OSVČ and s.r.o. in the Czech Republic: what’s the difference?

In this article, we explore the primary distinctions between running a business as a sole proprietor (OSVČ) and as a limited liability company (s.r.o.). The choice between these two options is a common dilemma for many entrepreneurs, because each carries its own set of advantages and disadvantages.

Entrepreneurs often grapple with the decision of whether to operate as a sole trader (OSVČ) or establish a limited liability company (s.r.o.). This choice significantly impacts various aspects of your business, including income taxation, Social Security and Medicare contributions, liability, and more. This concern persists not just at the inception of one’s entrepreneurial journey but throughout the entire business lifecycle.

Choosing between individual entrepreneurship and legal entity: key considerations

If an entrepreneur operates as an individual, his actions are primarily governed by trade license legislation. Entrepreneurial activity is defined as activity carried out consistently and independently, on one’s own behalf, under one’s own responsibility, with the goal of profit and under the legal requirements.

It is not difficult to obtain a business license. It is sufficient to contact the trade mission, obtain the necessary permits, and register with the appropriate authorities before the entrepreneur may begin his activity. However, there are numerous more requirements involved with launching a business that entrepreneurs must prepare before beginning their activities, depending on the type of organization.

Starting a business is a little more difficult for legal entities. A member must draft Articles of Incorporation in order to incorporate an LLC. This is normally done by a notary, who not only drafts an agreement but also submits a proposal to the Commercial Register for business registration.

To register a business, the shareholder must contribute the authorized capital (starting at one crown), provide a legal address, and register the company with the trade license office, among other things. Creating an LLC has significant administrative as well as financial requirements.

Understanding responsibility: individual entrepreneurs vs. legal entities in Czech Republic

A lot of business owners might not fully understand the important difference between running a business as an individual and as a legal organization. The main difference is a level of responsibility: an entrepreneur works for themselves, while a Limited Liability Company (LLC) is a separate legal body.

Individual entrepreneurs are personally responsible for any debts or losses that happen, and all of their assets are at risk, not just the ones that belong to their business. Because of this, private assets of entrepreneurs who owe money because of their acts may be able to be recovered.

LLCs, on the other hand, have their own assets and property because they are separate legal organizations. These assets are the main type of collateral they use to meet their responsibilities, which helps protect the personal property of the LLC’s shareholders.

Tax Options

Individuals have multiple options for recording and subsequently taxing their income and expenses. The most common choices include maintaining detailed tax records (i.e., accounting for actual expenses), applying a flat rate for expenses, or enrolling in a tax system with a fixed tax rate. In some cases, individuals are even required to maintain accounting records.

While individuals are taxed based on the discrepancy between their income and expenses (unless they maintain accounting records), legal entities face taxation on the difference between their income and expenses and are obligated to keep proper accounting records. Accounting is considerably more intricate than tax accounting, both in terms of administration and professionalism.

It is essential to differentiate between fundamental concepts: income and revenue, costs and expenses.

Income is defined as the products sold, expressed in Czech crowns, while expenses represent the products consumed (such as services and goods). Neither expenses nor income necessarily need to correlate with cash flow at a specific moment in time. In contrast, income and expenses directly reflect cash flow.

Additionally, distinct tax rates apply to individuals and corporations. Individual income is taxed at a rate of 15%, whereas corporations are subject to a higher rate of 19%. In certain situations, individuals may face a higher tax rate, for example, 23%.

Let’s examine the disparity in taxation between individuals and limited liability companies (LLCs).

Example

An individual entrepreneur issued invoices totaling CZK 500,000 for the year 2022. If they opt for tax records (i.e., applying the actual expenses system), the base for calculating income tax is CZK 390,000. However, if the individual entrepreneur chooses a flat rate for expenses (60%), the tax calculation base becomes CZK 160,000, despite issuing the same amount of invoices. In the case of an LLC (s.r.o.) that received an income of 500,000 crowns in 2022, the base for calculating income tax is 490,000 crowns.

From the above example, it’s evident that individual taxation is tied to the income actually received. In contrast, with accounting, the taxable amount encompasses products sold (i.e., income), irrespective of when it’s paid.

Entrepreneurs must exercise caution in managing their received funds. While individuals can freely use their income, this doesn’t hold true for legal entities. Realized income and received funds belong to the legal entity, not the shareholder. Consequently, a shareholder cannot casually spend a legal entity’s money. If they wish to withdraw profits, they must make the appropriate entries and pay a 15% tax.

Social security and health insurance

Individuals involved in business activities are obligated to make contributions for social security and health insurance. Subsequently, they are required to provide an extract for the preceding period, report on these contributions, and, if necessary, make additional payments. The exact amount of insurance premiums varies based on the income of individuals, while entrepreneurs are obliged to make minimum social and health insurance contributions.

In contrast, legal entities are exempt from social and health insurance contributions. The requirement to contribute to social security and health insurance arises solely when a legal entity hires individuals.

Source

https://www.podnikatel.cz/clanky/jake-jsou-hlavni-rozdily-mezi-podnikanim-jako-osvc-a-eserockem/