How an Individual Entrepreneur (IE) Can Become an LLC

It should be noted that it is impossible to simply convert an IE into an LLC, as these are different forms of business entities: an IE is an individual, whereas an LLC is a legal entity, and each is governed by its own set of rules. Therefore, the first step is to establish a new company, and only then close the existing business.

You can register an LLC through an Administrative Services Centre (CNAP), online, or with the assistance of a notary. Before registration, however, it is necessary to determine:

• how many founders there will be;
• the amount of the charter capital;
• the registered address;
• who will serve as the director;
• which taxation system will apply;
• what types of business the company intends to carry on, etc.

Founders

Based on the current legislation, a founder may be either an individual or a legal entity, and there is no limit on the number of founders. An Individual Entrepreneur may become a founder of an LLC, however, not in the capacity of a business entity but solely as a private individual.

Charter Capital

Charter capital may be contributed either in cash or in kind. The founders determine the amount of charter capital at their own discretion. Contributions to charter capital are not subject to taxation. Unlike an individual entrepreneur, who is liable for business obligations with all of their personal assets, LLC founders are liable only within the limits of their contributions to the charter capital. Funds contributed to charter capital are not considered financial assistance that must be repaid within a specified period. They are returned only when a founder withdraws from the LLC. Please note that a contribution to charter capital provides an opportunity to inject funds into the business tax-free and use them for business activities.

Registered Address

It is not advisable to use the residential address of one of the founders as the company’s registered address. Having leased premises is preferable.

When the tax address of an LLC is an apartment or other residential property belonging to a founder, this may create additional risks and give rise to unnecessary questions from the tax authorities.

Founders and Director

It should be determined at the LLC registration stage who the founder and the director will be.  The incorporation documents must specify whether the founder and the director of the LLC are the same person or different individuals. Depending on this, certain restrictions may be established for the director, for example regarding the size of loans, spending limits without founder approval, or limitations related to specific transactions.

Choosing a Taxation System

There are two taxation systems: the general taxation system and the simplified taxation system.

When selecting a taxation system, it is important to analyse the future business model, including:

• planned business volumes;
• whether purchases with input VAT will be involved;
• whether there is a significant cost component;
• the structure of relationships with counterparties.

Funds for Starting the Business

A newly established company requires funding to commence operations. These funds may be provided through contributions to charter capital. Very often, such funding may also be obtained under a loan agreement. If this option is chosen and the LLC director is the same individual who was operating as an IE, the agreement on behalf of the LLC must be signed by another person rather than by the director. Under current legislation, the same individual may not represent the interests of both parties in the same transaction.

Another option occasionally used is a contribution to additional capital. This approach is applied when there is no intention to increase the charter capital, but additional funds are needed to conduct business activities.

Transfer of Inventory from an IE to an LLC

In this case, it is important to understand that an IE and an LLC are two separate taxpayers. Therefore, inventory remaining with the IE cannot simply be used in the activities of the LLC. Such assets must be transferred legally and supported by appropriate source documents.

One option is for the LLC to purchase from the Individual Entrepreneur the property or goods required for its operations. However, transactions between related parties always attract the attention of regulatory authorities. Such transactions are not prohibited. What matters is that sales are conducted at market prices and that the transactions are genuine. To avoid unnecessary scrutiny of the tax authorities, it is preferable that when an LLC purchases inventory from an IE, the LLC's director and founder and the IE seller are different individuals.

Common Pitfalls to Avoid

As an individual entrepreneur, an individual can, in practice, use almost any of their personal property in the business. This principle does not apply to an LLC. The property of a director or founder is not the property of the LLC. The LLC property consists only of assets contributed to the charter capital or acquired on the basis of appropriate supporting documents.

A director may not freely use funds from a corporate payment card for personal needs. Such funds may be used solely for business purposes and within the limits established by relevant internal orders. If expenses are unrelated to the company’s business activities, they must either be reimbursed or may result in tax implications.

If the owner wishes to receive money legally for personal use, this is most commonly done through the payment of dividends and the payment of the corresponding taxes.

Employees hired by an IE cannot simply continue working for the LLC. They must first be dismissed by the IE and then officially hired by the LLC in full compliance with labour law requirements.

Natalia Shcherbak,

Accounting and Tax Consultant