Starting your own business is a daunting prospect without having to worry about what legal structure you shDefaultould choose, sole-trader or limited company. In the vast majority of cases, the incorporation route will be most suitable. A limited company structure provides a level of credibility and professionalism which a sole-tradership does not. Many larger companies, especially international companies, will not do business with sole-traders. Luckily, unlike in many other countries, setting up a limited company in Ireland is child’s play.
The benefits of limited liability can be quite substantial and include tax savings, enhanced personal protection, and the ability to pay yourself more tax efficiently than a sole-trader.
If you expect your new business to quickly make more profits than you will need to withdraw in earnings, then the relief from corporation tax for new start-up companies may be extremely beneficial. Where the total corporation tax payable by a qualifying start-up company in a year does not exceed €40,000 (ie. where profits are less than approximately €320,000), the tax changeable in that period will be reduced to zero (subject to certain conditions). This could be worth tens of thousands a year to some start-ups. It does not apply, however, where an existing business is changed from a sole-tradership to a limited company.
After the first three years are completed, there is still an ongoing tax saving as the Irish Corporation Tax rate is, famously, 12.5%, which is significantly lower than even the lowest marginal Income Tax rate. This means that a limited company can build up profits in the business without suffering a massive tax hit, whereas a sole-trader must pay tax on total profit at higher rates and, so, suffers a higher tax cost. Don’t forget, just like rent or energy, tax is one of your business costs, and you should be trying to legitimately minimise it.
As long as you operate your company in compliance with company law, and do nothing which could compromise the company’s ability to pay its liabilities as they fall due, you will enjoy protection from being personally pursued for the debts of the company if the business fails. This obviously doesn’t apply to situations where you have personally guaranteed any debts (such as bank loans, leases, etc).
You are also protected in situations where a lawsuit is brought against the company for consequential loss (when the products or services supplied by you have proved defective or deficient, and, by reason of that deficiency, have caused a financial loss for your customer) or for a claim from an employee or member of the public. Admittedly, in order to enjoy this protection you may have to close the business down – but that’s better than having the plaintiffs pursuing you personally to pay the damages.
With a limited company there is more flexibility in how you pay yourself. There are various means of extracting cash from a company, such as salary, directors’ fees and dividends, although all of these income streams are subject to the same income tax rate.
However, a company has the ability to pay proper business expenses to directors (and other employees) at civil service rates on a tax-free basis. Companies may make tax-free per-day travel and subsistence payments to directors working away from their normal base. The tax free amount is based on the length of time spent away from base, but is usually in excess of the actual expense cost. A company may also pay a certain percentage of the cost of every business journey taken in a private vehicle based on distance travelled. In this way, it is possible to make a “profit” on travel and subsistence costs, although you must be careful to keep this within acceptable limits. Revenue are also very particular about where your base is located. In contrast, sole traders are only entitled to recoup the actual costs of travel and subsistence and may not pay themselves a “mileage” rate.
Limited companies also provide efficient mechanisms to contribute to an executive pension or small self-administered pension (SSAP). Payments made by the company into a directors’ pension fund are allowable as a deduction against taxable trading profits, while the director is not taxed on this benefit. The value of the fund will grow on a tax free roll-up basis. This fund will only become taxable on retirement and may be passed as part of a will. We would strongly advise independent financial advice when considering taking out a pension.