Key Post Sole Trader v Ltd Company For Start Up Business . . .

[trajan]

Maybe the accountants on this forum can clear this up.

As I calculate it, a start up small firm is best constituted initially as a sole tradership until the income goes above ~ €20,000. Then you are better off working as a limited company - assuming you can maintain the higher level of income for your enterprise.

Yet many accountants advise people starting up to go for a sole tradership all times.

I don't get this.
Can anyone pencil out the reasons for this - to me at least - seemingly foolish advice ?

A friend has a (shop) business which pulls in about €3.5 k - €4k a week with a mere 2 employees (owner + wife, the proprietors) as a sole tradership on his wife's maiden name. I appreciate the fact that its his affair to do so but I reckon he's leaving tens of thousands of euros on the table every year for Uncle Paddy.

 

[Brendan Burgess]

I am surprised that we don't have a clear Key Post on the topic so here is my quick summary and conclusion.

The tax advantages of a company structure are hugely overstated
Some people simplistically say "Corporate Tax is 12 1/2% while income taxes are over 50%, so a company is better".
(I have just googled sole trader vs. limited company and most of the sites I have found say this without explaining it further.)

This is not correct, as the money is still in the company and will be taxed as income when it is taken out.

So setting up a company does not offer a tax advantage.

There is some flexibility regarding timing with a limited company, though I think this is a very minor consideration.

If you intend to retain substantial profits to invest in the current assets of the company such as stocks or debtors, then it may be right to leave profits in the company as they are taxed at the lower rate. (But if you are buying a premises, you should buy it in your own name and not the company's name. )

If your business requires very substantial starting capital, other than a premises, then it's similar to the previous paragraph. The director can lend the company the starting capital and repay it out of profits taxed at 12.5%.

If you are going to be very profitable and are going to be making huge pension contributions, then a company structure is better
A self-employed person is limited to a percentage of their salary each year.
The maximum a company can pay is much higher as it's based on how much a person already has in their fund and their salary and a few other issues.

And the pension is paid from the company before PRSI, so I think it saves you 4%.

The big disadvantage of the company is the paperwork
There is a cost in setting it up.
You must make annual returns and if you are late, you need an audit.
If your decide to cease trading, it's expensive to liquidate.

This paperwork should stop most small businesses starting a company.

A small disadvantage is that the annual returns are available for the public to see in the Companies Office. As a small company, this shouldn't matter as all they will see is your balance sheet.

A small advantage for a company structure is that your liability is limited
I know a few long-term self-employed people who have a few employees and have treated them very well and now the business is no longer profitable. They face a huge redundancy bill as their employees have been with them a long-time. They are personally liable for this.

If they had a limited company structure, the liability would attach to the company and not to the person.

If you have big corporate clients, they may wish to deal with a limited company
For example, if you are a self-employed IT contractor, and "employer" might insist that you operate through a company so that you do not acquire the rights of an employee.


In summary

Start as a self-employed person.

Change to a limited company when any of the following happens

• You take on more than two employees
• You become very profitable and want to stuff your pension fund
• Your main customer insists on it

 

[trajan]

The tax advantages of a company structure are hugely overstated
Some people simplistically say "Corporate Tax is 12 1/2% while income taxes are over 50%, so a company is better".
(I have just googled sole trader vs. limited company and most of the sites I have found say this without explaining it further.)

This is not correct, as the money is still in the company and will be taxed as income when it is taken out.

Yes - if they take it out as income.
But they can extract it (or its benefit ) as far as I know if they, for example:

* Boost their directors' pensions with it;
* Grant themselves company cars;
* Repay starting capital injected via directors' loans;
* Receive director's loans;
* Obtain benefits-in-kind (applicable to all employees of a small staff company)

But if you are buying a premises, you should buy it in your own name and not the company's name.

Correct me if I am wrong but it would seem to me that they can also buy a property in the company name and use it for their own purposes as long as those purposes somehow benefit the company. For example, an Irish tech company with a major client in the south of France may justify buying a house near their French client on the grounds of it being more economical than hotels for the many trips to that client, short sub-lets of the house to Lourdes pilgrims being a justifiable 'economy' to the company during periods when the property is idle.

