If you are thinking about starting your own business, you are probably wondering whether to set up as a sole trader or a limited company.
Generally speaking there is no legal obligation to trade using a particular entity, this is a choice you will need to make based on your own circumstances.
The main difference is that a Limited Company is a separate legal entity from the individuals involved (Directors and Shareholders). A Limited Company needs to make Annual Returns with the Companies Office and there is more compliance and red tape, however they are generally thought to be most tax efficient. For example, Company Directors can put profits into their pensions virtually tax-free (within reason of course!)
If you register as a Sole Trader or a Partnership you will need to register a Business Name if you are carrying out business under a name other than your own .You and your business are legally and financially the same person, so you don’t have ‘limited liability’ like you do with a Limited Company.
Some Advantages of Incorporation
Directors or shareholders personal assets are not at risk. This can only be changed if Directors have traded fraudulently or negligently, or if they continue to trade when the company has been struck-off.
Startup companies can avail of an exemption to corporation tax for the first three years in certain circumstances.
Taxed on Withdrawals
Sole traders are taxed on their share of the business’ profits regardless of what they actually withdrew. Companies are also taxed, but the rate of tax they pay under the current Irish tax regime is lower than individuals do, plus they pay no PRSI on their profits. The corporation tax rate is currently 12.5% while the marginal tax rate for individuals can be as high as 55%. Therefore, incorporation can be appealing if the intention is to retain some of the profits within the business. If on the other hand you plan to take all of the profits from the business, the tax benefit of being incorporated becomes somewhat irrelevant.
Seeing ‘limited’ at the end of a business’ name gives the business some prestige and gives an illusion that the business is large. In certain industries this can be particularly important.
Investors and Banks
Investors and banks usually prefer to put their money into a company rather than a sole trader or partnership.
Some Disadvantages of Incorporation
Directors and shareholders of the company may have to complete tax returns, and the company has its own filing requirements. It must submit its own tax return and annual accounts, and an Annual Return. Directors who own more than 15% of the shares of the company must also submit an income tax return even if all tax is paid by the company through the PAYE system.
Directors have a personal responsibility to deliver statutory documents to the CRO and failure to do so can be a criminal offence, in addition to late filing penalties.
The company’s details and accounts are held on public record and can therefore be accessed by anyone. Furthermore, information about the company’s directors, company secretary and shareholders can be accessed.
Separate Legal Entity
With an unincorporated business, the owners are free to make withdrawals without tax implications. However, the same is not true in a company situation and directors and/ or shareholders can often struggle to draw a distinction between the company and their own affairs.
Business losses may not be set against personal income
If you have other income and the business makes a loss, you can offset this loss against the other income if not incorporated. Alternatively if the business is incorporated, the losses can be offset in the future against future profits when they arise.
Some advantages of sole trader/partnership
- It is very cost-efficient and easy to set up and run this type of business.
- There is only a small cost to wind up the business.
- The sole trader or partnership does not have to register accounts with the CRO.
- Public does not get to access accounts.
Some disadvantages of sole trader/partnership
- No Limited liability. No limit on personal liability for the debts of the business
- Profit is taxed at personal tax rates (up to 55%) instead of corporation tax at 12.5%.
- Limited scope to avail of pension tax breaks and executive pensions
- Not suitable for certain contractors who need a limited company
- May not be considered as credible as a limited company when tendering for contracts
Some questions to ask yourself when making a decision on legal structure
Will the business make sufficient profits (now or in the future) to justify the additional expense of running a company?
- Is a company structure required for a grant application or is there a potential investor in the wings?
- Are you willing to deal with the paperwork associated with the business in a timely manner or will you outsource/delegate this to someone else?
- Is there a good marketing reason to trade through a company rather than as a sole trader?
- Do you accept that the company’s accounts will be filed on public record at the CRO (although these will be abridged for small companies)?
- Is limited liability important in your industry sector?
The choice is yours, but be sure you consider all the relevant factors before taking the plunge. Remember that you can set up as a sole trader and change to a limited company at a later date.
Still not sure what to do? Get in touch and we can talk you through the options in more detail.