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Setting Up A Business - Company or Sole Trader?

Good morning all, and dare I say it, but the day is looking positive. Not exactly fry an egg on a stone but there's some heat in it! It's fantastic to see a bit of positivity about the place. The vaccines are getting out there and people are very excited to get them. My sister, who is in her late 50's, got hers on Wednesday and is getting her hair done today. She wanted to get the hair done before getting the vaccine, so she would look better than all her age group. But you can't have everything! She got the Astra but still has her sights set on Portugal in July. I got a haircut myself on Tuesday and was only delighted. I was afraid to look on the floor of the barbers for fear that all sorts, hidden in there for months, was now visible. No solicitor’s letter has arrived through the post yet.

Last week we spoke about how company directors need to be very careful when filing their 2020 tax returns. In case you missed it see here

This week I had a great consultation on the question of sole trader or company with a guy starting a business. We wrote a blog on this before click here but thought it worth looking at some specifics that came up to lead to a decision.

Background

For the blog, I am calling the person Harry Hole. I got the name as watched a part of The Snowman on RTE on Wednesday night. Harry is in his early 40's and is working, earning a salary of about €35,000, so would pay tax at the lower rate. Our Harry doesn't smoke as many fags as Harry of The Snowman! He is married but separately assessed. He will need to invest about €60k in equipment to get his business started and has this in savings. The business will have an annual turnover of €100k, net of Vat, and expenses of €40k, so a net profit of €60k. Capital allowances on the equipment at 12.5% will be €7.5k per annum for 8 years. The question for Harry is which is the best route for him. Based on a profit of €60k and capital allowances of €7.5k the taxable profit in a sole trade business will be €52.5k. The tax payable on this is

First €35,30020%€7,060
Next €17,20040%€6,880
Total€13,940
Less Tax credits
Personal€1,650
Earned Income€1,650
Net Income Tax€10,640
Add USCvarious€1,665
Add PRSI4%€2,100
Total Tax€14,405


If we take the tax from the profit Harry has €45,595 left.

Company

Let's assume that Harry set up a company HH Ltd and carried on his new business through that and had the same numbers. This time the only difference is that Harry pays himself a salary of €35,000. This is to match his income before setting up the business. The tax on his salary is

€35,00020%€7,000
Less Credits
Personal€1,650
Earned Income€1,650
Net Income Tax€3,700
Add USCvarious€878
Add PRSI4%€1,400
Total Tax€5,978
Net Salary€29,022


The taxable profit in the company, after capital allowances, is €52,500. The company would get a deduction for Harry's salary of €35,000. The taxable profit in the company is now €17,500. Corporation Tax at 12.5% on that figure is €2,188. Total Tax is

Corporation Tax on profit of €17,50012.5%€2,188
Tax on Harry's salary€5,978
Total€8,166
Tax as a sole trader€14,405
Tax saving in company€6,239


As a sole trader Harry has €45,595 left and we will assume he needs €29,022 to live off. There is a balance of €16,573 left to play with. In the company after paying corporation tax, there is €22,812.

Net profit in the company after salary€25,000
Less corporation tax€2,188
Net cash in the company€22,812

We ignore capital allowances. They are available on the equipment that the company or sole trade purchased.

If he needs more money, he can money take back from the company. How can he do that?

Director's Current Account

Remember that Harry had savings and the business needed equipment to operate. Harry gave a loan to his company of €60,000. When funds are available Harry can take that money back from the company tax-free. Harry could decide not to take a salary in the first year of trading and repay himself €29,022 from the company. This would cover his living expenses. In that case, as he has no salary, the taxable profit in the company is €52,500. Corporation Tax at 12.5% on that is €6,563. So what cash is the company left with?

Profit€60,000
Less Corporation Tax€6,563
Less loan repayment [living expenses]€29,022
Balance in the company€24,415


As you will see the company is not that much better off if Harry repays his loan compared to taking a salary. It is only better off by €1,603. The reason it is that small is that the company didn't get a tax deduction for Harry's salary. The deduction the company would get for that is €4,375. This is €35,000 at 12.5%.

Tax on Harry's salary€5,978
Less Corporation Tax deduction€4,375
Difference€1,603


We would always advise the company owner to take some salary to ensure they had a PRSI payment for the tax year. Harry has the choice of drawing down the loan when he wants to, so the company gives him that flexibility.

Advantages of Sole Trader

I want to look at the advantages of a sole trader and compare to the advantages of a company. The advantages are;

  • The money is yours and not belonging to a company
  • Easier and cheaper to set up as less legal requirements
  • Easier to set up a bank account
  • Accountancy fees would be lower
  • Easier to close down
  • No legal obligations that a company director would have

Advantages of a Company

For me, a company has some huge advantages over a sole trader. Two of the most obvious ones are tax payments and pension. Being a sole trader, or in a partnership, you are dreading the end of October when it is D-Day for tax payments. If we look at Harry and assume he's a sole trader for 2021. He will have to file his tax return for 2021 by the 31st of October 2022. There is up to a two week’s extension, once you pay and file on ROS. He will also have to pay preliminary tax for 2022 by the 31st of October 2022. His preliminary tax for 2022 is based on paying 100% of his 2021 liability. His tax liabilities will look like this

Income Tax 2021€14,405
Preliminary Tax 2022€14,405
Tax €28,810


Harry will have to be well disciplined and organised to make sure he has funds available to pay his taxes. In a company situation the company deducts Harry's tax every month from his salary. He doesn't worry about saving for large tax bills. See our previous blog on this called November Pain see here

The other area is pension which we have covered before. As a sole trader, Harry can put up to 25% of his net profit, after capital allowances, into a pension. This is up to €13,125 based on a profit, after capital allowances, of €52,500. In a company situation the company can fund up to 2/3rd of Harry's salary, so can put in much more. Harry has the flexibility of increasing his salary so the company can put even more in.

Other areas to consider would include;

  • Bank finance and getting this. Banks will be looking at repayment capacity, and in a company there will be more, with less tax to pay. Remember the company saved Harry over €6,000 in 2021!
  • Expenses. As an employee of your company, you can pay yourself mileage and subsistence payments. This is on the basis you meet Revenue guidelines on this. As a sole trader, you can't pay yourself expenses but get a deduction for actual business expenses.
  • Customers. Will your customers want you to be a company? Bigger customers may only want to deal with companies as a policy.
  • Limited Liability. In a company your personal assets are protected. If a person takes a case against the company, they can only go after the assets of the company. If somebody takes a case against a sole trader, they can go after all your assets.

Summary

In cases where profits are increasing a company makes sense. If profits are lower and you are only paying tax at the lower rate, then a sole trader makes sense. Harry was undecided. He mentioned setting up as a sole trader first and then changing to a company. My view was to go with a company now. He would have to incur the costs in a few years and change bank accounts, tax numbers, and even loan accounts. A saving of €6,000 a year may not be huge. But if you are saving €6,000 a year for 25 years that is €150,000. Surely, that's better in your hands, investing to grow the business or in your pension, than resting in Revenue's account!

Interested in talking to us? Call Deirdre on 051396703 or contact us. Tell us a bit about you and your business and we'll see if we can help.



 

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