Where to begin?
The necessary things to consider when making your decision:
There is little formality to starting as a sole trader. You inform HMRC (and you have 3-months from commencement to do so) – and you are started.
There are several considerations to forming a limited company, which make this business vehicle more complex at the start. Is the name legal and available? Who will be the Directors? Who are the shareholders and in what % holding? Will you have a company secretary? Where will the registered office be?
Tax & National Insurance
Sole traders pay tax and national insurance on allowable profits.
Tax is paid twice a year, at 20 or 40% on 31 January and 31 July, and tax is paid in advance. Any amounts taken by the proprieter is called ‘drawings’ and does not affect profit.
A sole trader will also pay a Class 2 contribution of £2.75 per week.
The limited company will pay tax on profits at 20%. This is due for payment 9 months after the financial year end. Any amount drawn by the directors/shareholders will be taxed under PAYE and is a cost of the business and so reduce profit.
Tax calculations below, based on the UK tax rates and thresholds for 2014/15, a limited company still results in the lower overall tax charge than a sole trader (allowing for the extra accountancy fees incurred through trading as a limited company), whilst profits exceed approximately £16,500 pa:
Annual Business Profits
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*NB. The above calculations are based on drawing of all monies from the company and leaving no reserves.
As a sole trader – any business debts are personal debts and therefore, your personal assets – including your property are not protected.
A limited company has its own legal identity – shareholders liability is limited. In the eyes of the law, it is the company that would face any legal proceeding, not the shareholders. So, any liability is limited to that of the company, therefore protecting the directors’ and shareholders’ personal assets.
Sole traders are not legally required to file accounts for inspection. However, a record of business expenses and details of personal income are required for completion of a self-assessment tax return.
Limited companies are required to prepare annual accounts from the company records at the end of their financial year. The accounts have to be filed with HMRC as well as sent to all shareholders (if there are any) and Companies House. A limited company is also required to file an Annual Return (called an AR01) to HMRC.
An incorporated company may appear to be more credible. In certain sectors, contractors or agencies would choose to work with limited companies due to the legal protection it provides.
Would this be important to your customers?
The Deal Breakers
- Tax benefits
The tax benefits of trading as a limited company would appear more attractive for businesses with modest profits.
- Selling your business
Limited companies are more attractive to potential investors.
Is your business working on only one contract? IR35 is a piece of legislation concerning contractors that would negate tax benefits of a limited company.
There is a bigger investment with your accountant using a limited company that could eat into any tax benefits derived.
Sole trader – accounts and tax return
- Annual Return (AR01)
- Tax returns (personal and company)
- Accounts to be filed with statutory bodies,
- Corporation Tax Return (CT600)
- The need for a Registered office.
About the Author
Andy Penfold, Manager – Accounts & Business Development
Andy works with SME clients, and some refer to him as the ‘5th emergency service due to his experience in helping and advising this client group. He particularly enjoys working with owner managed SMEs, helping them achieve their personal and business goals – or as they say at PKB, ‘Aspire, Achieve and Enjoy’.
Andy says, “What’s important to you? I like working with my clients to find out what they need and advise them the best way forward.
Did you know you could be both sole trader and limited company at the same time? Talk to me about how I have helped some of our clients protect their business”
You can contact Andy at:
Let us help you make the right decision for you – www.pkb.co.uk