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 and exemptions it is entitled to. In Ireland, the most common options for an entrepreneur are sole trader, partnership, or limited company.
Recent guidelines from Revenue about what constitutes an employee are meant to crack down on de facto employees being hired as contractors, who then register as self-employed (sole traders). We expect that those serious about their contractor status will opt to incorporate as a limited company instead.
Incorporating as a sole trader
In Ireland, it’s 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 and the minimal paperwork involved.
A sole trader is not subject to charges from 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, and 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 admin 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 your risk and liability
As a sole trader, the entrepreneur is personally responsible for any risks or debts incurred. This is a serious consideration when entering into financial and/or business contracts. In this scenario, the entrepreneur is legally inseparable from his or her business.
A limited company, on the other hand, means limited liability for such risks. The company is viewed as a separate legal 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, which in Ireland is a very favourable 12.5% compared to the global average rate of 23.45%.
While a low CT rate is an attractive reason to incorporate your business, remember that this is only of real benefit if you plan to make significant profits. If all the profit is needed for your own subsistence – i.e. the profits from the company go to paying your salary – this amount is effectively being taxed at income tax rates.
Most new companies enjoy a corporation tax relief for their first three years, dependant on their overall CT liability and the level of employer’s PRSI they pay per employee. If it takes you a while to start making a profit, you can actually carry forward any unused relief from the first five years of trading.
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.
Better pension options
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). With a limited company, you will have various options when it comes to retirement planning, from Executive Pension Plans (EPPs) to Personal Retirement Savings Accounts (PRSAs) (with currently an impressive €2 million lifetime limit) and next year the new auto-enrolment retirement savings scheme. Private pension schemes allow company directors to deduct their pension contributions from company profits before deducting tax. Furthermore, the employer’s contribution is greatly improved as it is governed by more generous pension funding rules.
Commercial credence
It is also worth considering other people’s expectations of your business when weighing the advantages of incorporation. Being a company rather than a ‘freelancer’ or ‘self-employed’ person adds a level of professionalism and can give you more credibility. As a limited company, you may find it easier to secure contracts, particularly when working with non-Irish companies that expect to deal with a legal entity. As noted above, many businesspeople simply prefer the protection that limited liability provides.
Mileage allowance
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 according to Revenue’s approved civil service rates – i.e. cents per mile depending on the vehicle type and distance travelled.
Professional services
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.
Transferring assets
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. Typically, though, the additional administration and compliance associated with running a company will be outweighed by the gains to be had in switching from sole trader status.
Different corporate structures in Ireland
There are 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. Unlike some other countries, Ireland does not have a tailored legal structure for social enterprises, so those prioritising purpose over profit typically chose between LTD and CLG depending on their specific circumstances.
The main structures here 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