You mention that the associated paperwork is a big disadvantage.
To people unversed with this sort of thing, perhaps. But hardly to someone with basic accounting and company secretarial filings knowledge ?

One "benefit" presented by my acquaintance for the sole tradership structure is that his trade competitors cannot get his annual accounts from Companies House as it's not a limited company. As you said above, this provision is much less for smaller companies: these need only submit abridged accounts. So I feel this is an unnecessary caution as the abridged accounts would not show much commercial detail like turnover, operating margins, expenses, etc. In his business the key operating metrics are the price list, which is on public display, and the footfall which is readily gaugeable through observation.

Some years back, I saw that Ltd companies could contribute the use of their privately-owned cars to the company in return for an expense allowance at the "Civil Service" rate, then about €1 per mile for the first 5,000 miles and ~ 50c a mile thereafter. So a new car bought for say €30k and driving 25,000 miles a year would generate an expense allowance of ~ €15,000. The CS rate has been reduced in recent years but is still worth looking at and comparing it with a wear & tear allowance of 12.5% on a company-owned vehicle.

The perspectives of other members and accounting professionals on this Sole Trader v Ltd Co question would be of great benefit to the AAB Forum, I think.

 

[Brendan Burgess]

* Boost their directors' pensions with it;

As I said: If you are going to be very profitable and are going to be making huge pension contributions, then a company structure is better

* Grant themselves company cars;

I think that the tax disadvantages of a company car outweigh any advantages.

I presume a self-employed person can charge mileage for the use of his car.

* Repay starting capital injected via directors' loans;

As I said : If you intend to retain substantial profits to invest in the current assets of the company such as stocks or debtors, then it may be right to leave profits in the company as they are taxed at the lower rate.

I will reword it to allow for starting capital.

* Receive director's loans;

Correct me if I am wrong

You are wrong. It would be a very foolish director to take a loan from a company.

* Obtain benefits-in-kind (applicable to all employees of a small staff company)

Such as? A company can pay €500 in gift vouchers each year or something like that? Maybe so, but absolutely not a material consideration.

 

[Brendan Burgess]

Correct me if I am wrong but it would seem to me that they can also buy a property in the company name and use it for their own purposes as long as those purposes somehow benefit the company.

Yes, a company can buy a property but it would be very foolish to do so. You will be back on Askaboutmoney in 10 years saying "I have a property in the company. How can I get it out without paying CGT twice?"

Key Post - Selling a property held within a company.

I referred a social contact who asked me about this to askaboutmoney, but the posts on it are all quite old. So I will write an up to date post on the issue to check if my understanding is correct, and if there are any tax planning issues. I will simplify some of the facts to focus on the key...

www.askaboutmoney.com

 

[ryaner]

I think that the tax disadvantages of a company car outweigh any advantages.

I presume a self-employed person can charge mileage for the use of his car.

Self employed people aren't allowed claim mileage. They have to claim expenses from the actual journeys however this does extend to cover maintenance, insurance etc on a pro-rata basis.

 

[Brendan Burgess]

A small disadvantage is that the annual returns are available for the public to see in the Companies Office. As a small company, this shouldn't matter as all they will see is your balance sheet.

So I feel this is an unnecessary caution as the abridged accounts would not show much commercial detail like turnover, operating margins, expenses, etc.

It's only a small disadvantage. But it's probably better for people not to know that you have a company with huge amounts of cash in it or that you have a company which is close to insolvency.

The balance sheet is important.

It would not outweigh the advantages set out :

Change to a limited company when any of the following happens

• You take on more than two employees
• You become very profitable and want to stuff your pension fund
• Your main customer insists on it

 

[Brendan Burgess]

Self employed people aren't allowed claim mileage. They have to claim expenses from the actual journeys however this does extend to cover maintenance, insurance etc on a pro-rata basis.

Hi ryaner

Thanks for clarifying

So if I am an employee of my limited company and I drive 100 miles, how much can I claim?

If I am self-employed driving the same car, how much less can I claim?

