If you’re going into business, you will have to decide what type of business you are going to run. What kind of legal structure is best for your situation and business activity? The answer to this question directly impacts the structure of the business, the taxes it incurs, and the benefits/exemptions it is entitled to. In Ireland, the most likely options an entrepreneur will opt for are sole trader, partnership, or limited company.
Incorporating as a sole trader
It is common for a business to start out as a sole trading entity and incorporate as a limited company (officially known as a”private company limited by shares”) once revenues reach a certain level. For an entrepreneur starting out with a new venture, the sole trader option is attractive because of the freedom it offers.
A sole trader is not subject to charges from the Companies Registration Office or the restrictive measures outlined in the Companies Act. Ultimately, a sole trader business is a lot easier to set up, manage, shut down. However, the sole trader structure does not protect the entrepreneur from risk in the same way a limited company can and, although there is more paperwork involved, being a limited company can greatly reduce the amount of tax incurred on profits. Let’s take a closer look at the direct benefits of incorporating a limited company.
The advantages of a limited company
Lower risk and liability
As a sole trader, the entrepreneur is directly responsible for any risks or debts incurred. This is a serious consideration if entering into financial and/or business contracts. In this situation, the entrepreneur is legally inseparable from his/her business.
A limited company, on the other hand, means limited liability for such risks. The company is viewed as a separate entity and is accountable separately in such circumstances. Businesses such as restaurants and shops are usually set up as limited companies as they have risks associated with leases, employees, and customers.
Lower taxes on profits
Sole traders are taxed at the individual income tax rate and, therefore, incur up to 55% tax (40% PAYE, 4% PRSI, and 11% USC on profits over €100,000). Limited companies are subject to corporation tax on profits at only 12.5% (Ireland is in the top 10 countries with the lowest CT rate, the global average rate is 23.79%). This is probably the most attractive reason to incorporate your business.
However, it is worth noting that this is only of real benefit if you plan to make a profit. If all the profit is needed for your own subsistence – i.e. you take the profits from the company to pay yourself – they will be taxed at income tax rates. So incorporation is better suited to the sole trader business that is already generating profits and cash.
Better reinvestment potential
As outlined above, profits made by a limited company are more valuable for reinvestment purposes. As a sole trader, the hefty tax rate of 55% greatly reduces the potential for significant reinvestment. A limited company that can benefit from investment has a better opportunity to grow.
Higher pension reductions
For the sole trader, pension relief is capped at €115,000 and is simply by reference to their income tax (not applicable to USC or PRSI). However, for a limited company, private pension schemes allow company directors to deduct their pension contributions from company profits before deduction of tax. Furthermore, the employer pension contribution is greatly improved as it is governed by more generous pension funding rules.
It is also worth taking into account other people’s expectations of your business when considering incorporation. Being a company rather than a ‘freelancer’ or ‘self-employed’ person can give you credibility. As a limited company, you may find it easier to secure contracts, particularly when working with non-Irish companies that may expect limited company status. As noted above, many business people simply prefer the protection that limited liability provides.
With regards to mileage allowance, a sole trader can claim back a portion of the costs associated with running a car based on how much of its use is for business purposes (not personal use). On the other hand, a limited company has greater scope when claiming mileage. For employees of a limited company, mileage is calculated by reference to Revenue’s approved civil service rates – i.e. cents per mile, which varies by the vehicle type and distance travelled.
It’s important to remember that the 12.5% corporation rate rises to 19.5% if the principal part of the company’s income (more than 50%) comes from professional services. Professional services, in this case, refer to services that require a qualification to administer. It is a good idea to closely review what the company considers professional services to be, because in many cases, especially in the case of consulting services, a qualification may not be mandatory.
During the incorporation process, it’s likely that assets will need to be transferred. There are two main options when transferring assets from a sole trader to a limited company:
- sell the assets to the new limited company so that the money is owed tax-free to the owner, or
- avail of Incorporation Relief by disposing of the business assets in exchange for an issue of shares in the newly incorporated company.
The latter option is often used when a significant Capital Gains Tax (CGT) liability occurs, which can happen due to the procurement of taxable goodwill. The benefits of operating as a limited company are wide-ranging and will depend on your specific circumstances. For businesses looking to grow, the additional administration and compliance associated with running a company will typically be outweighed by the gains to be had in switching from sole trader status.
Different corporate structures in Ireland
There are, as you may expect, a wide range of different structures for different business situations. If you’re not starting a typical business, you may want to explore all the options available, starting with the information available on the CRO website. Some of the main structures are:
- Private Company Limited by Shares (LTD)
- Limited Partnership (LP)
- Designated Activity Company (DAC)
- Designated Activity Company Limited by Guarantee (DAC)
- Company Limited by Guarantee (CLG)
- Public Limited Company (PLC)
- Unlimited Company
- Undertakings for Collective Investment in Transferable Securities (UCITS)
- European Economic Interest Groupings (EEIG)
- Societas Europaea Company (SE)
- Cross Border Merger