Taking on larger contracts, working in a dangerous industry, or forming a partnership might all be valid justifications for wishing to change from a sole proprietorship to a corporation.
In this article, we take a look at some of the differences between sole proprietorships and limited liability firms and review some of the issues you need to take into consideration before making the switch.
What distinguishes a sole proprietor from a limited liability company?
As a sole proprietor, you conduct business using your unique Inland Revenue Department (IRD) number. You report your income to the IRD and subsequently pay any taxes you owe.
When your annual income starts to approach around $60,000, it may be a good time to consider whether operating as a sole proprietor is the best structure for your company.
One alternative option that will be open to you is registering as a limited liability company. To do this, you must register a company with the New Zealand Companies Office and obtain an IRD number for the firm. This IRD is a totally different entity from the personal IRD number you would have as a sole proprietor.
All of a company’s assets, liabilities, profits, and debts are disclosed under the registered company name while it operates as a limited liability company.
Why you may wish to consider switching from operating as a sole proprietor to a limited liability company
There are a few reasons why sole proprietors feel it’s time to create a corporation, as well as certain advantages to take into account.
1. You lower your personal risk
Working as a limited company offers you some liability protection. If something goes wrong and you’re a sole proprietor, you’re responsible for all incurred debts. That implies that your private property may be put at risk.
When weighing up the risk associated with personal liability, you may wish to take the risks associated with your industry into consideration. Some industries carry greater risk than others. For instance, if you’re a builder, you probably want to operate as a limited company to reduce the risks related to your line of work. But remember that operating a business doesn’t completely shield you from responsibility. It doesn’t imply that you can engage in careless or negligent behaviour while serving as a director or PCBU.
One way of offsetting any risk you may encounter as either a limited company or sole trader is to ensure you have adequate insurance in place. Public liability insurance can help to protect your assets in both circumstances should you find yourself on the receiving end of a lawsuit or cause an accident or damage.
2. It boosts your professionalism
In some situations, clients may prefer to work with a corporation than a sole proprietor.
If you are going to take on a large contract, it could be a good moment to switch from being a single proprietor to a limited liability company since the client may feel more at ease doing business with a corporation and perceive it as offering more.
Having a limited company may also be more beneficial from a financial perspective. Sole proprietors often have a harder time obtaining financing and loans, especially if they do not have a strong financial track record.
It depends on the type of loan you’re looking for. It shouldn’t be an issue for anything like a single vehicle, but if your business is going to need to finance big machinery or several automobile leases, a limited company can be an advantage.
It might be worthwhile for sole proprietors who plan to incur large debt to expand their businesses to consider changing their status to that of a corporation.
3. Operating a limited company has tax advantages
Last but not least, creating a limited company may have tax advantages since the business tax rate is 28 percent while the top tax rate in New Zealand is 39 percent for income over $180,000.
Although this argument receives the majority of attention, it’s a little exaggerated because becoming a corporation doesn’t always result in better tax consequences.
Personal income tax is a tiered system; as such, you will need to earn a lot of money to be subject to the highest rates of taxation. Since most small firms don’t make a lot of money, paying tax on it through personal income tax is frequently less expensive than paying corporation tax, which has a flat rate of 28 percent.
When the firm’s earnings are transferred to the shareholder’s account through a dividend, the company must pay an additional 5 percent withholding tax. The final tax rate is a flat 33 percent. The income tax is subject to graduated personal income tax rates, which will infrequently exceed an overall tax rate of 33 percent, when business tax-paid gains are distributed as a shareholder’s salary.
Sounds difficult? Basically, any tax advantages depend on the unique conditions of your organisation. Therefore, it is important to discuss your situation with your accountant to assess whether or not creating a limited liability company would ultimately result in tax savings.
What potential drawbacks could there be to running a limited company?
Operating as a business can require a little bit more time and effort, as well as some additional costs, albeit these are not significant. If you don’t already have one, you must apply for an NZBN and an IRD number for the firm at the Companies Office.
Additionally, you’ll need to move assets into the company’s name and open a bank account for it.
Furthermore, you are required to generate financial statements that meet the requirements of the Companies Act and the IRD, which includes filing an annual tax return with the IRD and the Companies Office.
A corporation does tend to need a higher quality of reporting. Some proprietors of small businesses attempt to complete their own corporate tax filings. Those with limited companies are advised to seek the assistance of an accountant to aid with your taxes, accounting, and any other related administration. Sometimes it’s preferable to focus on what you do best, which is running your business, and let a professional assist you with your finances.
Does the amount of pandemic support payments vary depending on whether I’m a sole proprietor or a limited liability company?
Small enterprises that are sole proprietorships or corporations have generally had equal access to government assistance, wage subsidies, and recovery payments. The now-closed company debt hibernation scheme was one significant exception; it was open to businesses but not to sole proprietors.
Until December 2023, applications for the Small Business Cash Flow Loan Scheme (SBCS) are accepted from sole proprietors and limited liability firms. Applications for loans of up to $10,000 plus an additional $1,800 per equivalent full-time employee are accepted from qualified firms, including sole proprietorships. If repaid within two years, there is no interest charged on the loans.
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