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Sole trader to Company

Last week we looked at Passing on the Family Business. If you didn’t get a chance to review that Read here

This week we are going to look at a sole trader who incorporates. We will look at the assets transferred in. We will also look at the salaries in the company. From this, we can see what the tax savings are and how this could be a better structure for the business. Find out below why Norma is jumping for joy!

Introduction

Dara and his wife Norma run a very successful social distancing business. They are very well established and have average profits of €190,000 for the last two years. Dara is the main driver of the business and Norma works part-time for him. She is on a salary of €24,000. Dara is a sole trader. He is thinking about transferring his business to a company. He understands that it could be more beneficial for his business. He is also ware that it could lead to some tax savings. Dara purchased the business for €350,000 in 2008. This was for goodwill to buy a strong customer list from an existing business. His average Income Tax liability for the last 2 years was €57,000 per annum. Dara and Norma need €6,000 per month for all living expenses. He speaks with his accountant Tara and asks her to run some numbers. Dara makes personal pension contributions of €28,000 per annum and would like to continue to do this.

Tara runs the numbers

Tara looks at the current value of the business. If you didn't see our previous blog on business valuation click here. She comes up with a figure of €360,000 which is €350,000 for goodwill and €10,000 for equipment. She also looks at the level of salary that Dara and Norma will need to give them a net of €6,000 per month. This comes to a salary of €100,000. She recommends that the split should be €74,000 to Darragh and €26,000 to Norma to maximise the lower rate bands. This would also reflect the number of hours each person works in the business. She also looks at the projected tax position in the company and notes the following:

Average Profitslast two years€190,000
Less SalariesDara & Norma€100,000
Less PensionCompany payment€28,000
Company profit€62,000
Corporation Tax12.5%€7,750
Add payroll taxes€27,000
Totalcompany taxes€34,750
Income Taxaverage liability two years€57,000
AnnualTax saving€22,250


Dara loves the numbers and is seriously considering the company option. He asks Tara what other taxes are at play if he goes down the company route.

Transfer assets into the company

He purchased the goodwill for €350,000 and that is the value that he is transferring it to the company. There is a disposal from Dara to the company of the goodwill. But, there is no gain on the disposal. As there is no gain there will be no Capital Gains Tax [CGT] to pay. There is also no CGT on the transfer of the equipment to the company. If there was a gain on the disposal then Dara could claim Entrepreneurs relief on the gain. This would mean that he would pay CGT at 10%, and not at 33%, provided he met the conditions of that relief.

If Dara has to sign documentation to transfer Goodwill then that would be liable to stamp duty at 7%. This would be a cost of €24,500. It may be possible to avoid paying this stamp duty. There wouldn’t be any stamp duty cost on the transfer of the equipment. Those assets pass by delivery and wouldn’t form part of a written agreement.

For VAT there wouldn’t be any Vat cost under the transfer of a business rule. This applies when you transfer a business from one entity to another entity. You need to make sure that at the date of transfer both entities are vat registered. You must transfer a business and not some business assets. For more information on this read here

Dara will be ceasing as a sole trader. On cessation, there are Income Tax rules that can increase the profits of the previous tax year. As Dara completes his accounts to 31 December each year this revision won’t apply to him.

Tara runs the numbers again!

Dara and Tara are quite clear on the numbers. Tara looks at these again and suggests another option to Dara. Dara transfers assets to the company worth €360,000 so the company owes him this amount. This is a liability owning to a Director and sits in the company accounts as a creditor. Tara suggests that Dara and Norma reduce their salaries to €70,000 per annum. Dara would be on a salary of €44,000 and Norma would remain at €26,000. On these salaries their Tax bill falls to approx. €12,300. This leaves them with a net monthly salary of €4,800. To make up the difference every month they draw down €1,200 from their Director’s current account. The tax position would now look like this

Average profitlast two years€190,000
Less salariesDara & Norma€70,000
Less pensioncompany payment€28,000
Company profit€92,000
Corporation Tax12.5%€11,500
Addpayroll taxes€12,300
Totalcompany taxes€23,800
Income Taxaverage liability two years€57,000
AnnualTax saving€33,200


Conclusion

There is no doubt in the above examples having a company structure makes huge sense for Dara and Norma. Norma will now be paying class S PRSI on her salary. This puts her in a position to qualify for a State Pension and other benefits. It would also be possible to fund a pension for her through the company. The company would be in a greater position to fund larger contributions for her up to 2/3rd of her salary. This would ensure a more tax-efficient spread of income when they retire and access pensions. The excess funds in the company can accumulate to

  • drive business growth
  • increase pension payments or/and
  • repay the money owing to them via their director’s current account

The company could also pay Income protection, medical insurance, and life cover. These will have BIK implications. But it would mean the net salaries would be more valuable to both directors.

Interested in company to run your business. To set-up a meeting call Deirdre on 051 396703 or contact us




 

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