It can be difficult to decide whether your business should start as a sole trader or a limited company. This is an individual decision for each business owner and dependent on your personal circumstances. Most small businesses start as sole trader and then move onto a limited company structure as the business grows.
A sole trader is the legal and financial owner of the business and is responsible for the debts of the business. The profits of the business are taxed at the marginal rate of the business owner. There is no way of avoiding tax on the profits of the business.
- Simple and cheap to set up and the taxpayer can do it themselves.
- Ongoing accounting fees are usually quite reasonable.
- Few legal obligations and the only return that needs to be filed is the annual tax return.
A limited company is a separate legal entity which means the debts of the business are contained within the company. It is more complicated than a sole trader to set up and usually needs external professional help to set up. Accounting costs are higher as there are multiple accounting and tax returns to be done with the CRO and Revenue each year. Profits of the company are taxed at 12.5% and the directors of the company are taxed at their marginal rate on the salary paid to them by the company. In most cases, a limited company must have two directors or if not, they must have a director and secretary who are different people. A memorandum and articles of association must also be in place. Some limited companies will also be subject to an audit and financial statements are published and available to the public.
- As a limited company is a separate legal entity, the directors are not responsible for the debts of the company.
- More flexibility from a tax point of view; if the cash from the business is kept in the company, it is only taxed at 12.5% plus directors can pay into a pension plan almost tax-free.
- Business name and brand is protected.
- Banks and other institutions look more favourably on lending to limited companies as the risk is perceived to be lower.
- Limited companies have more credibility and more prestigious business status.
There are some more details here on the process of setting up a limited company in Ireland.
On reflection, it makes sense for small, low-risk businesses to start out as sole traders to utilise the advantages of a simple set-up process and ongoing cheaper accounting fees. As a business grows and begins borrowing, it makes sense to change to the structure of a limited company to gain the protection of limited liability and tax benefits.
Disclaimer: This post does not constitute financial advice and is for information and educational purposes only. This blog does not constitute an accountant/client relationship.