Business association – self-employed, partnership or limited company
One of the big questions that concerns every business owner is how to improve the “bottom line”, or in other words how to earn more and pay less taxes to the state.
One of the common ways is to change our form of incorporation from independent to a partnership or a limited company, when there really is no absolute and correct answer for all businesses, because beyond accounting tax considerations, there are other, equally important considerations that require professional attention and attention, and we will present the main The things:
1. Tax and National Insurance rates:
Self-employed – will pay income tax on his profits which can reach up to 48% when starting with an annual net profit of NIS 800,000. The amount of the tax rises to 50% of the first shekel, the average national insurance is 14%.
In short, the tax burden for a self-employed person earning NIS 250,000 is 30% on average.
The tax burden on a self-employed person earning NIS 850,000 per year is 42.86% on average – heavy.
Partnership – the tax rates will be the same as those of the independent, but the big advantage is that the profit is divided according to the number of partners, or according to the percentage of control in the partnership, suitable mainly in family businesses or between friends. Experience shows that instead of establishing a partnership, it is better that the main part of the business be managed in the name of one person, while another partner will draw his profits in the form of management fees or the provision of marketing services, so that in the case of a “partnership dissolution” there will be no necessity to establish a new activity.
Limited company – since the company has no obligation to pay social security, the taxation on it should be lower, but in practice the question is how we withdraw the profits from the company, and there are 3 main options:
1. Profits can be withdrawn from a limited company in the form of a salary, which is the same as the tax rate of the self-employed.
2. Profit can be withdrawn as a dividend in which the tax after the 26.5% corporate tax and another 30% taxation of the controlling owner, is 48.55% in aggregate.
3. You can also take a loan from the company where the tax is actually the interest which is about 6% annually.
That is, in light of all the data, in the bottom line, in terms of consideration of the tax burden, the conclusion is that it is worthwhile to incorporate as a company only if it is a business activity that generates profits in the amount of approximately NIS 800,000 annually.
In the article framed up to withdrawal of profits of NIS 518,000 per year it is desirable to withdraw a salary from the company, above that it is already worth examining the withdrawal of a dividend.
2. Insurance coverage:
1. The self-employed do indeed pay a high rate of social security contributions, and sometimes the social security contributions will be a heavier burden than the payment to the income tax, so that in practice up to an annual profit of NIS 200,000 the burden of the social insurance is higher than the burden of the income tax.
At the same time, part of the payment to the National Insurance provides a tax benefit in that 52% of the payment constitutes a recognized expense for everything, so that in the high profit levels this benefit can amount to a saving of NIS 13,808 in income tax.
Also, the self-employed person’s income base is the basis for calculating National Insurance pensions, injury benefits in the event of a work accident or maternity benefits in the event of a birth.
These pensions can reach tens of thousands of shekels, so there is value for the fee, at the same time, there are much cheaper policies on the market, which can provide more extensive insurance coverage.
2. A controlling owner of a company will usually draw a salary according to his personal needs, which amount to covering the household economy and an additional amount for savings and personal insurance, the disadvantage is that when claiming a benefit from National Insurance, the controlling owner will be required to provide increased proof of the existence of an employer-employee relationship between him and the company on the one hand, and on the other hand Both the insurance coverage will be according to the salary you drew.
Is this an advantage or a disadvantage – each case on its own merits, those who withdraw large sums as salary, make regular bank transfers to their personal account will benefit from broad insurance coverage, and vice versa.
3. Cash flow / free money:
1. A self-employed person is required to pay almost immediately the full tax required of him on the full profits he presents to both the Income Tax and the National Insurance, a fact that makes it difficult to manage cash flow and allocate funds for business development, purchasing inventory, paying salaries and current obligations.
It is important to note that a self-employed person who pays low social insurance premiums will receive insurance coverage exactly according to the amounts he paid, therefore in order to benefit from insurance coverage that corresponds to the amount of income, the social insurance premiums must be paid in accordance with the existing profit in the business.
For more information on the matter, see the National Insurance regulation “Blocking benefit”.
2. In light of the fact that a company pays a “corporate tax” on its profits at a rate of 26.5% starting from the first shekel to the last shekel, where the term “profits” is after the payment of salary and social benefits to the controlling owner, compared to the total tax burden on the self-employed at a profit level of 250,000 is at a similar rate and with higher amounts can reach over 40% tax per month.
That is, there is a significant deferment of tax payment by the company compared to the independent,
It is a known fact that between 70% and 90% of businesses fail due to cash flow difficulties.
