When starting a business, should one be a sole trader or a company?
For a lot of people setting up a business the first question they ask is whether to set up a company to run it or to operate as a sole trader.
A business should be incorporated only when it generates more taxable profits than the business owner needs for their annual income.
Below are some of the main advantages and disadvantages of setting up a limited company:
As a sole trader you have unlimited liability to potential creditors. Once you incorporate you have limited liability.
Retention of Profits
A company will pay corporation tax on the full amount of profits in a year at 12.5pc. At this low rate, the potential to retain profits in the business is significant. The company directors would only suffer income tax on the income that is paid to them as salary.
Where an individual operates as a sole trader, one is subject to income tax on the full amount of the profits in the year, irrespective of whether they are drawn out of the sole trade or not.
For the self-employed the maximum pension contribution that is allowed for tax purposes is between 15-40pc of annual earnings, depending on the age of the individual.
A company, however, can introduce a pension fund for directors and the levels of contribution are far more generous.
It is possible to introduce stock options or other share schemes to retain and motivate key staff.
Close Company Surcharge
A close company is one that is controlled by five or fewer people.
A surcharge of 20pc (15pc for a service company) of a company's distributable rental and investment income (and half of its service income, where it is a service company) is imposed if the company has not made a distribution of the relevant income within 18 months of the end of the accounting period.
Capital Gains Tax
If a property is transferred into the company, then should the directors ever wish to sell the property there is a potential double tax charge arising in the company and then again in the hands of the shareholder.
Where you are a sole trader, you will have to pay income tax for the prior year and current year only once every year, on October 31.
However, when you are being paid a salary by a company, then PAYE and PRSI must be deducted on a monthly basis through the payroll.
There are far more costs associated with the running of a company compared with a sole trade.
Transfer of Sole Trade to Company
If an individual has already been operating as a sole trader, and subsequently wishes to incorporate, then there a number of items below to consider.
Capital Gains Tax
Capital gains tax normally arises on the transfer of assets.
However, relief on the transfer of a trade is available provided all of the assets, including goodwill (or all of the assets other than cash), are transferred.
This transfer should also be wholly or partly in exchange for shares in the new company.
Assets being transferred on which capital allowances have been claimed in the sole trade should be reviewed to ensure no balancing allowances or charges apply. (A balancing allowance is where the asset is sold for less than the tax value; a balancing charge is the opposite).
If both the sole trade and the new company are VAT-registered, then relief can be claimed so that the transfer is neutral from a VAT perspective for both parties.
All of the assets to be transferred must be reviewed for the purposes of calculating any stamp duty due.
Coming up with a business idea is only the first step. There are many items to consider when it comes to setting up the structure that will enable you to conduct a business.
Simon Ball is the founder of SB Tax Consultants - www.sbtaxconsultants.com email@example.com