Is it better to establish a company or a craft?

The decision depends on a number of circumstances: the planned scope of business, available capital, regulations, and expected profit. However, since the liquidity problem in Croatia has not yet been resolved, VAT can be a crucial criterion in choosing the legal form for starting one’s own business.

written by mr. sc. Marija Zuber [email protected]
advisor-editor at the magazine Accounting and Finance

There is no unequivocal answer to the question of whether it is simpler and more financially profitable to start one’s own business by establishing a company or registering a craft. The decision depends on a number of circumstances: the planned scope of business, available capital, regulations, and expected profit.  A newly established company can only start operating after being registered in the register maintained by the competent court. The preparation of founding documents, the process of notary certification, and registration can be completed in just a few days. In addition to the minimum capital, which cannot be less than 20,000 HRK, the founder or founders must account for several thousand in court fees, notary fees, and the publication of the company’s establishment in the official gazette. If specified in the company agreement or in the declaration of establishment, these costs can later be reimbursed by the company. An individual who wishes to conduct economic activity through personal work can register a craft if they meet the prescribed conditions. The registration process for a craft is carried out by the county office for economic affairs, and the costs only relate to the administrative fee and the issuance of a craft license. 

A craftsman can shorten the time required for registering a craft if they submit all the evidence prescribed as a condition for performing a specific activity (e.g., a certificate of health capability, proof of professional qualifications, etc.) along with the application. Regulations on establishing a craft do not require capital to be invested in the craft, but capital is often needed to start the business. A craftsman can bring long-term or short-term assets from the private sphere into the craft and use them for conducting activities. If they bring in long-term assets with a lifespan of more than one year and an estimated value greater than 3,500 HRK, they are entitled to depreciation expenses that reduce their tax base.

Special conditions
If special conditions are prescribed for the activity by specific regulations, both companies and craftsmen must generally meet them equally. In this regard, their obligations are equal. For example, special regulations on the minimum conditions that business premises must meet for conducting trade or hospitality activities equally bind all traders or hospitality providers, regardless of the legal form in which the activity is conducted. When it comes to the necessary education or qualifications of the individuals performing the work, there are differences. For related crafts, appropriate professional qualifications are required, but the same activity within a company can be performed regardless of the worker’s professional qualifications. If a craftsman does not have the required professional qualifications, this condition can be fulfilled by an employee they hire.

Expenses for contributions
A member of the management board of a company does not have to be employed in that company. If they are not insured for pension and health insurance on any other basis (e.g., not employed by another employer), they must ensure pension and health insurance, which entails the obligation to pay contributions based on the average salary. In this case, the expenses for contributions are 2,740 HRK per month (for 2009). Of course, a board member can be employed in the company, but then mandatory contributions and income tax are paid on the agreed salary. A craftsman is mandatorily insured for pension and health insurance from the day of registration in the craft register. A craftsman pays contributions for themselves based on at least 65 percent of the average salary (for 2010, the monthly expense is 1,780 HRK).

Business records
There is an important difference in the obligations related to keeping business records and preparing financial statements. A company is obliged to record business events and keep business records according to the Accounting Act, while a craftsman keeps so-called simple accounting according to income tax regulations. The costs of keeping business records for companies are generally higher than the costs for craftsmen. This is an expense that should be accounted for as a permanent cost during the business period. Although both companies and crafts must conduct payments through accounts opened in authorized organizations, managing cash is somewhat simpler in a craft than in a company.

Tax status
At the beginning of conducting activities, an entrepreneur estimates the expected value of deliveries in the first year of business. If they estimate that the value of deliveries will not exceed 85,000 HRK, they do not have to be a VAT payer in the first year of business. Only if the value of deliveries exceeds 85,000 HRK on an annual basis does it become a VAT payer from January 1 of the following year. However, once a company or craftsman becomes a VAT payer, their position differs significantly. A company is obliged to calculate and pay VAT based on performed deliveries and issued invoices, while a craftsman pays VAT based on collected fees. If liquidity problems are expected, this can be a crucial criterion in choosing the legal form for starting one’s own business. If it is an activity that involves delivering goods and services to end consumers who pay cash immediately, this may not be so important. However, if the delivery will be made with deferred payment, the method of paying VAT can influence the decision on the choice of legal form for starting a business. Of course, the method of paying VAT corresponds to the right to deduct input tax. Entrepreneurs who pay VAT based on performed deliveries have the right to deduct input tax from incoming invoices for received deliveries regardless of whether they have paid them, while for craftsmen an additional condition is required – that the received delivery has been paid. This information will be important for those who intend to invest in equipment procurement at the beginning of their business.

Obligations for direct taxes
In the first year of business, neither companies nor craftsmen pay advance tax payments, but settle the obligation after the annual calculation. Already in the next business year, they are obliged to pay monthly tax advances. The differences in obligations for direct taxes are greater the better the business result. Companies are always subject to profit tax (the profit tax rate is 20 percent). When profit is distributed to a member of the company, that income is not taxed as income tax. A craftsman is subject to income tax and pays tax at progressive rates of 12, 25, and 40 percent, depending on the size of the annual tax base. They have the right to use a personal deduction as a non-taxable part of income, for themselves and for dependent family members. They are also obliged to pay surtax on the calculated income tax, and the surtax rate depends on the municipality or city of residence. When it comes to smaller annual income amounts, the burden of income tax is less than paying profit tax. As annual income increases, the burden of profit tax is much less than paying income tax. A craftsman should take this into account and consider utilizing the legal option to choose to pay profit tax instead of income tax, which regulations allow. However, this changes their position in the VAT system, increases their business record-keeping costs, and expenses for contributions.