One of the most confusing aspects for aspiring solopreneurs is understanding the difference between them -as individuals- and their businesses. In this article, I describe the implications of the fact that you are not your company, in terms of obligations, finances and taxes.
This post’s been specifically thought for e-Residents owning an Estonian OÜ company. However, the basic ideas contained here are applicable to most micropreneurs who are the sole owners of their businesses.
You And Your Company Are Separate Entities
For quite some time now, I own a company in Estonia. One of the first things you learn is that you cannot simply get some money out of your company’s bank account to buy some clothes at the nearest store.
Even if you are the sole founder of your business, it’s still a separate entity. Yes, you are the boss, marketer, salesman, administrator and only employee. The company is essentially you. However, legally, it’s a separate entity.
To begin with, your company may be founded in a completely different place from your country of residence. That’s probably the case if you are an e-Resident owning a company in Estonia.
As a result, it’s a separate legal entity, subject to a different legislation, obligations and tax duties.
Getting Money In And Out Of Your Company
As I mentioned, you cannot simply use your company’s debit card to buy yourself a pair of jeans. You need to keep a strict separation between your personal finances and the money of your business.
Apart from the initial share capital, the proper way of getting money in your company is issuing invoices or charging a fee to your customers for your services or products. This money doesn’t belong to you, it belongs to your company.
Hence, you cannot simply transfer money from your company account to your personal one either. Let’s see some proper ways to transfer money out of your company’s bank account.
You can spend money from your company’s bank account as long as it’s a justified expense.
What is a justified expense? Any money you spend in something related to your business, such as:
- web hosting, domain names and other services for your website
- public transport tickets when visiting customers
- your company’s phone bill
- your co-working center fee
- office supplies
- your macbook
What is not a justified expense? Any money you spend for your personal use, such as:
- gifts for your parents
- your car
- leisure travels and holiday trips
Salary And Dividends
Alongside business expenses, the most common way of getting money out of your company is through dividends or assigning yourself a salary.
Dividends are an amount of money that a company pays to its shareholders out of its profits. In the case of a solopreneur, as the only shareholder, you will obviously receive all the dividends.
Your Estonian OÜ company will pay some taxes for distributing dividends. Later, when you do your tax report as an individual in your country of residence -if any- you might have to pay additional taxes as an individual. This greatly varies between countries, as we’ll see later.
Salaries work similarly, with one particularity. As a solopreneur, and the owner of your OÜ company, you wear several hats. On the one hand, you are the one and only board member. You take care of all the administrative stuff or your company. Even if you, like me, use a service provider such as Companio, you are supposed to be doing some administrative work for your company. On the other hand, you perform professional activities, and as such, receive an employee salary.
Generally speaking, the former pays taxes in Estonia, and the latter in your country of residence. Below I explain salaries in depth, with a concrete example.
Out Of Pocket Expenses
Imagine that you need to buy some office supplies while on the road, and left your business card at home. what can you do?
For those situations, the Estonian business system defines the “Out of pocket expenses” concept. Basically, you would pay with your personal card or even cash, and then declare it as a business expense.
Later, you can reimburse that money back to your personal account by simply issuing a bank transfer to your personal account.
Additionally, there’s a very interesting concept called Daily Allowance. When we travel, there are many extra expenses, like lunches, coffee, taxies and public transport to name a few. The daily allowance allows you to get some tax-free money from your business account to pay those justified expenses.
In order to be able to do that, you have to add some documents that justify your trip, like flight invoices or AirBnB reservations. Of course, daily allowance is only available for trips between two countries with a clearly predefined duration.
For example, traveling from Italy to Germany to attend a conference there and back in a week. It doesn’t work for changing your location on a semi-permanent basis.
The daily allowance allows you to expend 50 EUR per day for the first 15 days (max) in a calendar month, following 32 EUR per day for the rest of the month if the trip (or a combination of multiple trips) is that long. Tax-free.
Take into account that the Daily Allowance can only be claimed for a business trip with a very specific purpose! Some blogs depict this basically as if it was a tax-free 1230€ salary. It is not. You cannot travel to Thailand to live there for one year and claim the Daily Allowance every month.
Do I Need To Pay Taxes Twice???
Here’s where you need to clearly understand that you are not your company. Many countries have double-taxation treaties to prevent you from paying taxes for the same earnings twice. If both you and your company are based in Europe, most probably you are subject to a double-taxation treaty.
Let’s see how this applies to the case of your Estonian company for salary and dividends (the other ways discussed above are tax-free):
If your company is in Estonia, and you are resident of another country, the following rule applies:
Every time you want to assign yourself a salary, you split it in “board member salary” and “employee salary”. The usual distribution is 30/70 or even 20/80. It’s -to a certain extent- up to you. Let’s suppose you set a 20/80 distribution and assign yourself 1000 euros in total salary.
Your board member salary is, hence, 200 euros. Your company in Estonia pay taxes for this salary. Concretely, your company would pay 50€ (income tax) + 82,5€ (social tax), for a total of 132,50€. Your company will pay that amount the next month.
Your employee salary is 800 euros. Your company doesn’t pay taxes for this salary. However, if you are a tax resident in any given country -which is probably the case, unless you are subject to the 183 days rule– you will have to pay taxes in the yearly tax report of your country of residence.
As a result, there’s a clear separation between the two parts of your salary. One pays taxes in Estonia, and the other in your country of residence (if any). No double taxation here.
If you want to read more about this, I talk in depth about salaries for e-Residents owning a company in Estonia, and how they pay taxes, in this article.
Unfortunately, dividends, unlike salaries, are commonly double-taxed. If you have a company in Estonia, and assign yourself dividends -once a year, in January- your company pays 20% in taxes.
Then, when you receive the money in your personal account, most usually you will need to pay taxes in your country of residence too. The amount varies from country to country, and usually depends on how much money you received.
Some countries have the concept of “dividend allowance“, allowing you to not pay taxes up until a certain amount of money.
As an example, in the UK, the dividend allowance is, as of April 2018, £5000. That means that you won’t pay any taxes if you receive less than that in dividends that year. Above that threshold, you will pay 7.5% if the dividends are below £33500, 32.5% between that and £150k, and 38.1% from that point on.
Hence, you can effectively be taxed “twice” for the same dividends, even if double-taxation treaties exist. However, some legislations will allow you to claim that money back when you do your yearly tax report.
Please note: the legislation of every country on dividends and taxes is completely different, and out of the scope of this article. My suggestion is: ask a professional accountant from your home country.
The Dangers Of Conducting Your Global Company Locally
If you want to truly separate your company from you as an individual, you need to be careful not to focus your business around you and your country of residence. I talk about that in depth in this article. However, the main idea to keep in mind is that, if you have a Estonian company, and are a resident, your business cannot be limited to your country and a permanent headquarters outside Estonia.
Conclusion: You Are Not Your Company
In “You are not your company”, I try to explain the difference between you -as an individual- and your company. Many novice solopreneurs struggle in defining the boundaries between these two entities, or even acknowledging they exist. If you want to conduct your business stress-free, you need to clearly separate the finances and operations of your company from your personal accounts.