3 Upsides When Freelancers Start Their Own Company Right Now
When you are first starting as a freelancer, incorporation of your company seems far away.
As a Hong Kong company service provider, we can assure you that being the boss of your company can bring you many advantages rather than doing your business under your name, i.e. as a sole proprietor and the partnership.
Here are three significant benefits for freelancers to set up their first companies. The information below is also applicable to startups as a team of like-minded talents.
1. You can protect yourself from personally unlimited responsibility.
Think about the tasks you are carrying out for your new business. If any chance that your actions could go wrong and result in accidental damage to the other? Unfortunately, you (and your partners, if you have) take the underlying responsibility, you are liable to all the consequence, you are exposing your assets to the indefinite risk of losing not only all your money but also the debt.
To limit the possible liability of your business from you, you should incorporate a Hong Kong private company limited by shares, or just Hong Kong company in short.
On the registration of your company, you become its shareholder, as such that you will only be liable to the money you invested in it. The amount company’s share capital you own defines the amount of your investment.
After the incorporation, your company can take part in contracts with other parties under the name of your company so that your company will be the “person” to be held responsible. In case of dispute, someone files a lawsuit against your company but not against you. Therefore, incorporation can equip you the most straightforward tool to protect your assets from unlimited liability.
However, the director and shareholder of a company are held personally liable for any consequence if the company commits an illegal act. Apart from the above situation, incorporation is the first-step and the norm of doing businesses of any size.
2. You can structure the ownership, the controlling power and the assets of your business among other members (such as founders).
If you are building a startup as a team of talents, you should incorporate at the earliest moment. It’s because a company can allow you and other members to legally define how the business collaborate with internal members as well as external parties, like the investors for fundraising and specialists as your to-be project managers. In other words, you can better manage the expectation of the people around you if you develop and run your business under a company.
Here comes a legal document named the Articles of Association (AA), this is serving as the constitution of your company, and all your company member agree to follow.
Technologically speaking, this document is the rules to bound the rights and obligations of the shareholders and the directors; it also defines the purposes of your company and describe the organisation of it. Most importantly, your company can legislate your set of AA to fit your company (it is a formal document, it can be complicated especially for big business; however, I can ensure you that you should follow the official samples which are suitable to every small business, so you need not spend hours on it.)
A powerful tool from the AA is the issuance and subscription of share capital. In an ordinary situation, each unit of share translate to an equal weight of voting and ownership, it allows you to distribute the controlling power along with the ownership naturally among shareholders.
Besides, the AA allows your company to define the special-purpose share. For example, a common type of unordinary share is Non-voting Share; it allows the holders to retain the ownership and benefits like dividends but not the controlling power. Moreover, you can bound customised rights and obligations to a type of share in the AA.
That being said, you are recommended to stick with the straightforward Ordinary Share. It gives the sense of transparency and confidence to the other founders but also the to-be partners.
Apart from the AA, your company allows you to engage in formal agreements with your teammates. It is crucial to have these legal documents in place; it ensures that the work done of your teammates belong to the company rather than the person who works on this piece of work.
Setting up a formal Employment Contract with your employees can ensure any of their work under the contract are belonging to your company.
3. You can enjoy extra tax benefits by reporting your business income and expenses under your company.
Hong Kong government has adopted a further tax relief scheme for every company to retain its tag of “low-tax international business centre”.
For your reference, the first HK$2M taxable income of a Hong Kong company (i.e. Profits Tax is applied) is taxed at 8.25% annually (16.5% for the remaining amount). What is more, the Hong Kong government has a track record of giving away generous tax reductions (a fixed rate discount on the final tax payment) to the corporate and individual taxpayer (i.e. taxpayer of Profits Tax and Salaries Tax, respectively). Nevertheless, Hong Kong does not charge Capital Gain Tax and VAT.
To enjoy such corporate taxation benefits, you don’t have to give up your individual tax benefits. Actually, you can enjoy both of them by the setup of your Hong Kong company and file the taxes of your business under the corporate taxation scheme.
As a reminder, the extra benefits are not eligible to the unincorporated business bodies, so that sole proprietorship and partnership business are ruled out, unfortunately.
How does the tax-saving scheme work?
It can apply to corporate of any size, even the sole-member company (which means you become the sole director and shareholder of your company). The ratio of saving
After incorporation of your company, you, as the only director, are effectively an employee of your company thus, you are on the payroll; you are also the shareholder, so you are entitled to receive dividends from your company.
Assume that you make profits from your business which is the business of your company. Now, you need to cash out of your company.
Firstly, you should adjust your director’s salaries (yes, you have the power to decide how much your company pays you.) to enjoy all the tax benefits under the personal tax regime: Personally, your first HK$132,000 chargeable income is absolutely tax-exempted (tax-free income), and the remaining amount is subject to progressive tax rate starting from 2%, reaching to 17% at over HK$200,000 of effective chargeable income; Then, from the perspective of your company, the expense of salaries is treated as tax-deductible, this expense is booked against your chargeable profits.
Secondly, your company pays you the dividends (you can control how much your company pays the shareholders.). Since the Hong Kong government allows the dividends to be paid to the shareholders after the corporate tax is charged and does not adopts Capital Gain Tax, you can take out the first HK2M profits as dividend payment which is taxed at merely 8.25%.
You can even maximize the tax saving when you take the tax reduction into account. In the tax year 2018/19, the Hong Kong government gives a one-off fixed 75% tax reduction to both individual and corporate taxpayers separately, with a ceiling cap of HK$20,000 per case. In particular, the ceiling of reduction is applied to each company and each individual separately.
Combining all the approaches stated above, you can legally save tax burden by shifting director salaries and shareholder dividends on the accounting books, the ratio of distribution should be updated year-to-year to cope with the latest Hong Kong tax benefits accordingly.
Are you thinking about whether to incorporate your business? If you are serious about your business, incorporating earlier will get rid of unnecessary headache down the road.
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