Liability with your personal assets, double taxation and Article 299 CCC all have to be taken into account before you change the legal form, not after the first dispute
A limited liability company is not automatically the “better” way to run a business. Nor is a sole proprietorship always too simple or too risky.
This is not a choice between prestige and the lack of it. It is a risk calculation: liability with your personal assets on one side, and costs, taxes, formalities and management board liability on the other.
So before converting, one question has to be answered: what is the company actually meant to protect you from?
Step 1. See what risk stays with a sole proprietorship
A sole proprietorship is simple to run, but it has one fundamental consequence: the business owner is liable for the firm’s obligations with all of their assets. There is no separate company estate here to divide the business from the person running it.
In practice this means that trouble with a business partner, a sizeable contractual penalty, a lost case, a tax arrear or damage caused while performing a contract can become the owner’s personal problem.
With a small, low-risk business that may be acceptable. With larger contracts, employees, subcontractors, leases, loans and contractual penalties, the arithmetic starts to look different.
Step 2. Check what a limited liability company actually gives you
A limited liability company has its own assets and is itself liable for its obligations. The shareholders are not liable for the company’s obligations, and the minimum share capital is PLN 5,000.
That is the main reason business owners consider a company - separating business risk from private assets.
But that separation does not work in every situation. If you are only a shareholder, your risk is as a rule limited to what you contributed to the company. If you are also a management board member, liability under Article 299 CCC is added on top.
Step 3. Do not overlook Article 299 CCC
Article 299 of the Commercial Companies Code is the most important caveat with a limited liability company. If enforcement against the company proves ineffective, the board members are jointly and severally liable for its obligations.
A board member can mount a defence, but it is for them to prove one of the statutory grounds. In practice this most often turns on whether a bankruptcy petition was filed in due time, or whether appropriate restructuring proceedings were opened during that period.
So a limited liability company is not a way of running a risky business without responsibility. It is a way of putting responsibility in order, provided the board keeps an eye on liquidity, documents, accounts and the moment when action has to be taken.
Step 4. Work out the taxes and the fixed costs
With a sole proprietorship, taxes and social security contributions are settled directly by the owner. With a limited liability company a separate CIT taxpayer appears.
Under classic CIT the basic rate is 19%. A 9% rate may apply, among others, to small taxpayers or to taxpayers starting out in business, if they meet the statutory conditions and do not exceed the revenue limit of EUR 2 million.
If the profit is to be paid out to a shareholder as a dividend, the 19% dividend tax on income from dividends and other income from participation in the profits of legal persons has to be taken into account as well.
It is this mechanism that is usually described as double taxation. First tax at the company level, then tax when the profit is paid out to the shareholder. The arithmetic does not always end with simply adding the rates, though. A company may offer other ways of paying people, different contributions, different costs, and possibly Estonian CIT, which has its own conditions and separate taxation rules.
So the decision to set up a company should not rest on the slogan “lower taxes” or “no social security”. In a single-shareholder limited liability company the shareholder may also have obligations towards the Social Insurance Institution. ZUS states that the obligation to register for insurance covers, among others, the shareholders of single-shareholder limited liability companies, because they are treated as people running a sole proprietorship.
Step 5. Establish whether conversion actually makes sense
Converting a sole proprietorship into a limited liability company can make sense once the business risk starts to outweigh the cost of maintaining a company.
It is most often worth considering if you sign high-value contracts, take on responsibility for other people’s work, use subcontractors, employ staff, hold business assets, operate in an industry with contractual penalties, or want in future to bring in a partner or an investor, or to sell the business.
A limited liability company can also put succession and business continuity in order. A sole proprietorship is tightly bound to the person of the owner. A company is a separate entity, with shares, a management board and a structure of its own.
That does not mean, however, that conversion wipes out the history. On the conversion of a business owner into a capital company, the converted company acquires the rights and obligations of the business owner being converted, and the individual is jointly and severally liable with the company for obligations arising before the date of conversion for a period of three years from that date. If the business already has arrears, disputes or a risk of insolvency, conversion should not be treated as a way of escaping liability.
Step 6. When a company may not pay off
A limited liability company may make no sense if you run a simple service business, have no significant liabilities, employ nobody, sign no contracts with high penalties, and want to draw the profit into your private budget as you go anyway.
In that case the cost of fuller accounting support, corporate formalities, resolutions, financial statements, the National Court Register and tax settlements may exceed the benefit of reduced risk.
A company should not be a decision taken “just in case” when it is unclear what risk it is meant to limit. First name the risks, and only then choose the legal form for the business.
What is worth checking before you decide
Before setting up or converting into a company, it is worth preparing a list of the largest contracts, contractual penalties, liabilities, leases, loans, disputes, employees and subcontractors. Financial data will also be needed: revenue, income, how money is drawn out of the business, and the plan for the next 12-24 months.
A few simple questions also have to be answered: is the profit to stay in the business or be paid out as you go, are you planning a partner or an investor, do you hold private assets you want to separate from business risk, do your contracts provide for high penalties or liability for other people’s acts.
Only then can you judge whether a limited liability company is genuine protection, or merely a more expensive way of running the same business.
In short
- A sole proprietorship is simpler, but it means liability with your personal assets.
- A limited liability company separates the company’s assets from the shareholder’s, but it does not release the board from responsibility for the moment when the company stops meeting its obligations.
- Double taxation, social security, accounting and formalities have to be counted together with the risk from contracts, contractual penalties, employees and subcontractors.
- Conversion genuinely pays off when the reduction in risk is worth the cost of the company. Not when the company is merely meant to look better on an invoice.
This article is for information only and does not constitute legal advice. Assessing a specific case requires reviewing the documents.