Brendan

 

[ryaner]

As an employee you can claim up to the civil service rates per mile.

Self employed you are meant to calculate the full cost of the car over the year, then work out the percentage time used for work vs personal and claim that pro rata amount. Tax goes into the yearly tax return then in its own line item.

 

[trajan]

Yes, a company can buy a property but it would be very foolish to do so. You will be back on Askaboutmoney in 10 years saying "I have a property in the company. How can I get it out without paying CGT twice?"

Brendan: What's the problem with getting the property back in the Ltd co's owner's name ?

A market valuation is made and Owner buys it from his/her company.
The Ltd co is making a capital gain on an asset but, as it's not development land, the gain is taxed at the corporation tax rate of 12.5% rather than 33% for CGT.
Owner may have an existing house that is his/her principal private residence (PPR), so here the property bought from the company will be subject to CGT if it is sold on later unless disposing of the first house and making the acquired house the PPR. Indeed, if the intention is just to liquidate the property asset, it would reap more reward by selling it direct from the Ltd co and pay the lower tax on the capital gain. Owner then extracts the benefit of the cash within the company via higher pension payments, BIKs and other ways like using Ltd co assets as security for loans.
If it's not a second property but the house in which Owner lives, Owner is simply buying a first house like many people, albeit that he was effectively owner of it already via his/her Ltd co.

 

[AAAContributor]

The Ltd co is making a capital gain on an asset but, as it's not development land, the gain is taxed at the corporation tax rate of 12.5% rather than 33% for CGT.

I'm not an accountant or tax adviser but the company will effectively pay tax at 33% of the gain on the disposal of the property as far as I understand it.

Corporation tax is calculated on the grossed up capital gain so that:-

Property gain x capital gains tax (33%) = Adjusted property gain for corporation tax x corporation tax (12.5%)

See the example here:

Capital gains for companies

This page explains about capital gains for companies

www.revenue.ie

 

[T McGibney]

Yet many accountants advise people starting up to go for a sole tradership all times.

I doubt if this somewhat sweeping statement is even remotely true, by the way.

 

[trajan]

Yet many accountants advise people starting up to go for a sole tradership all times.

I doubt if this somewhat sweeping statement is even remotely true, by the way.

Then please give your elaborate take on it all.

 

[T McGibney]

Then please elaborate on how you and others you observe advise.

In all seriousness, how do you think we advise, except on the basis of the facts of each situation and the priorities and profile of the customer and their business?

 

[T McGibney]

Imagine you were asked (and paid, of course) to speak to a gathering of wannabe small businesspeople.
What would you say to them on their business structure and why ?

In short, "the advantages of option 1 are a, b and c. the drawbacks are d, e and f. The benefits of option 2 are g, h and i. Its drawbacks are j, k and l. You will need to decide which option is best based on your own circumstances. The decision is yours. Beware of any advisor who seeks to make that decision for you."

 

[T McGibney]

Yes, a company can buy a property but it would be very foolish to do so. You will be back on Askaboutmoney in 10 years saying "I have a property in the company. How can I get it out without paying CGT twice?"

Not always foolish, Brendan. If the purchase is highly leveraged, buying it through a trading company means that the company only has to pay 12.5% Corporation Tax on the earnings it must make to finance it, while an individual will have to pay 50%+ on the same income.

There are of course downsides as well, but it is often much less risky to have the company buy it.

 

[trajan]

In short, "the advantages of option 1 are a, b and c. the drawbacks are d, e and f. The benefits of option 2 are g, h and i. Its drawbacks are j, k and l. You will need to decide which option is best based on your own circumstances. The decision is yours. Beware of any advisor who seeks to make that decision for you."

It would be less nebulous if actual common examples were used to illustrate the balance of advantage in different circumstances.
For example, a shop business versus a services only business, e.g. web design.
Or any better comparison you may choose that shows the contrast.

 

[T McGibney]

It would be less nebulous if actual common examples were used to illustrate the balance of advantage in different circumstances.

Why would I want to do that? It's not up to me as advisor to illustrate or determine the balance of advantage. That's my customer's job.