When most people have decided to set up their own business, the first issue they encounter is how to do this. This inevitably leads to the question: "Should I operate as a sole trader or start my own limited company?" There are many factors to consider and many advantages and disadvantages to setting up as either. The decision often depends on the personal preference of the person who owns and runs the business and the type of goods or services that they are providing. There is never one standard answer for all businesses, therefore it is worth spending the time to consider this carefully.
What's the difference?
Here are some basic definitions describing a Sole Trader and a Limited Company.
Sole Trader: A structure in which a business is owned by one person, acting under their own name or using a 'trading name'. This person is fully liable for the company's debts and contracts and there is no distinction in law between the business and their own personal wealth i.e. unlimited liability. This means that their personal possessions are at risk.
Limited Company: A corporate structure in which the shareholder(s) own the businesses and their responsibility for company debt is limited to the amount they have invested in the company. The company is run by a board of directors who act on behalf of the shareholders, although in most small businesses this may well be the same individual(s).
What are the factors I should consider?
There are a large number of factors which affect your decision. Some of the main ones include:
One of the main reasons that people decide to trade as a limited company rather than a sole trader or partnership is due to the tax benefits. The use of dividends and sensible payroll planning often mean that the business owner(s) can make substantial tax savings. These savings would of course need to be set against the additional administration costs of running a limited company, however generally most individuals are substantially better off by acting through a limited company.
Your accountant should be able to guide you in relation to tax planning and how you can minimise your tax liability, whilst still working within the parameters of recent IRD rulings e.g.Penny and Hooper
Another significant reason why people decide to trade through a limited company is due to issues regarding liability. When operating as a sole trader there is no legal distinction between the identity of the business and the individual, which means that any debts of the business are the responsibility of the individual. However if the business is set up as a limited company, the debts are the responsibility of the company (unless the directors have signed personal guarantees). The shareholders are only liable to the extent of the capital they have in the company (i.e. their personal possessions are not at risk). This is a significant factor to consider.
By deciding to trade as a limited company, this often creates the perception that the business is an established, long term business which can be of benefit. Trading as a limited company is usually viewed as the most professional way to trade. As well as giving confidence to consumers, this may also improve relationships with other businesses.
4. Accounts & Administration
When trading as a sole trader, you will need to prepare accounts and submit an individual tax return on an annual basis. Depending on your circumstances, there may be some other requirements during the year, such as GST and/or provisional tax returns. However the level of detail in the accounts and general amount of administration is significantly less than trading through a company.
When trading through a limited company, detailed accounts need to be prepared. The directors must also ensure that the company complies with the Companies Act, including keeping a company register and maintaining the relevant records for example. As a result, accountancy and administration costs are likely to be substantially higher for a limited company
There are also other factors you may need to consider and therefore you should think about consulting your Accountant if you are in any doubt as to what structure is right for you.
Adapted from http://www.squidoo.com/sole-trader-vs-limited-company
Great article here on company formation http://www.bizbuzz.co.nz/node/10957
Info from IRD here http://www.ird.govt.nz/yoursituation-bus/starting/structure/