Advantages of a limited company over a sole trader

Jan 14

This is a common issue for entrepreneurs, Should they operate as a sole trader or limited company. From a purely tax point of view if your company profit is larger than you need to live on a Ltd company is the likely to be the most tax efficient option.

The savings would work as follows, 
Profit for yr €1.2M
Drawings required to live off €200K (These will be taxed as income tax either option)
Remaining Profit €1M

Taxed as a sole trader
€506K income tax (approx)
Remaining Profit €494k

Company option (again using €1M remaining profit)

€1M @12.50 % = €125k corporation tax due

Remaining Profit €875k

BUT funds are stuck in the company , final step is to ultimately liquidate the company and pay CGT on the increase in your share holding

Current CGT Rate 25% 

So remaining funds of €875k @ 25% = €219K

Remaining Profit €656K

Saving €656k-€494k = €162K

There is also better scope for sheltering pension contributions using a company and you can get limited liability. 

Disadvantages include increased compliance costs, Solicitors, Accountants ect.

This technique would be used as part of a long term tax plan and would in the real world is not that as simple as above as capital gains rates may change ect.

Voluntary liquidation comes with its own issues you may not be allowed operate as a director for a time afterwards all of which would have to be researched before embarking on this.

This blog post is from an Accountant based in Galway if you would like to discuss this further please do not hesitate to email

tax@domybooks.ie

Disclaimer: This blog post is my opinion and should not be treated as tax advice.

8 Comments

  1. Jan 14

    Interesting post Ralph.

    A couple of thoughts/queries:

    1. The company wouldn’t need to liquidate surely – a share dividend issue with attract the same rate of CGT? The same people (most likely) would benefit the same way. Dividends are a key part to investing/developing business and they should be factored in

    2. If the company didn’t have debts – they could go for a members liquidation, with the blessing from Revenue, therefore not necessarily involving further costs or restrictions

    A very difficult taxation issue for Sole traders -v- Directors is that Sole Traders pay tax on the profit at (or toward) the end of the year. So the tax is almost an additional source that needs to be found on top of the “profit” (or salary/drawings as it is commonly called). So if you made €50k “profit” – you now need to find nearly as much to pay the tax on it; whereas a director’s salary is net – and is calculated.

    Reply
    • admin
      Jan 14

      Hi David,

      Thanks for your comments
      Dividends are unfortunately taxed in Ireland at your marginal tax rate which in the case above would be higher rate of tax except for the the ‘ISEQ 20 ® ETF’ so to avail of the lower CGT rate of tax the easiest thing to do is liquidate and pay the CGT.

      You could be correct there im not certain on the restrictions following a voluntary tidy liquidation.

      Another advantage of the Ltd company is the ability to claim expenses at civil service rates from the company ‘tax free’

      Reply
  2. Mar 3

    The only caveat I would mention in relation to your example is that people should not think that they can set up a company generate profits liquidate and then set up again and repeat the process especially if they were to operate each company for a short period of time.

    To do this might be seen as tax evasion!

    As for restriction of directors in a members voluntary liquidation this would not apply (solvent liquidation). Only, directors of High Court or Creditors Voluntary Liquidation are investigated.

    The other advantage is the limitation of losses if for some reason your business fails (provided of course you act honestly and responsibly)

    Reply
  3. admin
    Mar 3

    Hello Stephen,

    Thanks for your comment. I completely agree, Generally I would recommend the solution above should be used once in a directors lifetime.

    I’ve just checked out your website I expect with your area of expertise you will have a busy 2010.

    Ralph

    Reply
  4. Mar 3

    Thanks Ralph,

    Lets hope this year is a good year for all!

    It is just unfortunate that many business ignored basic prudence in the past few years and are now suffering due to lack of credit. Credit that they were using as working capital!

    All the best.

    Stephen

    Reply
  5. Apr 27

    Hi Ralph,

    As a sole trader about to become a Ltd company your post gives me a clear understanding of the tax efficiencies of doing so.

    Where can I find more information on claiming expenses at civil service rates (what’s allowable, what are the rates etc)?

    Thanks,

    Alan

    Reply
  6. admin
    Apr 27

    Hello Alan,

    The latest circular on civil service rates from the department of finance is here

    http://finance.irlgov.ie/documents/circulars/circular2009/circ072009.pdf

    Ralph

    Reply

Leave a Reply