This is an important decision for any small business and can have significant consequences.
The most recent CSO Business in Ireland report found that 69.6pc of Irish private sector employees work for a SME, accounting for 52pc of total employment in the state. The number of new companies recorded declined sharply when the recession hit and until recently have remained fairly flat. However, in recent times the prevalence of incorporating a trade has become increasingly apparent with the number of new businesses setting up in Ireland approaching pre-recession levels.
The advantages of incorporating a business are numerous, such as separate legal identity of the corporate body, limited liability, access to funding through issuance of shares and often increased business credibility for a body corporate. From a purely tax point of view, if the profits of a business are larger than that needed to live off, the most tax efficient option is generally to incorporate the business. Below are some of these tax advantages:
1. Start-up exemption
Relief from corporation tax for new start-up companies may apply for the first 3 years of trading for a new qualifying start-up company. Where the total corporation tax payable by a qualifying start-up company in a year does not exceed €40,000, the tax referable to income and gains of the qualifying trade in that period will be reduced to €Nil, subject to certain conditions.
2. Corporate Tax Rate
Arguably the most relevant is a corporate tax rate of 12.5pc on company trading profits. A sole trader will be taxed on trade profits at their marginal income tax rate of 41pc plus USC and PRSI resulting in a tax rate of up to 55%.
3. Remuneration and pensions
With an incorporated company there is more flexibility regarding the method of remuneration. There are various means of extracting cash from a company, such as salary, directors’ fees and dividends. Furthermore, a company has the ability to pay proper business expenses to employees & directors at civil service rates on a tax free basis.
Companies may make tax free travel & subsistence payments to employees & directors working away from their normal place of work for each day that this applies. The tax free amount is based on the length of time spent away from the normal place of work. A company may also pay a certain percentage of the cost of every business journey taken in a private vehicle based on distance travelled.
If operating through a limited company, it may be quite efficient to contribute to an executive pension or small self-administered pension (SSAP). Since 2011 the available tax reliefs on personal pension contributions by reference to net relevant earnings were reduced, therefore it can be more tax efficient for a company to contribute to a pension plan on behalf of the employee/director as these contributions are not subject to the same limitations.
The tax benefits of employer contributions into pension schemes are enjoyed by both company and director alike. Payments made by the company into the directors’ pension fund are allowable as a deduction against taxable trading profits while the director is not taxed on this benefit. The value of the fund will grow on a tax free roll-up basis. This fund will only become taxable on retirement and may be passed as part of a will.
4. Double Tax Agreements
Given Ireland’s renown in terms of international trade, Irish SMEs are seeing increased levels of trade within the EU and further afield. Ireland has a plethora of Double Tax Agreements with various foreign jurisdictions which are available to incorporated businesses serving to reduce the burden of tax.