Last week we looked at a Tax Strategy for a sole trader/partnership business. In case you missed it see here This week we will look at a Tax Strategy for a limited company. The main topics we will cover are
- Company set-up – getting it right
- Transferring a sole trader business to a company
- Salary, bonus, and dividends
- Company pension
- Looking to the future
Company Set up
Often not much thought goes into the shareholdings of the company you set up. If a spouse is working in the business, then it makes sense that they have a shareholding in the new company. If not involved in the business, then the entrepreneur should own all the shares. Why would it make sense for a spouse to own shares? Among the reasons are
- Class S PRSI if a spouse has a 50% shareholding. This can save on employer’s PRSI
- Can maximise lower rate bands with a spousal salary
- Your spouse can build up PRSI contributions. He/she couldn’t do this if an employee of their spouse.
- The company can fund a pension for your spouse
- Can have advantages on sale or exit from the business with the doubling of CGT reliefs
It can be that a spouse is not working in the business when the company is set up. He/she comes into the business at a later stage. If this is the case it is worth exploring a transfer of shares from the owner at that stage. Best that this happens before you are 55 so you don’t eat into Retirement relief thresholds.
Many business owners will set up a company at the beginning of their business journey. There are many reasons for this which can include
- Limited Liability – protects your assets
- Profits likely to be high
- Businesses that you work for are companies and the expectation is you trade in a company
- Look to take advantage of tax relief for new start-up companies
- Look to avail of tax reliefs on investing in a new company
- Looking for outside investors who will want some shareholding
- Looking to reward key employees with some shares
For more information on tax initiatives for investing in companies click here
Transferring from a sole trader to a company
If transferring the business from a sole trader to a company, there are lots of things to think about. One of these, which is often overlooked, is goodwill. Is there Goodwill in the sole trade business? If so, then look at getting a valuation to support the goodwill number. Goodwill is an asset. Transferring assets into your company from you is a disposal of those assets. This can have all sorts of tax consequences from CGT, Stamp Duty, Income Tax, and VAT. If the value of the assets you transfer in is greater than the liabilities the company owes you the balance. This can create a Director’s Current account in your favour. You may need this to pay off some loans or liabilities of the sole trade or it can come to you as part of your salary payment.
In our blog last week, we looked at Paul and Sinead and how profitable their retail business was. Paul decides to transfer the business into a company. He wants to expand the brand and invest money into online sales where he sees real potential. To become more profitable, he will have to buy stock in bulk. To do this he will need a larger stock loan from his bank. He plans to rent and then buy a warehouse to store stock. With lower corporate tax rates, he will have greater repayment capacity. This makes sense for him, and the bank recommends this too.
They set up a new company Paulaid Ltd in 2021 and expect to start trading through it in January 2022. Paul had €150,000 profit in 2020 and he expects that to be higher this year. Paul had a tax liability of €54,000 in 2020. He expects the profits to be €200,000 before salaries in 2022. They will take salaries of €80,000 next year which will give them a monthly net pay of €5,275. This will be enough for bills and living costs.
Roger, their accountant estimates their corporation tax liability to be as follows
|Net Profit After Salaries||€120,000|
|PAYE on Salaries||€16,700|
|Total Taxes Payable||€30,138|
If Paul continues to trade as a sole trader in 2022, he would pay over €81,000 in Income Tax. With the large tax saving Paul and Sinead will invest this money into the business. They plan to hire a new store person for the warehouse and invest €20,000 into a new website.
For more info on moving from a sole trade to a company see here
Salary, Bonus & Dividends
For the first few years they are happy to take enough salary so that they are comfortable enough to meet bills. They want to invest as much as possible to grow the company. Down the line they foresee their eldest daughter Megan going to college. They will need to fund this outlay from the company and think it will cost €12,000 per annum. All the courses she is applying for are as far away as possible from Paul and Sinead. There could be a message in there somewhere! They ask Roger what is the best way to get the money from the company?
He suggests that they take a bonus each year to meet this cost as it will be more tax-efficient. A bonus of €24,000 between the two of them will give them a net amount of €12,000. The company will get a tax deduction for the bonus at 12.5% thereby reducing the tax cost from €12,000 to €9,000.
If they take a dividend of €24,000, they get €18,000 net of dividend withholding tax. They would pay tax on the gross dividend of €24,000 at 50% being €12,000 less a credit for the withholding tax of €6,000. They are in the exact same position as if they take the bonus. But the company doesn’t get a tax deduction for the dividend payment. That comes out of after-tax profits
For more information on salary or dividends see here
For those of you that read these blogs, you will know that I am a big fan of pensions. I am even a bigger fan of company pensions. It is one of the best ways of getting company money into your hands. The company funds this so your net salary stays the same. You don’t have to make any contributions, but you can if you want. The company will get tax relief on the pension contributions. And Paul and Sinead will not be liable to BIK on the company pension payments. A win-win, if ever there was one.
Let’s assume Paul is on a salary of €50,000 and Sinead is on a salary of €30,000. The company can fund a pension of up to 2/3rs of these salaries. That would be a pension fund of €33,333 for Paul and €20,000 for Sinead. They set up a company scheme and the company will contribute €500 per month for each for 2022. This will increase to €1,000 per month for each from the start of 2023. The company will get a tax deduction of €1,500 in 2022 and €3,000 in 2023 for these pension payments.
See here for our previous blog on company pensions
Looking to the future
Let’s imagine that it is now 2040. Paulaid has traded very well in the last 18 years. Paul and Sinead have increased their salaries. The company has increased their pension payments. The company also pays some benefits for them to include
- Company car – an electric vehicle with no BIK
- Medical insurance – liable to BIK
- Keyman cover – not liable to BIK but company doesn’t get a deduction
- Home phone and broadband – no BIK
- Annual €500 for a voucher – no BIK
The company has €1 million in cash. Their daughter Megan now works in the company and is doing well. Paul and Sinead would like to step back. Paul is looking to buy a couple of investment properties. He thinks the company could buy these. Would like to get out and pass some of the business to Megan, but he is not sure how this works. He needs some help. Roger is long since retired and he finds a new company on Google called Tax Magic Ltd. He reads some of their blogs and decides to visit them. Stay tuned and find out what happens next week!
A company can be a very attractive structure to trade through. No doubt the 12.5% rate is a huge draw. This can reduce the taxes you pay. You can invest that extra cash into the business to grow and expand. From a commercial point of view, it makes sense on so many levels. A company can give you this flexibility. This means you can control the level of salary and pension you take. If you need extra funds, you can take a bonus or dividends. By focusing on the business, you can grow it by putting in good systems and processes. Investing in your staff and having great advisors will help you on your journey. Planning ahead is important too. As always, please take specific advice to your circumstances.
Need help on your business journey? Call Deirdre on 051396703 or start here. Tell us about you and your business and we’ll see if we can help.