Saturday, May 9, 2009

Limited company or sole trader?


When setting up a business you have a choice of operating structures being sole trader, partnership and limited company.


A sole trader is an individual in business who is personally responsible for the debts and liabilities of that business. A sole trader and a partnership have the same main advantages and disadvantages – the main difference between the two is that a sole trader means that just one person owns the business; whereas a partnership means that there are two or more owners of the business.

A limited company takes on a separate legal existence from the individual shareholders (owners) and directors. The shareholders are only personally responsible for the debts and liabilities of the company to the extent of their unpaid share capital. The personal assets of directors or shareholders cannot be seized to pay off company debts (with the exception of extreme cases where directors are considered to have been trading recklessly).

Overview of respective advantages of each structure:

Sole trader

  • Quick and easy to set up;
  • No requirement to file annual accounts or returns with the Companies Registration Office;
  • For tax purposes, losses can be offset against other income that you may have.

Limited company

  • Limited liabilities i.e. if the company becomes unable to pay its debt, your personal assets are protected.This is because the limited company is considered to be a separate legal entity to you as an individual;
  • Low rates of corporate taxation, normally 12.5% - new companies setting up during 2009 are exempt from corporation tax for the first three years of trading;
  • Increased scope for tax planning, particularly in terms of pension contributions. Funding your pension through a limited company is very tax efficient.

Overview of respective disadvantages of each structure:

Sole trader

  • No protection for your personal assets should the business fail and you become unable to pay your creditors;
  • Profits are taxed at your marginal rate of tax i.e. 41% if you are a higher income earner.

Limited company

  • Increased legal responsibilities for directors;
  • Requirement to file annual return and annual accounts with the Companies Registration Office;
  • More paperwork and cost involved in setting up and closing down the business.

How to choose which business structure is most appropriate for you:

When deciding which option is best for you, you should review the advantages and disadvantages of each option and consider whether, in your circumstances, the advantages outweigh the disadvantages.

Is limited liability important to you?

For some businesses, limited liability protection may be very important. If your business requires capital investment e.g. in stock, machinery, equipment; limited liability can be important in order to protect your personal assets, in the event that the company becomes unable to repay the loans or credit facilities offered by your suppliers.

If you are an individual providing mainly only services e.g. graphic design, bookkeeping services, marketing services, professional services i.e. anything where the biggest investment in the business is your time, then limited liability is likely not to be as much of a priority for you.

It is important to be aware however that limited liability does not usually protect you personally against defaulting on bank loans. This is because most banks will require a personal guarantee from the directors when issuing a loan to a limited company. This means that in the event of the company being unable to repay its loan, the directors will become personally liable for the loan. If you require bank financing for your company, be aware that you will most likely be required to provide a personal guarantee for the borrowings.

Is the 12.5% corporation tax rate important to you?

To determine how important the 12.5% corporation tax rate is to you, you should consider what your expected turnover and profits will be and also how much of that profit you wish to take as a salary and how much you wish to reinvest in the business.

Your expected turnover and profits are very important for selecting a business structure. Sole traders pay the marginal rate of tax (20% or 41%) on all their profits before their own drawings/salary. Limited companies pay only 12.5% on their profits (or zero % for the first three years for certain companies commencing to trade in 2009) after paying out salaries.

If you expect the business to be making more profits than you require as salary for yourself, a limited company is useful as the tax you pay on retained profits is lower. If however, you plan to take all business profits as salary each year, then there is no real benefit to having the low 12.5% corporation tax rate.

A simple illustrative example:

Assume that you wish to earn a salary of €70,000p.a and your business is capable of generating profits of €100,000p.a. before you take out your salary:

If you were a sole trader, the tax treatment in this situation would be that you are taxed at your marginal rate of tax (20% or 41%) on your profits of €100,000.

If your business operates through a limited company, the tax treatment would be that you will pay your marginal rate of tax (20% or 41%) on your €70,000 salary, and 12.5% (or zero if commencing to trade in 2009) on the remaining €30,000 profit.

Is the greater scope for pension planning important to you?

Pension planning is at some stage a very important consideration for all of us. A limited company structure affords excellent opportunities for pension planning. A limited company can make contributions to the directors/employees pensions and these contributions are fully tax deductible.

To cover all the main points of pension planning through a limited company is beyond the scope of this particular help sheet. However, it is very important to be aware that are significant benefits open to individuals wishing to set up a company pension scheme for themselves. If pension planning is important to you, you should talk to Fenero or your existing financial advisor to learn more about the benefits of a company pension scheme. You may find that the benefits of a pension scheme alone make it worth setting up your business as a limited company rather than as a sole trader.

In summary:

There are some significant advantages to trading through a limited company than as a sole trader. But these do come with extra costs and extra responsibilities. If you are happy that one or more of the advantages of operating as a limited company will be beneficial to you, then it is worth exploring this option further.

Frequently a small business is initially carried on as a sole trade or partnership. This may be because the sole trader does not benefit from any of the advantages offered by a limited company and therefore cannot justify the extra administrative burdens and costs of operating as a limited company.

A final point to bear in mind is that it is easy to start business as a sole trader and transfer into a limited company at a later stage. It is a significantly more time consuming and costly process to commence as a limited company and to later change to a sole trader.

If you are not sure how much you may benefit from trading through a limited company over a sole trader, Fenero’s advisors are happy to discuss your specific situation with you and provide advice.

Fenero Contact Details:

Fenero Tax & Accounting

Fenero Financial Services

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Telephone: +353 (0)1 8851735

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