 

In the Retail Industry, unincorporated stores operate in a variety of areas. Over 75% of retail sales are generated from the following industries: pharmacies and drug stores; other direct selling establishments (i.e. direct personal retailing operators), convenience stores; gasoline stations with convenience stores and other gasoline stations; grocery stores; used car dealers; all other general merchandise stores; sporting goods stores; gift, novelty and souvenir stores; and used merchandise.

The unincorporated sector of the Trucking Industry generated about $2.8 billion. Most of these are owner-operator carriers (self-employed) that are under contract to for-hire or private carriers. Another segment is small for-hire carriers with operating revenue of less than $1 million.

5.1  Gross domestic product unincorporated enterprises by industry

Unincorporated enterprises in aggregate generated about one tenth of the total business sector GDP between 1997 and 2002. However, there are enterprises of the unincorporated sector that generated more than half of their industry’s business sector GDP. The shares for Offices of Physicians (73.7% in 2002), Offices of Dentists (64.6%), Legal and Accounting Services (66.0%), Lessors of Real Estate (44.7%), Agriculture (44.9%) and Fishing (58.9%) represent a large portion of the total business sector GDP in each of their respective industries (Table 8).

The shares were high for physicians, dentists and lawyers because many were not permitted to incorporate in several provinces during the study period. The declining share of the agriculture industry for unincorporated farms (60.5% in 1997 to 44.9% in 2002) may be the result of several historical trends (as mentioned in the previous page) in the industry.

5.2  Gross domestic product of the incorporated sector in 2002

The incorporated sector generated $734.8 billion of GDP in 2002. Slightly more was generated from the service-based industries (about 55.7% of total GDP) compared to goods-producing industries (44.3%) (Table 9). The incorporated sector was more volatile in terms of growth rates compared to the unincorporated sector largely because of large swings observed in the goods-producing industries. The Manufacturing Industry grew by 13.5% and 10.1% in 1999 and 2000 respectively, and then fell by 4.0% in 2001. The Mining, Oil and Gas Industry fell by 19.4% in 1998 and grew by 26.1% and 77.5% in 1999 and 2000, respectively. The growth in the unincorporated sector is more stable since it is largely composed of service-based industries and the overall service industry increased steadily between 2% to 6% during 1997 to 2002.

5.3  Slower growth in the unincorporated sector

Between 1997 and 2002, GDP of the unincorporated sector grew on average 3.1% per year, more slowly than that of the incorporated sector, which grew at an average rate of 5.9% per year.

The weaker GDP growth of the unincorporated sector compared to the corporate sector was reflected in both the goods-producing and service-based industries (see Tables 7 and 9). The weak goods-producing industries were largely the result of the shrinking unincorporated sector in the Agriculture Industry. The service-based industries showed substantial growth throughout the period but the corporate sector still outpaced the unincorporated sector in most industries (in particular finance, health and professional services). For instance, the Offices of Physicians and the Offices of Dentists grew an average of about 11% between 1997 and 2002, while the unincorporated sector averaged only 4%. This arose from the increased economic activity of corporate physicians and dentists predominately in Alberta and British Columbia. ²⁷  Also, the average growth of the retail industry for the corporate sector almost doubled that of the unincorporated sector. In retail, new formats such as the expansion of big box stores, have led to the growth in chain stores, which are part of the incorporated sector. Since the mid-nineties chain-store sales have grown faster than independent stores in general. ²⁸ 

There are several other possible reasons why the unincorporated sector shrank between 1997 and 2002. It may very well be that more unincorporated businesses, farms or professionals have incorporated relatively to previous years. Second, it may be the case that self-employed individuals have begun to work in corporations. Between 1997 and 2002, employment in corporations went up by close to 1.4 million workers while employment in unincorporated enterprises fell marginally (Table 3). The strong economic conditions in the last half of the 1990s may have favoured the incorporated sector.

6   Conclusion

This study quantifies the unincorporated business sector in terms of its contribution to the Canadian economy (gross domestic product (GDP)). The unincorporated sector contributed $82.2 billion overall in 2002, representing 10.1% of total business sector GDP. However, the share of the sector is much more important for some industries than others. Over 75% of the total was service-based industries where landlords in the Finance Industry and the many professionals made up a large part of the sector. Moreover, the balance between the unincorporated and incorporated sectors in the economy is evolving. For instance, more professionals are now permitted to incorporate. ²⁹ 

The unincorporated sector grew between 1997 and 2002, averaging about 3.1% growth per year. However, its share of total (business) GDP declined as the incorporated sector outpaced the unincorporated sector in most industries. The incorporated sector almost doubled its average growth over the unincorporated sector in Finance, Health, Professional Services and Transportation. It also grew substantially more in the Construction, Administrative and Other Services, and Retail industries. A noticeable decline in the unincorporated sector occurred in the Agriculture Industry while this industry in the incorporated sector increased substantially.