Should I be a sole trader or limited company?

If you are self employed or you are thinking about starting your own business, you are probably looking at the advantages of working as a sole trader vs trading as 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

As a sole trader you do not have to file accounts or have an annual audit, both of which add to the costs of operating your business. On the flipside, you are fully liable for any debts the business incurs and claims that customers may have against you.

In this article, we review the advantages and disadvantages of trading via a limited company.
 

The Advantages of Incorporation

 

Limited Liability
First and foremost, the principal benefit of trading as a company has always been the limited liability bestowed upon the company's shareholders. Directors or shareholders personal assets are not at risk in the event of a winding up or receivership.

Tax Relief
Start up companies can avail of an exemption to corporation tax for the first three years in certain circumstances.  The relief is limited to the amount of employer’s PRSI that is paid by the company and only applies to new businesses.

Taxed on Withdrawals
Proprietors of unincorporated entities 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 might be appealing if the intention is to retain some of the profits within the business.

Status
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
Investors prefer to put their money into a company rather than a sole trade or partnership because if they purchase shares, their investment has more protection and their liability is limited to their shareholding (should the company run into difficulties and fold). Therefore limited companies can offer investors more security.
 

Bank Finance
Banks tend to prefer dealing with companies, again for similar reasons to individual investors. Furthermore, they are able to taking out extra security by lodging a ‘floating charge’ over the assets of the company. The charge effectively means the bank gets first call on the assets stated in the charge should the terms and conditions of the loan be breached etc.

 

The Disadvantages of Incorporation

 

Administrative Burden
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’ Responsibilities
Directors have a personal responsibility to delivery statutory documents to the CRO and failure to do so can be a criminal offence, in addition to late filing penalties.
 

Bank Finance
Whilst there is a perception that finance may be easier to obtain by companies, it is worth noting that it is common for banks to ask for personal guarantees from the directors (particularly in newly formed companies), which means the directors can still be liable for the company’s debts.
 

Less Privacy
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.
 

Losses
Losses made by a sole trader or partner are far more malleable than if they had been generated by a company, and can for example be set against PAYE income of a spouse. Losses made a company can only be utilised by the company.

Start up relief for sole traders

Budget 2014 introduced a new relief from income tax on the first €40,000 of income earned by a sole trader in each of the first three years of trading.  This is only available where the sole trader was unemployed for at least 12 months prior to starting the business.

 

Date published 22 Apr 2014

This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.