Limited Company -v- Sole Trader

So you’ve decided to set up your own business?  If so one of the first decisions you’ll be faced with is whether to operate as a sole trade or incorporate into a limited company.

Personally I prefer operating as a limited company for a number of reasons:

1.  Better treatment of taxes, pensions and allowable expenses
2.  “Limited Liability” which basically safeguards the owners’ personal assets (however this doesn’t include personal guarantees required by banks)
3. A more suitable structure to faciliate investment, business mergers etc..

However I must stress that  a limited company isn’t appropriate for every business and for very small businesses operating as a sole trader probably makes more sense.  Also some professions are restricted from incorporating for example solicitors.  Don’t forget you can always incorporate your business at any stage as it grows.

The headings below should help give you more guidance on which structure is more suited for your business.

Allowable Expenses

Directors of limited companies can claim unvouched expenses for mileage and subsistence tax free (in accordance with civil service rates).

Sole traders can only claim vouched expenses eg diesel receipts but they can claim for the cost of their own car used in the business.

Entertainment expenses are disallowed for tax purposes for both structures however limited company directors have the advantage of using the company’s cash for these expenses.

Set-Up Costs

The costs of incorporating are higher and usually start from about €200.  Annual accountants fees will also be higher as financial statements will be required each year in accordance with Companies Law.  There is also the additional paperwork of filing an Annual Return Form (B1) each year in the Companies Office.  Accounts must also be filed with this return each year and these are publicly available (although the information made public is limited for small companies).

VAT & PAYE

There is no difference in the treatment of VAT for limited companies and sole traders.

PAYE, PRSI & USC rates and allowances are also the same for owner directors and sole traders.

Corporation Tax

12.5% Corporation Tax is applied to the profits of most limited companies (although this can be higher for some professional service companies).  Some companies can apply for exemption to Corporation Tax  for their first 3 years of trading.

Whereas all of a sole trader’s profits are liable to income tax at their personal marginal tax rate.

Preliminary Tax

Sole traders must file an income tax return on the 31st of October in the year following the end of their accounts period.  This first tax return must cover payment for their income tax bill for their trading year (subject to income tax commencement rules) and also preliminary tax for the following year.  For example a sole trader with accounts ending 31 December 2011 will be due for filing and payment on 31 October 2012.  Preliminary tax for accounts year ending 31 December 2012 will also be payable on 31 October 2012.  For following years the balance of income tax for the year and preliminary tax for the following year is payable.

Directors in a limited company pay their taxes monthly through the company’s payroll and paye operation.  Once all salary is declared this way no preliminary tax will be due to be paid.  Although preliminary tax will be due to be paid on any corporation tax liability.

Pensions

Directors of limited companies can contribute more tax free funds to their pension funds.  There is also the additional tax efficiency gained by establishing a company pension scheme.

Winding up the Business

Closing down a company is more difficult and more costly than a sole trader especially if you have debts and a liquidator is required.

Should the company fail and the directors can prove that they acted honestly and responsibly they can be protected by the limited liability status and there should be no adverse financial consequences for them.
However sole traders have no protection from their creditors and if their business fails with substantial debts they could be forced into a precarious financial situation.

The above list isn’t comprehensive but as you can see there is a lot to consider when deciding the best structure for your business. 

Perhaps you can think of some more advantages / disadvantages that I’ve omitted from the above?