When this question is posed to us we try and get as much information as we possibly can from the individual so that we can fully understand their personal circumstance and the likely success and profitability of the business. This is key to determining the appropriate structure.
Common questions to ask would include;
- Is the individual married or single
- If married is the spouse working
- If working what is the level of spouse income
- What dependents are there and what ages are they
- Is there a mortgage in place and are there other borrowings
- Has the individual built up savings or has other assets and liabilities
- What is the individuals current income if in employment or self-employed
These questions give us a good understanding of what financial requirements an individual has and give a clear indication of a salary that he/she will require from their company or what level of drawings needed from a sole-trade business.
The Tax angle!
- Company profits are taxed at 12.5%
- Professional service companies are taxed at an effective rate of 19%
- Sole trader profits will be taxed on a number of rates starting at 20% but this climbs to 40% and when USC and PRSI are taken into account this can climb as high as 55%
Typically the higher the turnover and profits, the more attractive a company can be especially when a lower salary can be taken.
For example John Giggs sets up Giggs Construction Ltd and in 2015 the company has a turnover of €200k. Operating costs are €100k and John has taken a salary of €50k to leave a profit in the company of €50k
The tax liabilities are as follows;
|Company profit €50k x 12.5%||€6,250|
|Tax on John’s salary*||€11,975|
|Total Tax Cost||€18,255|
*assume John is married and spouse is not working and they have dependent children
In a sole trader situation John wouldn’t have a salary and any money taken from the business is referred to as drawings. In this scenario John would be taxed on the entire profits of €100,000 and including Income Tax, USC and PRSI the tax cost of that profit would come to €37,775. As you will see this is more than double the tax cost through the company route.
Are you comparing apples with apples?
No you are comparing apples with oranges in a way as there are some key differences to be noted;
- As a sole trader the money belongs to John, so once his taxes are paid the balance of €62,225 belongs to him to do with as he pleases
- In a company situation the balance of the profit, after paying the corporation tax, belongs to the company, so if John needs to get that money he will have to pay PAYE on taking it out by salary
So there is €43,750 left in the company what does it do with that?
- A number of possible scenarios
- Use that money to fund a pension for John
- Use the money as working capital
- Use the money to pay down debt in the company
- Use it to pay a salary to his wife, at lower tax rates, provided she is working in the company
- Build up funds in the company
Many individuals find it difficult to get used to the fact that even though they own the company the money belongs to the company and there are tax implications (and potentially company law considerations) for taking it out. The higher the salary one takes the less tax efficient the company becomes. In the above example if John was on a salary of €100,000 there would be no tax advantage to being in the company as the PAYE cost of the salary would be the same as his Income tax bill. Therefore the profit subject to corporation tax is nil.
Anything else relevant?
- Companies have limited liability so if the company fails the assets of the individual are protected but beware personal guarantees!
- There are new developments on the horizon – have you read Comerford Foley Companies Act 2014 summary – see www.comerfordfoley.ie
- With new developments there is scope for planning
- Pension planning opportunities are usually better through a company
- Make sure all CRO filing dates and tax return filing dates are met, otherwise it will cost you
- A business can be set up as a sole trade first and then, as the business becomes more profitable, it can be transferred into a company
- Beware of tax relief available such as start your own business relief for those unemployed for over 12 months and the seed capital scheme
We have seen a noticeable increase in the formation of companies in the last year or so and there is certainly an appetite for structuring your business as tax efficiently as possible.
Remember always get professional advice from your accountant or tax adviser, the benefit will outweigh the cost very quickly.