Choosing the correct business structure is one of the most significant decisions any person starting a business activity must make. While some self-employed individuals rush to open a file and start working, others discover too late that the path they chose is not suitable for their business scope, and sometimes they also pay more tax than necessary.
To make an informed choice, it is important to understand the real differences between the three business structures in Israel: exempt business, licensed business, and private company (Ltd.). Each structure is suitable for a different type of activity, income level, responsibility level, and business maturity. The following guide will detail clearly what characterizes each structure and how to choose the most suitable one for your business.
Exempt Business for Small Businesses Just Starting Out
Exempt business is suitable for those starting a business activity with a relatively limited scope. Membership in this structure is determined by annual revenue turnover, not by profit, so it is important to correctly estimate the expected turnover amount before opening a file.
The main advantage of this structure is simplicity: there is no VAT collection obligation, VAT reporting is done only once a year, and there is no need to issue tax invoices but only receipts. For those operating point-in-time services, giving private lessons, or selling a small number of products, this can be a great structure.
On the other hand, an exempt business cannot deduct VAT from business expenses, which can make some expenses more costly. Additionally, there is a professional limitation; there are professions that are prohibited from registering as an exempt business, even if the turnover is low. Those who estimate that their activity is about to grow quickly should consider whether the structure is suitable for the long term.
Licensed Business for Businesses with More Significant Activity Scope
Licensed business is suitable for self-employed individuals whose turnover exceeds the exempt business threshold, or for those engaged in a free profession that requires registration as a licensed business regardless of income.
A licensed business charges VAT to its customers and is authorized to deduct VAT from its expenses. This allows for managing a broader business activity and enjoying a tax mechanism that allows paying only the difference between transaction VAT and input VAT.
The main disadvantage is the issue of periodic reporting. A licensed business is required to submit monthly or bi-monthly VAT reports, maintain meticulous records, and meet higher reporting obligations compared to an exempt business. On the other hand, this is the structure that allows greater flexibility, higher professional image, and the ability to work with large business clients.
Private Company (Ltd.), the Choice for Businesses Wanting a Serious Structure and Growth Potential
Private company (Ltd.) is a business structure intended for businesses in the process of expansion or for businesses seeking complete legal separation between the owner and the business.
The company is considered a separate legal entity, and therefore provides legal protection and in many cases also a significant image advantage against large clients, suppliers, and investors. Beyond that, there is also some flexibility in tax planning, especially in profitable businesses where corporate tax may be more worthwhile than the tax applied to individuals.
However, a private company (Ltd.) requires registration with the Companies Registrar, opening a dedicated bank account, maintaining meticulous records, filing audited annual reports, and making regular payments to the Companies Registrar. This is a structure that is not suitable for a small business just starting out, but rather for those at a stage where order, clear boundaries, and the ability to manage complexity are part of their business vision.
How Do You Know What to Choose? 4 Key Decision Points
Expected Income Level
Those who estimate relatively low turnover can start as an exempt business. Those exceeding the threshold must choose a licensed business or company structure.
Type of Occupation
In free professions, there is no option to be an exempt business. In such cases, the choice begins with a licensed business and above.
Level of Risk and Responsibility
A private company (Ltd.) provides legal separation that protects shareholders. Self-employed individuals with high risk levels should take this into account.
Business Growth Plans
A business just starting out can begin as exempt or licensed, but a business whose goal is to grow quickly will benefit from a private company (Ltd.) structure.
Choosing the correct business structure is not just a matter of bureaucracy; it is a decision that affects the taxes you will pay, how you report, your level of responsibility, and the business's ability to grow.
Professional guidance from the initial stage can save mistakes, money, and resources. It is recommended to receive guidance before opening a file and choose the structure that fits exactly your business nature, activity scope, and future plans. Contact us at CPA Digital and together we will choose the correct business structure for your business