Selecting a legal entity for your new venture
Sole trader versus limited company ? This is probably the first critical decision you will be faced with at the beginning of your new venture. To a large extent this decision will be determined by the way you want to organise your start-up and whether you intend to work on your own or in conjunction with others.
The legal entity you choose will have a significant impact on the way you are protected under the law, the way your business profits are taxed and the compliance obligations you will face. So lets take a dive into the details of trading as sole trader versus limited company.
There are three basic forms of business organisations, sole trader, partnership and limited company. Each has its own benefits and drawbacks and are treated differently for legal and tax purposes. I would not recommend a partnership to any start-up so I am just focusing on the main differences of trading as a sole trader versus limited company.
A sole trader is typically a business owned and operated by one individual. A sole trader is not considered to be a separate legal entity under the law, but rather is an extension of the person who owns it. The owner has possession of the business assets and is directly responsible for the debts and other liabilities incurred by the business. The profit or loss of a sole trader is combined with the other income of an individual for income tax purposes.
A sole trader is perhaps the easiest form of business to own and operate because it does not require any specific legal organisation. A sole trader typically does not have any rules or operating regulations under which it must function other than those contained in industry specific regulatory licenses or permits. The business decisions are solely the result of the owner’s abilities. Most startups will begin life as a sole trader and transfer into a limited company at a later date when the limited liability protection of a company is required. I usually advise incorporation when the first employee’s are being hired or when credit facilities are advanced to the business by suppliers or banks.
A limited company is a separate legal entity that exists under the authority granted by the Companies Acts. A limited company has substantially all of the legal rights of an individual and is responsible for its own debts. It must also file tax returns and pay taxes on income it derives from its operations.
Typically, the owners or shareholders of a limited company are protected from the liabilities of the business unless they have traded fraudulently or recklessly. However, when a limited company is small, creditors often require personal guarantees of the principal owners before extending credit. The legal protection afforded the owners of a limited company can be useful.
A limited company must file accounts and other statutory information at the Companies Registration Office annually.
Incorporating a business allows a number of other advantages such as the ease of bringing in additional capital through the issuing of shares, or allowing an individual to sell or transfer their interest in the business. It also provides for business continuity when the original owners choose to retire or sell their shares.
If after reviewing the pros and cons of being a sole trader versus limited company you decide to incorporate your business venture, we can advise you on tax planning opportunities that can maximise your cash flow.
Sole Trader versus Limited Company – A Comparison
|A company must be formally incorporated with a written constitution. There is an initial formation cost, and the business name needs to be registered at Companies Registration Office.||The business name needs to be registered at Companies Registration Office, but otherwise there are minimal formation cost.|
|Companies are governed by the Companies Acts 1967-2014. A company must:-
· Keep accounting records
· Produce audited accounts, unless eligible for Audit Exemption.
· File accounts and an Annual Return with the Companies Registration Office. This information is available to the public.
· Keep Statutory Registers and Minute Books.
| Sole traders are not required by law to have annual accounts nor to file accounts for inspection.
However, simple annual accounts are necessary for the completion of Revenue self-assessment tax returns.
In general a sole trader will pay less for accounting and tax services than a limited company.
|Companies can borrow in their own right using company assets as security.
Shareholders are not personally liable for company debts unless they’ve signed personal guarantees.
|Sole trader are unrestricted in the amount and purpose of borrowings but are personally liable for all debts.|
|Shares in a company are generally transferable, therefore ownership may change but the business continues.||A sole trader cannot sell a share in his business without having to convert into a partnership.|
|Incorporation does not guarantee reliability or respectability but gives the impression of a soundly based organisation. Personally, there may be prestige attached to directorship.||The unincorporated business does not carry the same prestige.|
|A company pension plan has greater flexibility and higher limits for deduction against profits for payments.||Pension planning is not as flexible for a sole trader.|
|Losses in a company can only be off against profits of the company||Losses incurred by a sole trader can be set against other personal income.|
|All funds withdrawn must be by salary or dividend and an immediate tax charge arises in the month. Residual profits are taxed at 12.5%.||Taxation is calculated on the entire profits regardless of the amount drawn out of the business.|
Please contact Robert Kelly FCA at firstname.lastname@example.org or on 01-5175211 if you would like any further advice on trading as a sole trader versus limited company or have any tax planning or compliance requirements. We are a firm of Chartered Accountants based in Sandyford, Dublin 18 specialising in helping SME’s with all their tax and accounting needs.
About the Author.
Rob is a Fellow of the Institute of Chartered Accountants Ireland and is also a Xero Certified Advisor. With over 25 years professional and business experience in both the SME and Not for profit sectors, he is the trusted advisor of many clients across numerous sectors. Loves all things business, otherwise it’s a game of golf, running the odd marathon and still believing next year will be Liverpool’s year! #YNWA!