Making the decision as to which structure your business operates as can be crucial, whether that be in terms of tax savings, perception to the outside world, keeping things simple or future plans you may have.
As a new tax year beckons, our team of accountants in London illustrate some of the main differences between trading as a self-employed sole trader compared to a limited company, in terms of the tax consequences, administration and other non-financial aspects.
With small business being our area of expertise, we have worked with a huge number of both sole traders and limited companies from a range of industries, helping them perform and grow to the best of their ability within their elected business structure.
So, what are the key advantages and disadvantages of trading as a self-employed sole trader in comparison to a limited company for the 2018/19 tax year?
(Based on 2018/19 tax year)
As per the graph above, the orange line is representative of a limited company's take home pay after corporation tax, available dividends and tax on dividends is accounted for. The blue line represents the take home pay of a sole trader after income tax has been taken into account.
According to the Government themselves, setting up as a sole trader is “the easiest way to start a business in the UK.”
Looking at the requirements of setting-up as a sole trader, they’re not wrong. All you need to do is; Let HMRC know that you’re self-employed (be sure to have your NI number ready), register for Self Assessment as a sole trader, and pick a business name (or trade under your own name).
Subject to getting hold of any industry-specific licences you may need, you’re free to start trading immediately after that. There’s no need to register with Companies House because, although you have a bona fide business, it isn’t a company.
When setting-up as a sole trader, you won’t need to employ the services of a solicitor or company formation agent (as some people do when they form a limited company) so, unless you hire an accountant from day one, there are no professional fees to pay at the outset.
You also won’t have to pay a registration fee to Companies House, which will make you a tidy saving of about £13.
As a sole trader you’ll have to keep accurate records of sales and expenses.
You’ll also need to complete and file an annual Self Assessment tax return with HMRC but, the good news is, unlike your limited company compatriots, there is no need to file year end accounts.
Filing forms at Companies House – for example, to appoint or remove directors, allot new shares and suchlike – are irrelevant to a sole trader, as is the requirement to maintain a list of statutory registers.
So, if you’ve truly gone solo (that is, not employed by anyone else), you get to pocket all the post-tax profits from your business rather than having to distribute them to other shareholders or leave the profits in the business. You also get to hold ownership of all the assets.
The lack of bureaucratic red tape allows you to make quick decisions – for instance, about your pricing structure or service provision – making your business agile and responsive to clients or competition, which is gold dust when competing with larger, lumbering competitors.
As a sole trader an individual must pay tax on all profits over and above their personal allowance, for most taxpayers the personal allowance is £11,800 for the 2018/19 tax year.
Once the personal allowance has been breached tax is paid at the rate of 20% in the basic rate of tax (up to £34,500 income), 40% as a higher rate taxpayer (over £34,500) and 45% in the additional rate band (over £150,000 income).
As well as tax, for a sole trader there is a form of national insurance to consider - Class 4 - which charges a rate of 10% on earnings between £8,060 and £43,000.
As you can see, being a sole trader business and a limited company are two completely different things. Make the right choice or your business by speaking to our small business consultant.
Whether you’re a team of one or a growing small business, statistics from the past five years have shown that the popularity of operating as a limited company is on the rise. In fact, in the period of 2012 to 2017, the registration of limited companies outgrew those of sole traders by 20%.
More recently, between 2016 and 2017, the number of companies in the UK operating as a limited company has risen by 72,000 (1.9%), which has resulted in limited companies representing 70.7% of all UK business.
More importantly, 47.1% of these companies are single employee businesses, thus distinguishing the popularity of the limited company route among startups.
Why is this the case?
Well, most notably, with a limited company comes limited liability. As a shareholder, your maximum liability is the capital you have invested into a company which creates a safety net of sorts for those about to foray into the business world and encourages a degree of entrepreneurial risk-taking.
In the event of a limited company incurring an unforeseen liability (such as a legal claim) in most cases this liability will be limited to the assets owned in the name of the company.
The directors do need to be careful with regard to personal guarantees and the potential for wrongful trading (e.g. continuing to acquire credit which the company has little chance of servicing), in these instances they can become personally liable in a situation known a “piercing the corporate veil”.
For a sole trader there is no such distinction between personal and business assets as the business and the individual have no separate legal status.
Therefore, personal assets such as the family home could be at risk, certainly where the business operates in a fairly litigious or highly sensitive sector and where a risk is not adequately covered by insurance.
A limited company pays corporation tax on taxable profits at a rate of 18% from 1 April 2018 (previously 19%), over and above this there can be personal income tax to be paid with regard to dividend extractions from the business.
In order for the extractions to be as tax efficient as possible the director normally would draw a small salary from the company within their personal allowance but not above the point at which national insurance becomes payable, this salary would be an allowable business cost for corporation tax so 18% corporation tax is saved on the gross salary.
The remainder of their withdrawals would be in the form of dividends, these are paid out of post-tax profits and are not deductible expenses for corporation tax purposes so offer no tax saving, however there is no national insurance to pay on dividends.
In the 2018/19 tax year dividends are taxed at 7.5% in the basic rate of tax up to £46,350, with rates of 32.5% on dividends between £46,351 and £150,000 and an additional rate of 38.1% on dividends which exceed £150,000.
The first £2,000 of dividends that would otherwise be taxable at the above rates are currently subject to a tax free allowance, otherwise known as the dividend allowance.
There is no requirement for the owner to withdraw all profits from the business if they do not want to, and indeed it can prove tax efficient to leave some profits retained in the company for extraction at a later date or to re-invest in the company (e.g. to invest in equipment or staff).
Need help on deciding whether you should choose to be a sole trader or limited company? Get in touch with our team of small business accountants and let them help you make the best choice for your business' future.