4. Business image
As is known in the business world, impression and image are an important element in recruiting and attracting customers; A business activity incorporated as a limited company creates a more positive and serious impression compared to incorporation as an independent company, and this in light of many reasons: public perception that a company is safer and more established than an independent company, the existence of a careful audit of the company’s books of accounts, the existence of a board of directors and external / internal auditors in public companies, and more .
5. Raising capital and protecting the capital invested in the business
A business that would like to raise funds from investors in order to expand its activities or alternatively to reduce the risks of its owners, can do so by selling shares in the company in exchange for an infusion of funds from stakeholders in the company, when the move is legal, simple and transparent to the tax authorities.
In such a course, the investor receives the right to receive profits from a business activity that is supervised and financially controlled at a high level by professionals.
Also, an owner’s loan to the company carries interest and linkage differences which on the one hand constitute tax-free income for the shareholder and on the other hand are considered a recognized expense for the company itself, so that the investor benefits from both worlds.
On the other hand, this move is almost impossible in the incorporation of a self-employed person, and this is in light of the fact that raising capital with the self-employed person means accepting responsibility for all aspects of the partnership, and an increased reporting obligation to the tax authorities.
(opening a case and regular reporting to VAT and the obligation to pay social insurance on the profits).
6. Limitation of criminal and financial liability
One of the prominent advantages of incorporating as a limited liability company is that the liability of the shareholders is limited up to the amount of the share capital allocated to them, but it is important to emphasize that this amount is not final and absolute in the face of the parties that require a personal guarantee such as banks and others that require a personal guarantee. (Eval guarantee).
At the same time, unlike most entities, the tax authorities are treated as a separate legal entity, therefore in the case of debts to the authorities it is not possible to “go down” to the shareholders’ assets, except in cases where a clear criminal intent is proven.
The limited liability is also reflected in cases in other areas of the company’s business conduct, such as: contract violations, exposure to civil lawsuits and reporting obligations in most cases.
Of course there are exceptions such as: aspects of professional responsibility and offenses where it can be proven that the company took an unreasonable risk in its activity or that it broke the law on purpose.
7. Unlimited lifespan
The lifespan of an individual or partnership business is limited to the lifetime and health status of the business owner, while a limited liability company can exist regardless of the age of its shareholders, and as long as it has not been dissolved and liquidated before the Registrar of Companies, there is the possibility that it will continue to operate.
Why and who is it good for?
During its life, a business creates a reputation, customers, relationships of trust with the tax authorities, banks, suppliers, staff and more.
Upon the death of a business owner or one of the partners in the partnership, all these assets can go down the drain.
In a limited company, the death of one of the shareholders does not affect the business activity to a similar extent, and this is in accordance with the principle of “separate legal personality” which turns the company into a body that accrues rights and obligations separately from the shareholders and its managers.
It is important to remember that a limited liability company that has accumulated losses over the years will be able to offset them against future profits that it will have, while in the independent business, upon the death of the business owner or the dissolution of the partnership, the files with the tax authorities are closed, a fact that zeroes out the remaining losses in the business activity and of course makes any agreement that was in the past In front of the income tax, not relevant. (Appraisal agreements after review or discussion).
8. Costs for professionalism and miscellaneous
One of the notable disadvantages of incorporating in a company is the professional and legal costs involved in managing, setting up and liquidating a limited company, which are usually higher than managing an independent business of similar scope.
A limited company is obliged to manage a double bookkeeping system, an audit by a CPA of the accounting books in the annual report, dealing with the Registrar of Companies through a lawyer, paying an annual fee to the Registrar of Companies, etc.
9. Sale \ split \ merger
Taxation of the profit in the sale of a business activity in a company is higher than in the sale of a self-employed business, a fact which can be expressed in tens or even hundreds of thousands of NIS.
A limited liability company can split its activities into smaller companies, in the form of subsidiaries under its control, thereby reducing financial and legal risks on the one hand, and on the other hand, receiving tax-free profits from these companies.
The company has a huge advantage over the freelancer in that it can purchase a business at a loss, thereby offsetting its existing profits, of course, provided it is a non-artificial transaction, while the freelancer does not have this option.
10. Law enforcement requirements
There are situations in which the law requires us to incorporate as a limited company as a basic condition for obtaining a license or various tax benefits, for example: the Capital Investments Encouragement Law which provides tax breaks requires the business to incorporate as a limited company, or alternatively in order to
To register on the stock exchange there is an obligation to incorporate as a company and more.
In these situations, this consideration is decisive in all opinions.
In conclusion:
As we have seen, choosing the form of a business association is not a simple matter and the answer is not unequivocal, but varies from business to business, at the same time an informed choice can save thousands of shekels and give us significant advantages over our competitors, so in any case it is advisable to use a professional in this weighty decision.