There may come a time when remaining as a sole trader does not make sense anymore for your business. Making the transition to a private limited company can be a daunting task, but it can also offer a range of benefits, from increased credibility to greater financial protection.
In this blog post, we will go through when the right time is to make the change, the steps you will need to take, and what the tax implications can be.
When it makes sense to incorporate
The marginal tax rate (tax paid on any additional euro earned on top of your current income) in Ireland is very high once you start earning more than €40,000 per annum.
| Income | Marginal Rate of Tax |
|---|---|
| >€40,000 | 48.5% |
| >€70,044 | 52% |
| >€100,000 | 55% |
As we can see from the above table, it even increases to 55% for sole traders earning more than €100k.
When you operate as a sole trader, you will be taxed on all income generated, even if you do not use it to fund your day-to-day living expenses.
If you compare this to a private limited company, the profits will be taxed at 12.5% corporation tax, and then you will only pay personal taxes on the salary or dividends you decide to take out of the company. The rest of the retained earnings can be reinvested in other business opportunities to grow your wealth in a much more tax-efficient way.
This means it may make a lot of sense for you to consider changing from being a sole trader to incorporating a limited company when your income generated by the business more than exceeds what you need to cover your day-to-day living costs.
There are also other benefits such as the such as limited liability to think about too.
The steps you need to take to make the change from a sole trader to limited company
In order to fully execute a change from a sole trader to a limited company you will need to go through the following steps:
- Register a limited company with the CRO
- Register that company for tax with the Revenue Commissioner
- Open a new bank account for the limited company
- Transfer the sole trader business including all goodwill etc to the new limited company
- Prepare a capital gains tax return that accounts for the transfer and pay any capital gains taxes that could arise.
- Cease the trade of the sole trader business.
- You will still need to remain registered for income tax however if you will be acting as a director of the new company.
This may take a little bit of time depending on if you are doing a lot of the admin work yourself of setting up the new company (approximately 1 month) or if you are buying an off-the-shelf company that is already set up and ready to go. The cost of setting up a company will vary though depending on what route you take.
The timing of all these events will be key, so make sure to sit down with your accountant to make sure that you don’t end up making any errors. You could end up in a scenario where you have transferred the business but still some of the transaction are going through your sole trader business and it is important to have these accounted for correctly.
How to make the change as tax efficient as possible
A limited company is like a person in itself that is completely separate to you. So when you decide to transfer your sole trader business to this limited company you are essentially selling the business and will need to work out the capital gains tax implications of that.
Section 600 of the Taxes and Consolidation Act 1997 makes a provision for such scenarios that will allow you to defer some of all of the capital gain when transferring your sole trader business to a new limited company.
To avail of this relief, you will need to transfer the sole trader business as a whole with its assets (or the whole of its assets excluding cash) as a going concern in exchange for shares in the company.
In the future, if and when you then sell the shares in the limited company, you will need to deduct the Section 600 gain, for which you got relief on at the time of transfer, from your cost in the future when calculating the capital gain on disposal of the shares. As we mentioned above you are just deferring the need to pay capital gains tax.
One very important thing to be aware of is if there is any other consideration received asides from shares in the company (e.g a cash payment) when you transfer your business, then the capital gain will need to be apportioned and you will only get Section 600 relief for the gain that relates to the shares. You will need to pay capital gains tax immediately for any capital gain related to non share consideration.
There are a couple of other relief that can come into play here such as Retirement relief and Entrepreneur Relief that are worth discussing with your accountant.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.
