Sole trader v Limited Company

Which structure should you use?

Many start-ups ask for advice on structuring their business when getting started. New business owners often get advice from well-meaning friends and family but it’s important to understand the structures from the very start.
The type of structure that you choose really depends on the business you plan to run, your growth plans and who you will service as clients or customers.

Let’s look briefly at two main structures that you can use.

Sole Trader

This is when a business is owned by one individual. It’s often the simplest option when setting up a business. You will need to register as a sole trader with the Revenue. You submit accounts as part of your income tax return once a year, on 31st October.

Legally, having a sole trader business is not a separate entity, but an extension of the person who owns it. The business owner is responsible for the profits as well as the losses and debts the business may get into and must file an income tax return.

Many sole traders register a business name and trade under it, for example Joe Smith T/A Smith Motors.

We often have business owners start out as sole traders. As the business becomes more complex or indeed as there appears more certainty in its longevity, the business owner transfers to a limited company. We also have sole traders operating significant businesses as sole traders for years.

Closing a sole trader business is straightforward enough.

Limited Company

A limited company is in itself a legal entity that exists under the authority of the Companies Act. It is completely separate to you as an individual. It has directors and shareholders. You need more than one person to set up a company. We often see limited companies being set up by one person and a family member is a fellow director. Since the Companies ACT 2014, there now is the option of being sole director, only requiring a second person to act as a company secretary. However, you own 100% of the shares in the company.

Every year, an annual return must be filed with the Companies Registration Office. Serious penalties apply if you do not fulfil this requirement. The company must also file an annual Corporation Tax return with the Revenue Commissioners. Each director also files an income tax return.

Closing a limited company is complex and requires a number of steps.

There are several main issues which separate sole trader from a limited company. These are

  • how you are legally protected
  • how your business profits are taxed
  • what compliance obligations you have
  • how you can borrow or finance the business
  • how your pension is created.

 

Legal Protection

In terms of legal protection, sole traders have all the responsibility of their business. There is no limit on personal liability for the debts of the business. As a director or share-holder in a limited company, the liability is restricted. Shareholders are not personally liable for company debts.

Taxation of Business Profits

As a sole trader, all profits are taxed, regardless of what is withdrawn as salary. You will have to pay income tax as well as PRSI & USC on all profits. Depending on your profits, including PRSI, this could amount up to 55%. That being said, losses made as a sole trader can be offset against other personal income as long as certain qualifying conditions are met.

As a limited company, tax on profits is at the rate of 12.5% and the director will also pay tax on any wages taken from the company.

Compliance Obligations

As a sole trader, your compliance issues are minor. You don’t have to submit annual returns to the CRO. You simply include your sole trader accounts with your self-assessment tax returns to Revenue.

Both directors and shareholders of the company have filing requirements. Directors may have to do a self-assessment tax return similar to sole traders. If they own more than 15% of the shares of a company, they have to submit an income tax return even if all tax is paid by the company through PAYE. The company must file a CT Return with Revenue.

Then the company must deliver annual returns to the CRO and the directors have responsibility to ensure that happens on time, every year. Loss of audit exemptions, financial penalties and potential legal issues will occur if this doesn’t happen.

Borrowing

As a sole trader, you are unrestricted in the amount that you can borrow, subject to the financial institution’s rules. However, you are personally responsible for all debts.

A company can borrow and place their company assets as security. As a director of a company, you are not responsible for the debts of the company, unless you’ve signed a personal guarantee. Some financial institutions do require director or shareholders to personally guarantee loans.

Pension Planning

Having a limited company allows the creation of a company pension account. It offers great flexibility in terms of pension planning. All pension contributions lower the limit of profits made, which in turn lowers your tax liability.

A sole trader doesn’t have the benefit of a company pension plan and relies on creating a personal pension plan. This isn’t as flexible.

If you’d like to talk to us about anything in this article, please feel free to contact us. We can help keep your business in shape this year.

www.agassociates.ie