Structuring Your Business - Part 1

Welcome to 'The Bottom Line'. If you're in business, or just starting out, then you've certainly at least considered how your business should be structured. There is a lot of noise out there around what the best structure is; Limited Company, Sole Trader, Partnership, Group Structures, and so many others. Between this week and next, we will cut through the jargon to help you decide which structure is best for you and why. ​The most common question small business owners ask ...

us about structure is whether they should incorporate as a Company or operate as a sole trader. Most accountants will give the same generic answer, "a Company is always better". This, however, is not always the case. The structure best suited to your business is completely unique, and needs to be considered based on your business type, turnover, profitability, future goals, ownership and a raft of other factors. In addition, this is actually not a simple choice between two structures. As I mentioned above, there are numerous structures which can be put in place for you, and each of them has their own unique advantages and disadvantages. Furthermore, as your business grows and changes, so too does the structure which suits best. It can often be the case that the structure you need now, is entirely different to what you needed 5 years ago, and different again to what you may need in 5 years time. An entire series of blog posts could be dedicated to explaining the various structures. I have therefore decided to split this over two weeks; this week, I will dive into the decision on whether to incorporate as a Company, or operate as a sole trader. Next week, I will discuss in more detail some of the different Company and partnership structures.  

Limited Company vs Sole Trader
This is the age old question, well, since 2014 anyway. When the Companies act was signed into law by Michael D. Higgins on 23rd December 2014, a new type of company was introduced to Ireland; the Private Company Limited by Shares (LTD). When people think company, this is what they are thinking of. This new type of Company was a game changer. Essentially, due to the reduced administrative and legal restraints, it opened up the option of incorporating as a Company to just about every business in Ireland. 

​At this stage, in the year of the LTD's 10th birthday, most of you will already be aware of the headline advantages and disadvantages of a Company as opposed to a sole trader. These are the ones you learn off in school;

Advantages:​

• 12.5% Corporation Tax rate, as opposed to 52% higher personal tax rate
• Limited Liability for owners (You can't loose your house due to business debts)
• Easier to raise finance and bring in external investors 
• More scope for pension planning
• Easier to transfer/sell the business
• Availability of various tax incentives such as the R&D tax credit, CT exemptions, etc. 

Disadvantages:

• Company profits are not yours, Income tax must be paid when money is extracted by directors
• Increased administrative burden, returns etc. to be filed with the CRO and strict penalties for late filings and non compliance
• Strict obligations now imposed on directors to ensure the Company is operated correctly 
• Accounts must be publicised on the CRO
• Companies must hold annual meetings, and follow strict rules as regards shareholders etc. 

I don't feel this is enough though. The above list is extremely generic, and while all of the points are correct, it may be difficult to understand what they mean for your business in a practical way. You need a clear path to a decision for your business. This is why I will now set out a list of 5 very simple questions to ask yourself, the answers to which should make the decision for you. 

Is My Business Going to Generate Profit?
While this may sound like a strange question, it's probably the most important one to ask in making this decision. If you expect to make losses, then it could be more beneficial to trade a sole trader as you can offset your trade losses against other personal taxable income. Furthermore, if the business is going to generate profit, but you expect to spend it all during the year on your lifestyle, then a Sole Trader may be best. This is because you would be paying the high income tax rate on any monies withdrawn from the Company for personal expenses anyway. The Company tax rate is only beneficial when a business generates more profit than the owners spend personally, and this can then be left in the business for future investment, or to be withdrawn more tax efficiently at a later date. If your business has a high level of profits being left in the business, then a Company could be a great option. 

What Does My Business Do?
If your business is deemed a professional service Company, for example a solicitor, architect etc. then a Company operating that trade would be subject to a surcharge on undistributed income. Basically, this means that any profit the Company makes which it doesn't then pay out to shareholders gets hit with a penalty. Furthermore, if your business receives passive income, such as rent for example, a similar issue applies whereby the undistributed income is hit with a penalty. On top of that, passive income such as rent, is taxed at 25% in a Company instead of 12.5%. These are all items to consider before rushing into an incorporation. If your business falls into any of the above categories, a sole trade or partnership could be more attractive. 

