Form of Business – Sole Trader v Limited Company

A question I am often asked is whether someone should be trading as a sole trader or as a limited company.

In most cases, a business should only incorporate, i.e. trade as a company, where the taxable profits are greater than what the owner plans to take out of the business by way of salary. The reason for this is that if the owner is taking out all the profits then the profits are being taxed twice – once in the company, usually at 12.5%, and again at the individual’s marginal tax rates.

Tax Rates

As a sole trader, an individual pays income tax on all taxable profits. As a company, tax is levied at 12.5%, in most cases, on the taxable profits and the individual will also pay tax on any salary taken from the company. So in a situation where profits are retained in the business, the combined tax paid is usually lower when trading as a company and in that situation operating as a company may be best.

Note, however, that if the company is a service company there may be a 15% surcharge on undistributed profits. This applies to accountants, architects, etc.

However, there are other factors that should also be considered.

Cash Flow

If the owner needs to invest cash in the business, it may be more effective to incorporate and retain cash by minimising tax payments rather than borrow and pay interest on the borrowings.

Pensions

Tax Relief on pension contributions is more restricted for sole traders than for company directors. If an individual wants to maximise a pension fund then it may be best to trade as a limited company.

Succession Planning

Generally speaking, a company is a more attractive business proposition for a buyer or for transferring ownership to children.

Limited Liability

In businesses where there is a risk to the owner from claims against the business, then Limited Liability companies are best.

Terms of Business

For some businesses, laws or regulations may not allow the business to be carried on by an incorporated entity. For example, auditors cannnot be limited companies and the it appears that while doctors can practice as unlimited liability companies, the GMS only awards contracts to individual doctors.

Investment Property

In almost all cases, it is better to have investment property owned personally so as not to have a double tax charge.

Investment Capital

Some tax incentives require the business to be incorporated so if you are going to be raised funds under the Business Expansion Scheme, the Seed Capital Scheme.

Three Year Tax Holiday

Qualifying companies which were formed after October 14th, 2008 and which commenced to trade on or after 1st January, 2009 and in 2010, will be exempted from Corporation Tax and/or Capital Gains Tax in each of the first three years to the extent that their tax charge from qualifying trading activities does not exceed €40,000. There is marginal relief where the tax charge falls between €40,000 and €60,000. In other words, a company can generate up to €320,000 in taxable profits each year, at the current tax rate of 12.5%, for three years without paying any corporation tax.

Conditions apply which seek to ensure that it is only new businesses that qualify rather than businesses being transferred from another Irish entity or businesses being moved to a limited company from a sole trader/ partnership.

The information in this article is not intended to be a comprehensive overview of all tax issues relating to your business and is presented as guidance to help you understand where you may need more detailed advice. You should seek professional advice before making any significant decisions.

If you have any questions, be sure to let me know by emailing me at jim (at) accountsplus (dot) ie.

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