Launching A Business: Self-Employed Versus Incorporated

This paper will aim to briefly summarize the different pros and cons, without leaving out too much detail necessary to make an informed decision (Photo © Shutterstock)

Should I carry out the work under the “self-employed” status or should I incorporate my own company?

One of the questions an entrepreneur is poised to be confronted to sooner or later is: should I remain self-employed, or should I create a company [1]?

The advantages of remaining self-employed (indépendant) seem obvious: no fees for the incorporation of the company and other purely corporate-form related fees and obligations. Furthermore, there is quite some opacity regarding the fees, and unless the entrepreneur has legal contacts, this point will remain unclear.

Yet, the main downside of the self-employed status is the liability. This is, at the same time, the principal advantage of a company – depending on the corporate form, it’s a liability shield. Carrying the business out under the corporate veil also presents other advantages, be it from a capital raising perspective, exit or on-going day-to-day business. Each status has its own compliance obligations.

Last but not least, taxation also has to be considered: a company is, at the end of the day, usually taxed at a lower rate than an individual entrepreneur; yet this means that the profits remain in the company and are not freely at the disposal of the shareholder – the entrepreneur. A limited liability company is subject to net wealth tax [2]. Social security charges may also be due in both cases, but the burden of which is allocated differently.

This paper will aim to briefly summarize the different pros and cons, without leaving out too much detail necessary to make an informed decision. As such, the main different topics to consider will be discussed from both perspectives. This contribution will also try to explain as much as possible in plain English, refraining from legalese which may not be helpful enough. Unfortunately for the reader, this paper will not present a clear conclusion in favour of the one or the other option; such decision remains very dependent on the fact-pattern, the business plan and other factors which are too numerous to be exhaustively be listed. The reader will find a high-level recap-table at the end.

1. LIABILITY

The liability factor is the most important factor to consider. This topic will only become an issue if the person (be it a self-employed individual or a company) has caused harm, or made a (contractual or civil) fault opening itself up to liability. Such liability may not only arise upon the production and sale of a faulty product (e.g.: the bike brakes you produced and sold don’t actually brake, causing an accident and injuring the rider), but may also arise upon the provision of services (e.g.: you provide bike repair services; yet you did not repair a bike really well, causing an accident and injuring the rider).

If such liability against the person is not covered by an insurance, the person itself needs to pay and the creditor (in the example above: the injured bike rider) has different options to recover such money: seizure of bank accounts, assets etc.

In the case of a limited liability company (a SARL [3], SARL-S [4], SA [5], or SCA [6]), the creditor is “limited” to the assets the company owns; and may even only be a second-ranked creditor depending on other privileges a bank (or the tax administration) may have. In case of a newly created SARL for instance, having a share capital of only EUR 12,000 and no other reserves or profits, the creditor would be limited to these EUR 12,000. Indeed, shareholders only have, principally, the amount of their equity (i.e.: the shares) at stake. However, for completeness’s sake, there are a few exceptions, for instance (i) legal exception: in case of gross misconduct of the manager(s), or (ii) contractual exceptions: banks usually ask the entrepreneur, which normally is the (sole) shareholder of the company, to provide a guarantee.

In the case of the self-employed entrepreneur being liable, the creditor can seize (up to the amount at stake) any assets belonging to the entrepreneur, even if these assets are not used for business purposes: the private car, laptop, camera, TV, flat/house etc.

Here is an example with actual figures illustrating the above:

Liability amount not covered by an insurance Limited liability company Conclusion Self-employed status Conclusion
EUR 10,000 Total balance sheet assets: EUR 15,000 Company will still have EUR 5,000 “left” Total assets:

EUR 35,000

Individual will still have EUR 25,000 “left”
EUR 50,000 Total balance sheet assets: EUR 15,000 Company will be bankrupt. Remaining amount (EUR 35,000) may not be recoverable and “lost” for the creditor. Total assets:

EUR 35,000

Individual will have no more assets, and still have EUR 15,000 in debt which needs to be paid off.

Having a company means having a legal entity which has its own share capital. Share capital is a form of equity – equity allows for fund-raising, as profit-split mechanism are usually foreseen via the implementation of different share classes, giving right to a preferential dividend return. While this could, with appropriate contracts, also be implemented for a self-employed entrepreneur, this is very rarely the case. This, together with some tax (mentioned below) and regulatory reasons, explains why capital raising is usually only done for incorporated entities.

Venture capitalists may also want to have their say regarding corporate governance; in which case a corporate entity is also the solution as they may want a seat at the board (director or manager, depending on the legal form) table.

Furthermore, the process of a creation of a company involves fees: potential lawyer fees advising on the articles of association, notarial fees (if applicable, which is the case for SARLs and SAs, for instance) etc.

2. TAXATION

The self-employed entrepreneur is taxed on his income at progressive rates, starting at 0% and increasing up to 42% (plus solidarity surcharge). A (fully taxable, tax opaque) corporate entity will be subject to tax at a combined income tax rate of 24.94% if the registered seat is, for instance, in Luxembourg-City. This rate can fluctuate a bit, as this rate also includes a so-called “municipal business tax”; this rate depends on each municipality.

Private individuals are not subject to net wealth tax. A corporate entity, depending on its legal form and balance sheet, is generally subject to net wealth tax.

