This article examines the disadvantages of doing business as a sole trader compared to doing business through a trading company. In the article, you can also find a brief description of the stages through which the procedure of transferring the commercial activity from a sole trader to a trading company passes.
When starting a new business, every entrepreneur faces the choice in which form to exercise his commercial activity. Bulgarian legislation provides a choice for the natural person to register as a sole trader or to establish a trading company.
Historically, entrepreneurs have preferred to register as sole traders as such registration did not require an upfront investment of funds for the capital of the trading company or for registration fees. Registration as a natural person – sole trader is a quick and easy procedure with minimal costs for government or other types of fees. For comparison, before the year 2005 the minimum capital when establishing a limited liability company was BGN 5,000, while the registration of a sole trader did not provide for the contribution of a sum of money in the form of capital.
At present, the legal framework has changed significantly. The establishment of a limited liability company takes about 5 working days, which includes all actions such as notarization of the relevant documents, opening of a bank account, as well as the initial registration of the company in the Commercial Register. The minimum amount of capital when establishing a limited liability company is BGN 2. In this sense, the initial investment when starting a business through a limited liability company is reduced to a minimum amount.
That is why after the changes in the legislation in the year 2005 the limited liability company is a form preferred by entrepreneurs for developing commercial activity. On the other hand, exercising activity in the form of a sole trader has many disadvantages and carries risks for the individuals.
Below in this article, some of the disadvantages and risks of doing business as a Sole Trader are set out:
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The natural person – a sole trader bears unlimited liability for his obligations.
The natural person – a sole trader is liable for obligations arising from his commercial activity, both with the property that is part of his commercial enterprise and with his personal property. In comparison, when the commercial activity is carried out through a trading company, the individual is liable for the company’s obligations up to the amount of its capital.
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The natural person – sole trader is subject to higher taxes.
The individual taxes the income from his activity as a sole trader with 15% annual tax. In comparison, the profit realized by a trading company (e.g. limited liability company) is taxed with 10% corporate tax. In this sense, sole traders pay a significantly higher annual profit tax compared to trading companies.
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Regarding social security
The natural person – a sole trader owes and pays mandatory insurance contributions on all income from his activity (until reaching the maximum insurance income provided for by law). On the other hand, a partner in a limited liability company can choose on what basis to be insured, namely whether not to be insured at all (if he does not participate in the activities of the company), to be insured under the Civil Code (if he is registered as a manager of the company ) or to be insured as a self-insured person (if he is not registered as a manager, but performs work in the company). Depending on the basis for insurance, the partner in the OOD also chooses the amount of insurance income on which to make his insurance contributions.
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Regarding VAT de/registration
The conditions for initial VAT registration of sole traders and commercial companies do not differ. However, the situation is different with the grounds for VAT deregistration.
According to VAT law, the registration of a sole trader is terminated upon the death of the individual. The death of the individual – sole trader is one of the grounds for mandatory deregistration, which entails important consequences. According to the law, on the date of deregistration, the person is considered to be making a supply within the meaning of VAT for all available goods and services for which a tax credit has been used in whole or in part. This means that on the date of deregistration, for the heirs of the deregistered person, an obligation to pay VAT arises, even though the available goods and services have not actually been realized in the commercial turnover.
The law provides for two exceptions to the rule for charging VAT on available goods and services, depending on whether the tax base of the available goods and services is higher or lower than BGN 25,000.
If the total value of the tax bases of the available goods and services is equal to or less than BGN 25,000, then, according to the law, no delivery has been made and accordingly the obligation to charge and pay VAT on them ceases.
On the other hand, if the total value of the tax bases of the available goods and services exceeds BGN 25,000, the law requires that VAT be charged on the total value of all available goods and services. This rule does not apply when one of the heirs of the deceased natural person – sole trader takes over his enterprise, but only on the condition that this person is already registered for VAT or is registered for VAT by the 14th of the month, following the expiration of six months from the death of the natural person – sole trader.
On the other hand, in the case of trading companies, the death of the capital owner is not a reason for VAT deregistration of the legal entity. This results from the fact that the trading company is a separate legal entity distinct from its sole proprietor.
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Regarding the business initiative
A natural person can register as a sole trader only once. This forces the entrepreneur to carry out all his commercial activity under one common entity. The person does not have the possibility to separate his commercial activity, he does not have the possibility to separate his assets from his operational activity, and thus, when starting a new venture, he bears the risk with all his property.
On the other hand, a person can establish an unlimited number of companies through which to develop different commercial activities. This way, incompatible activities can be separated, limiting the risk of starting a new business.
Transforming the business from a sole trader to a trading company eliminates the risks mentioned aboveThehe costs of doing business are significantly reduced, and at the same time, entrepreneurs can separate their assets in a way that protects them from operational risks.
The procedure for transferring the activity from a sole trader to a trading company is complicated and complex. The complexity of the procedure is determined depending on the financial condition of the sole trader and the assets he owns – real estate, motor vehicles, machinery and other movable property. In order for the procedure to go smoothly and without negative tax effects for the individual, the procedure requires complex and in-depth knowledge of law, finance, taxes and accounting.
The procedure itself for transferring the activity of the sole trader goes through several stages:
- Submission of Notification under Art. 77 of the Code of Criminal Procedure;
- Transfer of the commercial enterprise of the Sole Trader;
- Entry of the transfer of the commercial enterprise in the Property Register (in case the sole trader’s commercial enterprise owns real estate).
Each of the stages listed above proceeds according to a certain regulatory order and requires a thorough knowledge of the legislative framework and the special requirements of the competent state institutions.
Insofar as the commercial company represents a simpler form of doing business in Bulgaria, the Mikinski & Associates Law Firm recommends it to its clients in its legal practice, taking into account all the factors set forth above in this article.
