Now, one of the most common questions I get asked from my sole trader and company clients is:
“Which is better – sole trader or company?”
I’ve written about business structures before over here, but since this particular question keeps cropping up, I thought I should address it again.
When deciding between operating as a sole trader or as a company there are mainly two things to consider:
You will pay taxes at different rates.
Now, in many countries around the world, individuals are taxed on a progressive scale rate (this includes countries like NZ, Malaysia, Australia and Singapore). What this means is that you are taxed progressively higher the more money you earn. This means that your effective tax rate increases as your income increases.
Companies on the other hand, pay tax at a flat rate. This is known as the corporate tax rate – this means that regardless of how much profit a company makes, it will ALWAYS be taxed at the one same rate.
Let’s take NZ for example:
The individual tax rate operates on a scale from 10.5% to 39% (as of February 2021)
The corporate tax rate is a flat 28% (as of February 2021)
What this implies is that as a sole trader, if you are making lots and lots of money, you may end up paying MORE taxes than if you were to operate your business as a company.
I’m not saying that a high income sole trader will be slammed with a 39% tax rate (please read this article I wrote on income tax) but at higher levels of income (say profits of $300,000 and above) – you will be paying more tax overall than if you were operating as a company.
Conversely, if you are a low income sole trader, you are paying tax at a lower rate than 28% In which case it might be a better idea to remain as a sole trader and not register as a company (as you might be paying a higher amount of tax).
A company provides limited liability protection
A company gives you ‘limited liability’. Limited liability here means that your personal assets are not up for grabs in the case your company defaults on any loan repayments to your creditors. This can potentially protect yourself from bankruptcy.
This means that liability that the company incurs is ONLY limited to the assets held by the company. This is true across many countries where you can setup companies. Depending on your country, when you setup a company, you will have a tag behind its name – this can be Ltd, LLC, Sdn Bhd, GmBH etc etc etc.
This allows some flexibility as a shareholder of your company to take calculated risks without exposing your personal assets. Hence the popularity of the limited liability company structure across the globe.
You need to remember that operating behind a limited liability company does not absolve you, as the managing shareholder, of responsibility. In fact, if it can be proven that you are negligent in managing your company, the creditors may still convince the courts to let them come after your personal assets! In other words – don’t be a jerk, pay your bills on time and don’t try anything funny!
So with those two considerations in mind, you can make up your mind about whether or not operating as a company is suitable for you.
Generally speaking, if you are just starting out, there is nothing wrong in operating as a sole trader. Once business starts to pick up and you are making more money, you can consider starting a company for your business. Do remember that every business is different and you may want to talk to your accountant for more specific advice with regards to your situation.
Take care accounting fans and as always:
Stay positive!