In any case, it will be necessary to register for VAT purposes, even if there are return exemptions if the turnover does not exceed EUR 35,000. However, even if the turnover respects this threshold, it is possible to opt out of this simplified regime. Indeed, under this exception, any input VAT cannot be recovered (i.e. the VAT the entrepreneur (regardless the status) has paid on, for instance, a computer or received services). Depending on the expenses, one may prefer to recover this input VAT.

3. EMPLOYMENT

While both options allow for the employment of others, depending on the fact and circumstances, it may be possible for the entrepreneur to also be an employee of his company. If this option is available, it may be interesting to opt for. Indeed, unemployment benefits, as well as retirement income, is more favourable for employees than for self-employed people [7].

This is generally not possible if the sole shareholder is also the only employee and manager of the company.

4. COMPLIANCE

In both cases, there are rules regarding accounting and tax returns which apply. The rules for a corporate entity may seem a bit more cumbersome (the rules applicable to a self-employed entrepreneur generally do not require as many accounting documents).

However, in both cases this task is usually outsourced to a third-party service provider in order for the entrepreneur to be able to focus on his/her business. This outsourcing is also generally recommended by the various start-up associations or help-desks.

5. MISCALLANEOUS

Depending on the specific activity, the incorporation of a company can be necessary. Indeed, some activities, especially in finance (payment services etc.) require a legal entity. Please note that some payment service institutions may also need to provide a business plan.

Furthermore, it seems that most grants (Luxembourgish and/or EU) require a legal entity as recipient as well.

The above developments can be broadly summarized in the following table [8]:

Self-employed Company
REGISTRATION & CORPORATE
Incorporation fees 0 Lawyer: depends on the complexity

Notary: EUR 1,200 – 1,500

Incorporation duration n/a Approx. 10 days for the notary & lawyer; the bank account opening process may take longer
Minimum share capital n/a Yes; between EUR 12,500 and EUR 30,000 for capital companies (which provide for a liability shield).
Business licence needed Yes Yes
Business plan Recommended Recommended
Chamber of commerce EUR 14 starting at EUR 140 if capital company
Liability [9] Unlimited Limited
Capital raising Technically possible, rarely implemented Yes
Profit split mechanisms Via agreements Articles of association and/or separate shareholder agreements
TAXATION
VAT: Registration Yes Yes
VAT: return exemption Yes, if the turnover does not exceed EUR 35,000 Yes, if the turnover does not exceed EUR 35,000
 

Income tax

Progressive rates, starting at 0% and up to 42% Combined corporate income tax of 24.94% in Lux-City. Dividend income by shareholders needs to be analysed separately.
 

Net wealth tax

No Yes, with a minimum of at least EUR 535
EMPLOYEMENT
Employment of others (employees) Yes Yes
Collaboration with others (freelancers) Yes Yes
 

Status of the management

n/a The manager [10] can still be self-employed. As such, he will be invoicing the company for provided (management) services. Depending on the set-up, the manager could also have the status of an “employee” (full time, or in parallel to the self-employed manager status).
Social security Approx. 24.6% Employer part: approx. 12.2%

Employee part: approx. 12.4%

COMPLIANCE
Accounting obligation Yes, but administrative tolerance accepts a “simpler” accounting Yes, full accounting rules
Tax compliance VAT returns and income tax returns by the self-employed person only VAT returns, income tax returns and additional tax returns at shareholder/founder/employee level
MISCALLANEOUS
IP rights protection Yes Yes
Regulated activities Limited options; some activities need a business licence which is only given to companies Yes
Grants / Subsidies Limited options; Unemployment benefits can Yes (National: LuxInnovation; EU: Horizon Europe, etc.)
EXAMPLES
Graphic designer As a graphic designer, the liability exposure is relatively small. Except for software and some hardware, no major capital requirements are required (in the beginning). The collaboration options are neutral. Consequently, for this type of activity, the self-employment status could be better suited. However, if the business grows, employees are added, office premises are rented, and business partners want to join the adventure, a corporate form may become more interesting.
Bakery As a baker, the liability exposure should be limited; yet, in case of food poisoning for instance, the liability exposure may increase. The carry the business out under the corporate veil could be interesting from the very first step, but is not necessary.
Payment services Payment services are a regulated activity [11]. Save for one exception [12], this business can only be carried out by certain legal entities. Consequently, the self-employed status is generally not suited.
SUMMARY
Main advantages ·     Less documentation

·     less administrative burden (especially in the beginning)

·     Liability shield

·     Capital raising

·     Access to some regulated activities

Main disadvantages ·     Liability ·     Incorporation fees

·     net wealth taxes even if the company only makes losses


[1] For ease of reference and clarity purposes, only limited liability companies are considered for this comparison.
[2] A resident individual (natural person) is not liable to net wealth tax.
[3] Société à responsabilité limitée
[4] Société à responsabilité limitée-simplifiée
[5] Société anonyme
[6] Société en commandite par actions
[7] Please note that there is a current debate to align both regimes; this may consequently change in the future.
[8] Please note that these are approximate fees regularly applied in Luxembourg. Depending on the fact pattern, these costs may be higher or lower. The numbers are given for an informative purpose only. Some Yes/No answers are dependent on other criteria, and should be understood as a general guidance only.
[9] Please refer to item 1. « Liability » above for further precisions on this topic.
[10] Or ‘director’, the title being dependent on the legal form of the company.
[11] Regulated by the law dated 10 November 2009 on payment services, as amended (the 2009 Law).
[12] As per article 48 of the 2009 Law.

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