Is There Much Risk in The Business?
One of the main advantages of a Company, in my opinion, is the limited liability of shareholders. If the Company is subject to a lawsuit, the owners are not personally liable. The same is true for debts of the Company, they owner's assets are protected. There are certain scenarios where the courts make exception to this rule, however, this is only in the case of serious wrongdoing by the directors. If your business has a higher commercial risk, for example it employs staff, has a premises open to the public, or deals with a large number of customers, these would all be risk factors making the limited liability protection of an LTD very beneficial. Incorporation would certainly be a good option in this case. 

How is The Business Funded?
Almost every business requires funding in some form. The form your funding takes can have a significant influence on your decision to incorporate. If you are taking out a bank loan, it is generally far more beneficial to do this through a Company. In addition to the limited liability protection discussed earlier, you will also  benefit from having more money free to repay the loan due to the lower Corporation Tax rates. Capital loan repayments are not tax deductible, and are therefore paid using after-tax profits. For example, if your loan repayment is €500 per month, as a sole trader this is paid out of profits which have already been taxed at potentially 52%. This means it takes €1,041.66 of profit to pay the €500. On the other hand, at the CT rate of 12.5%, only €571.43 profit is required. It's also easier to take on external investors as issuing new shares in the Company is relatively straightforward. An added benefit is eligibility for EII and SURE schemes, which are investment incentives in Irish Companies which I will explain in a later blog post. Even if you are funding the business with your own money, this initial investment is usually eligible as a tax deduction either on CGT when selling the shares, or as repayment from the Company tax free. Essentially, if your business requires a high level of external funding, it's most likely a Company is best for you. 

What Are Your Long Term Plans?
Your long term plans have a massive influence on this decision. If you wish to sell the Company in the future, then the benefits of a Company cannot be argued with. Investors much prefer to purchase Company shares, benefitting from a 1% Stamp Duty charge as opposed to 7.5% on business assets. You can grow the business much quicker as more of the after tax-profit can be retained, and there are several holding Company structures, to be discussed next week, which could make your exit very tax efficient. In general, even if transferring to a relative, Company shares are usually easier to manage. They are designed to be simple to transfer, such is their nature. If in the future you plan to transfer your business to someone else, a Company could definitely be more beneficial. 

If you are contemplating incorporating a Company, I would suggest that you take a couple of minutes in a room by yourself to contemplate your answers to these 5 questions. That should take you a long way towards understanding which options are right for you. There are further considerations to be made, for example; if the business has property, this should potentially be left outside the Company, due to a double charge of Capital Gains Tax (CGT) and Capital Acquisitions Tax (CAT) in the future. This would also affect the relief on CGT when 'selling' the trade to the Company. Furthermore, if your company is a farming business, there are even more considerations to be made around grants, leases, and agricultural reliefs in the future. I will dedicate a future post solely to dealing with the agricultural issues around Company incorporation as I feel this is worth exploring due to the serious implications, especially when farms are being transferred to children down the line.

Essentially, while these further considerations are extremely important, they are not necessarily major factors in deciding whether or not to incorporate. They are usually only relevant after the decision has been made, and the 5 questions above should allow you to weigh up the direct benefits of a Company for you, and whether it's worthwhile proceeding with incorporation. After that, we can then discuss the detailed issues such as those I mentioned here at the end. 

As always, I'd like to thank you for taking the time to read, and I hope it has been of value. Watch out for next weeks post, where we will dive into Company structures and partnerships, and how these could benefit your business.  If you'd like to get in touch with any questions, or to learn more about structuring your business, please do not hesitate to leave a comment below, or reach out to us at [email protected] .

Be advised that the information provided in this blog post is for general informational purposes only and does not constitute legal or tax advice. While we strive to ensure the accuracy and completeness of the content, it should not be relied upon as a substitute for advice tailored to your specific situation. We are happy to provide this should you require assistance on any of the matters outlined above.