The Sole Trader structure for starting a business is a simple and straightforward way of getting up and running. A Limited Company structure is more complex but it does provides better taxation structure, protection for your personal wealth and is a flexible vehicle for growth and investment.
Long Term Objective
If you’re starting a fledgling business or experimenting with a business idea and you’re not too sure about it’s long term prospects, then you might consider starting as a sole trader. If you’re confident that you’ll be growing your business over the long term, then a Limited Company structure is likely the best vehicle.
Because of this, many businesses choose to begin life as a sole trader structure and transition to a Limited Company structure once business becomes stable.
As a first step, consider your ability to leave money in the business after paying yourself and all the bills. If you can do this then it will be the right time to incorporate. If you can’t, then consider starting and continuing as a sole trader until you can afford to allow the business bank balance to build up.
A Limited company will allow you to ring fence the obligations of the business and protect your personal wealth. If things go wrong, your personal assets won’t be at risk. The downside to gaining this protection is a more burdensome regulatory and administrative regime as well as additional responsibilities under Company Law.
Although Sole trading is a much simpler and easier to set up (it’s all done in your personal name), you will have personal liability for the debts of the business. If things go wrong your personal assets (to include your home) would be at risk from the creditors of the business.
When considering legal protection, keep in mind that a limited company structure will not provide 100% protection. If you’re borrowing money from a bank you’ll likely be asked to sign a personal guarantee which puts you back on the hook for the debts of the business. Company law also makes provision for the personal liability of the directors in certain circumstances, for example in cases of reckless trading.
The money and assets in a Limited Company do not belong to the company directors or it’s shareholders. Rather, the belongs to the Company itself. This can sometimes cause confusion, particularly when the directors\shareholders want to take money out of the business.
To access company money, Directors must either take a salary or pay themselves a dividend. Both of these events trigger a tax liability.
For salaries and dividends to be paid in the first place, money must already exist in the company and this will usually be as a result of the company making a profit. The rub is that the company will also have to pay tax on it’s profits and the money left after the tax is paid is what salaries and dividends are paid from. Some people look on this as a double taxation, but actually it becomes clearer once you understand the concept that the Company is a completely separate entity.
For Sole traders on the other hand, the profits of the business are taxed just once directly on profit and the owner can take the money out of the business without complexity. This is done in the form of drawings.
In Ireland, a company’s profits are subject to corporation tax at a rate of 12.5%.
Salaries and Dividends paid out to employees, directors and shareholders are taxed under the PAYE system (income tax PRSI and USC) and the rate of tax varies depending on the amount being paid.
A Limited Company is a separate legal entity to its owners. As a Director, you’ll have an obligation to act in the best interests of the company. This means that you’ll need to ensure that the Company always has enough money to pay it’s debts. Other rules include restrictions on transactions between the Company is its directors (for example the giving of directors loans by the company), and also rules on how directors must act in the best interest of the Company and not for their own personal gain.
The Company must also comply with company law statues which in Ireland are tightly enforced by the Office of Director of Corporate Enforcement (ODCE).
Sole trading on the other hand, will give you more flexibility with the cash in the business. You won’t have to worry about company law and the business can be flexible in what it undertakes in order to make money.
Both Sole traders and Limited Companies must make tax declarations each year with the Revenue Commissioners. Limited Companies must also file annual statutory accounts with the Companies Office so you may also need to pay an accountant for tax advice. The costs of setting up and operating a limited company are higher than a sole trading structure and the process does take longer. Also, if things don’t work out, it’s more complex to close down a Limited Company than for a sole trading business.
So it’s easier to set up as a Sole Trader than a Limited Company. In general, all you need to do is register for income tax with the Revenue Commissioners (although depending on your particular activities, you may be regulated by other authorities). If you trade under a name that is different to your personal name, you will need to register that business name but this is easily done online and at a low cost.
A limited company is better for long term growth. It also gives you more credibility with customers and potential investors as it shows that you are invested in your business and willing to operate in a regulated environment. In addition a company’s shares can also be sold and transferred which facilitates exit strategies for founders and investors without the need to windup the business. Sole trading on the other hand is better suited to smaller businesses, typically with few employees and for business owners with less appetite for regulation and administration.
A private Limited company is the route for the majority but it may not be the right choice every time. As a general rule, a private limited company is the way to go if you intend building and maintaining a business over a long period and allow assets, cash and good will to accumulate and remain in the business. On the other hand, a sole trader is an appropriate structure for a once off venture or a quick turnover idea which will bring in cash over shorter life span.
SOLE TRADER ADVANTAGES
> Easier to set up
> Minimum regulation
> Taxed once on profits
> Greater privacy
> Easier to wind up
> No corporate filings
LIMITED COMPANY ADVANTAGES
> Personal assets protected
> Tax efficient for growth
> Tax free pension benefits
> Flexibility with ownership & investment
> Enhanced credibility
> Flexibility with expenses
SOLE TRADER DISADVANTAGES
> Risk to personal assets
> Difficult to transfer partial ownership
> Pensions not facilitated
> Expenses must be vouched
> Profits are taxed as income
LIMITED COMPANY DISADVANTAGES
> Perceived double taxation
> Must file annual returns
> Company law obligations
> Expensive to set up & maintain
> Details are publicly available