Deciding whether to establish a Sole Proprietorship (SP) or a Limited Liability Company (LLC) is a crucial step for any entrepreneur. In an SP, you bear full financial responsibility for your business's debts and obligations, while an LLC offers the benefit of limited liability, protecting your personal assets beyond your investment in the company.
Our latest blog post breaks down the process of establishing each type of entity, from the initial documentation and registration to compliance requirements. Learn about the tax implications, risk management, and the steps needed to transform an SP into an LLC as your business grows. Whether you're starting a new venture or reassessing your current business structure, understanding these key differences will help you make an informed decision.
Should you choose a Sole Proprietorship or a Limited Liability Company?
In a sole proprietorship (SP), a physical person is responsible for a business activity. This individual, commonly referred to as a proprietor, bears the financial liability for the business's debts and obligations.
However, in a limited liability company (LLC), the owner benefits from what is known as limited liability. The owner, known as a shareholder, is not personally liable for the company's obligations. Essentially, the shareholder risks only the investment made in the company's shares. However, this premise is modified by the concept of director's liability.
Also read: How to establish a Norwegian branch of a foreign company?
How to establish an Limited Liability Company?
To establish an LLC, it is required to have an incorporation document, articles of association and a share capital of minimum NOK 30 000. The share capital contribution must be deposited and confirmed by a financial institution, auditor, attorney, or an accountant.
Furthermore, the company must register with a board of directors, and receive an organisation number.
There is a registration fee to the Central Coordinating Register for Local Entities for registering an LLC.
Also read: Establishing a private limited liability company in Norway
How to establish a Sole Proprietorship?
While there is a requirement for a share capital, a board of directors and incorporation document and more in a LLC, this is not the case for a SP. There is however a registration fee to the Central Coordinating Register for Local Entities for registering a SP.
The registration of a SP is rather straight forward and will require that a standard form is used, signed, and submitted to the Central Coordinating Register for Local Entities.
The name of the SP must include your surname as part of the business name.
When should you choose an LLC and when should you choose an SP?
Often, an income-generating activity starts as a hobby or as a standalone consultancy project and not as an LLC.
When the activity extends over a certain duration, has a certain scope, is likely to generate profits, and is conducted at one's own expense and risk, it is, however, considered a business — and then the question of the appropriate business form should be on the agenda.
Also read: Starting a business in Norway - 3 grey areas
Three key considerations to make
When reflecting on the appropriate business form, either before establishing an income-generating activity or after starting a business, there are several important points to consider, including:
- Risk management: Is my business exposed to any risk?
- Taxation: Is my business structured optimally from a tax perspective?
- Compliance matters: Are all regulatory requirements being met by my business?
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1. Risk management
In a sole proprietorship, the owner bears personal responsibility for the company. The owner has full control and operates at their own expense and risk, which also entails complete financial liability for debts and obligations.
In a limited liability company (LLC), your obligations as a shareholder are initially limited to the share capital in the company. This means that the owner exposes themselves to less personal risk than in a sole proprietorship. However, the directors have personal liability in an LLC, and board members can be held personally accountable.
2. Taxation
Taxation is a key factor to consider when assessing whether to establish an SP or an LLC.
In an SP, as the owner, you are not classified as an employee and do not receive a salary. Instead, you have access to the profits and can make private withdrawals as desired. Your taxable income will be the profit generated by the enterprise. The marginal tax rate for a single-person enterprise is 50.6 percent for the year 2024.
On the other hand, taxation in an LLC occurs in two stages. Firstly, the company pays a corporate tax of 22 percent. Subsequently, the shareholder is subject to a 37.84 percent tax on dividends received. Consequently, the total marginal tax rate in an LLC amounts to 51.5 percent.
If you intend to be employed by an LLC, rather than solely receiving dividends from the company, employer's contributions become mandatory. However, this obligation does not apply to an SP unless you hire additional personnel beyond yourself, in which case employer's contributions would apply to the employee's salary.
Moreover, one shall be aware that the choice between an LLC and an SP also impacts your entitlement to social benefits such as sick pay, leave, and pension rights.
2.2 Tax flexibility with an LLC (exemption method):
If the LLC generates more profits than the shareholder requires for personal consumption, the advantages of the LLC become evident. The surplus, taxed at 22 percent, can be reinvested back into the LLC. Subsequently, the shareholder has the discretion to decide if and when to withdraw funds from the company in the form of dividends, subject to the subsequent taxation rate of 37.8%. If you have your LLC in a holding structure, you have a significant degree of flexibility with regards to timing the dividend tax.
2.2.1. Norwegian Shares
The exemption method entails that a limited liability company (LLC) whose purpose is to invest in shares can buy and sell Norwegian shares without having to consider taxation. Profits from the sale of shares can be reinvested without any tax implications. The tax bill, namely 37.84 percent of dividends, only arises when the private shareholder wishes to withdraw funds for personal consumption.
2.2.2. Foreign Shares
An LLC investing in foreign shares must be more mindful when it comes to taxation. The exemption method will apply to shares in companies domiciled within the EEA. However, for the exemption method to apply to shares in companies domiciled in "normal tax jurisdictions" outside the EEA, the Norwegian company must have owned more than 10 percent of the foreign shares for over 2 years.
3. Compliance obligations
There are various compliance rules for LLCs and SPs. LLCs have more and stricter obligations than SPs. Many of the regulations are listed in the Limited Liability Companies Act.
Firstly, the LLC needs to have a board of directors of at least a single member. A board of directors can only consist of physical persons. In addition, at least 50% must be resident in the EEA/EU, UK or Switzerland. If the company has operating or financial income of more than NOK 50 million, the board cannot be represented by approximately more than 60% of one gender. Please note that this slightly varies depending on the number of board members.
In addition to the board being regulated, an LLC must meet the bookkeeping requirements. The company must produce annual financial statements including income statement, balance sheet and statement of cash flow. The statements must be made according to Norwegian requirements, which closely align to GAAP. LLCs with an annual income above NOK 7 million or balance of more than NOK 27 million must also have the statements independently audited.
Companies that are not defined as “small companies” by the Accounting Act must also prepare an annual report containing a thorough analysis of the operation prepared by the general manager alongside the board of directors. Note that such companies must also prepare an annual report according to the Norwegian Transparency Act.
There are also a few similar requirements for the SP and LLC. First, both must submit tax returns, and both must submit VAT returns if the company sell VAT liable products and has higher gross sales than NOK 50 000 in a 12-month period.
SPs must also keep books of accounts, but whereas all LLCs must prepare annual financial statements, only SPs with assets exceeding a value of NOK 20 million or with a workforce of more than 20 man-years are under a duty to prepare such statements. Note that SPs can also exceed the threshold of “small companies” and be under duty to prepare an annual report.
Transfer a Sole Proprietorship to an Limited Liability Company
We experience that many starts with a SP and later want to transfer this to a LLC, as the activity, risk and turnover expands. Under certain circumstances and rules such convention to an LLC can be done, tax-free.
Our lawyers have great experience with such transfers and are stand by to assess and assist if this applies to your business.
Magnus Legal assist several of our clients with the decision-making process, and in the steps that follows with regards to the incorporation, compliance, and potential transfers.
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