There are a lot of factors to consider when you start your own business.  One of the biggest factors to consider is what structure should you use when setting up your business.  It’s a question we get asked a lot by start-up businesses – should I operate as a limited company or a sole trader?

Here’s some information to help you determine what the best option is for you.

Limited Company

Characteristics

  • You and the business are separate legal entities
  • The business is formally incorporated with Companies House
  • The business pays corporation tax on its profits
  • The business must file statutory accounts with Companies House
  • Statutory registers must be kept at the registered office address
  • Directors have legal duties and obligations to the business, namely fiduciary duties, such as to act in the business’s best interest

Practically what does this mean?  Pros and Cons

  • Pro: As a separate legal entity, and because you have limited liability, you aren’t liable for the business’s debts – you’re only liable for what you put into the business
  • Pro: Once incorporated no one else can use your business’s name
  • Pro: Getting investment and financing is often easier for limited companies
  • Pro: The company can claim Research and Development costs back from HMRC
  • Pro: There can be tax efficiencies when operating as a limited company – we’ll come back to this one
  • Sometimes a Con: Costs incurred must be in the business’s name
  • Con: there’s more administration with the statutory obligations

What else?

  • Operating as a limited company is often seen as being more professional
  • Depending on your ambition for the business, it’s easier to sell a limited company than a Sole Trader business

The tax stuff

  • Limited companies pay corporation tax on their profits
  • You, as the owner and director, only pay tax on the money you’ve taken from the business
  • You can take money from the business as salary – which is 100% tax deductible for the business
  • You can also take dividends from the business – dividends are a distribution of profit, so no profit means no dividends can be taken
  • Dividends are taxed at a lower rate than income tax, and aren’t subject to national insurance
  • The business can contribute to a pension on your behalf, and it’s 100% tax deductible for the business
  • As an employee of a limited company you can claim Employee Trivial Benefits; £50 for an item (not cash or a voucher) purchased for you by the business – this is capped at £300 for directors
  • You can also spend £150 on a Christmas party as an employee of a limited company – there’s no tax implication for you, and the business can claim it back

Sole Trader

Characteristics

  • There’s no legal separation between you and the business
  • There’s no formal set up, making it quick and easy to get started – you just have to register as a Sole Trader with HMRC
  • There’s no statutory obligations or filings with Companies House
  • You do have to file a Self Assessment annually
  • You’ll pay income tax and national insurance on the business’s profits

Practically what does this mean?  Pros and Cons

  • Pro: there’s no statutory obligations, so less administration than a limited company
  • Pro: you and the business can share costs, because you’re not separate legal entities
  • Con: you’ll be taxed on the business’s profit, regardless of how much you take out of the business
  • Con: it can be more difficult to get investment and financing as a Sole Trader
  • Con: as there’s no separate legal entity, you’re personally liable for the business’s debts

The tax stuff

  • You pay income tax and national insurance on the business’s profit, regardless of how much you take from the business
  • How much you take from the business isn’t tax deductible
  • The business can’t contribute to a pension for you, you must do that personally with money taken from the business
  • You’re not an employee of the Sole Trader business, you are the business, so there aren’t any employee benefits

For Both Type of Business

  • If you hit £85,000 of turnover in your business you must register for VAT – whether you’re a Sole Trader or a Limited Company
  • Both types of business can voluntarily register for VAT
  • Both types of business can employee people

Cost Comparison

As already mentioned, there are differences to the allowable tax deductible costs for limited companies and sole traders – here’s a table detailing the biggest differences

CostLimited CompanySole Trader
Working from homeSet amount per week dictated by HMRCCan apportion an element of home costs (mortgage interest, council tax, light & heat etc) to the business
Mobile PhoneBusiness pays – 100% tax free benefit for you personallyApportion the percentage of business use to the business, the rest is yours
Car CostsClaim 45p per mile from business as expenses*Either mileage or percentage of car costs (insurance, fuel, servicing etc)
Home InternetMust be in the business’s nameCan apportion the percentage of time it’s used for the business
*Typically, it’s not usually tax efficient for a limited company to own the car you use, as it creates quite a large benefit in kind that you’re personally taxed on. 

Are you a start up business?

Would you like to know more about business structures? Or work through the tax scenarios with some numbers? Get in touch CONTACT US.

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