As your business develops, there can be advantages to restructuring as a limited company. However, incorporation is not for everyone, explains David O’Connor.
For sole traders, restructuring your business as a limited company can be an attractive option, particularly if you are in the higher income tax bracket or if you need to raise funds to grow your business. However, it is important to take professional advice as incorporation may not necessarily be the best, or the only option, to consider.
Advantages of Incorporation
Tax is usually cited as the main advantage when forming a limited liability company. This is because companies pay 12.5 percent corporation tax on their trading profits whereas a sole trader’s profits are taxed at the marginal income tax rate plus USC and PRSI. While the directors and shareholders of the company must still pay income tax, they can limit their earnings so that they are taxed at the lower income tax rate, leaving any remaining profits in the company to fund future development or be extracted at a later date.
Other advantages of incorporation include:
- A company is a separate legal entity. This means that, with some exceptions, where the company incurs a liability, the liability rests with the limited liability company rather than with the directors and shareholders.
- The liability of company shareholders (with the exception of unlimited companies) is limited to the amount they paid for the shares whereas for sole traders there is no limit on their personal liability for the debts of the business.
- Company pension contributions enjoy greater tax advantages than self-employed pension plans.
- Companies have greater flexibility to when it comes to remuneration. For example, they can reward directors and shareholders by way of salary, directors’ fees and dividends.
- Companies can pay business expenses to employees and directors at civil service rates whereas sole traders can only claim for the actual expenses incurred.
- Companies have the ability to raise finance by issuing shares and are more attractive to investors because of their limited liability.
Disadvantages of Incorporation
A disadvantage of incorporation is that companies have additional reporting and filing obligations and directors can be prosecuted for failing to comply with company law.
Loss of confidentiality can be a concern for some businesses as certain company information is publicly available through the Companies Registration Office.
Another issue is that incorporation can sometimes have an adverse tax impact, especially for businesses with trading profits below a certain threshold. Therefore, unless there are other compelling reasons, incorporation is generally not advisable for these businesses.
There are also anti-avoidance measures in place to counter situations where the main motive behind a transaction is avoidance of tax.
For certain businesses, alternatives to incorporation may be worth considering. Farm businesses, for example, should weigh the advantages of partnership and/or succession partnership before deciding to incorporate.
Having considered the options and taken appropriate professional advice, if you decide to proceed with forming a limited company, there will be a number of practical issues to address. These include transferring assets, property, insurance, utilities and contracts to the company, setting up new bank accounts, advising creditors and debtors of the change, revising employee contracts, notifying Revenue and registering the directors as employees, updating licences, and ordering new stationery.
Changing your structure is a major business decision and professional advice should always be obtained. It is important to consider not just immediate needs, but also your long term plans, including your succession plan. While forming a limited company can be the right choice for many businesses, it is not for everyone.