What is the best business structure for you and your business?
We take you through the pros and cons of a limited company when compared to a sole trade.
Limited Liability - If you have significant personal assets (such as a house and savings) they cannot be used to pay the company's creditors (people the company owes money to) if you have acted reasonably and in the best interests of the company.
Tax Efficient - Usually more tax efficient but this isn't always the case (see graph below). If you're of pensionable age this probably won't be the case as you won't need to pay national insurance contributions as a sole trader.
Tax Planning - You will only pay personal tax if you pay it out to use personally as a dividend. You can also pay into a pension more tax efficiently. You can gift your spouse a proportion of the company's shares which will enable you to pay a proportion of the profits to them in dividends - these dividends may be taxed at a lower tax rate depending on your spouses other personal income.
Prestige - It's the general consensus that trading through a limited company is considered to be more credible (although this is not necessarily the case).
Entrepreneurs Relief - It may be possible to pay out the funds held within your business at a 10% tax rate (instead of the current 32.5%/38.1% higher rate personal tax rates). You'd have to close or sell the company, you must have owned the business for at least one year, own at least 5% of the shares (and voting rights) and not set up a similar business for two years. Some trades are also excluded from this relief and you may also have to pay an insolvency practitioner in the region of £3,000 to liquidate the company if the capital held is above £25,000. Click here for more information.
No Customer Constraints - Some businesses will only work with limited companies. The reason for this lies within income tax legislation which states that where an individual provides services to an end client they may be liable to deduct income tax and national insurance from you. Instead of worrying about this, it is much easier for them to insist that the individual operates via a limited company rather than as a sole trader.
Accountancy Fees - It takes longer to file accounts as they are much more complex and much more advice is provided to directors and so the accountancy fees are significantly higher.
Complicated - It's a lot harder to explain how to run a limited company. For example, it's most tax efficient to take a small salary and pay dividends - you'll need to keep money in the company bank account in order to pay your tax bill at the end of the year. We can talk you through this complexity every step of the way though.
Accounts - Your annual accounts which show your assets and liabilities (but not your income and expenses) are shown online at Companies House for public inspection.
Bank Fees - A sole trader can use their own bank account as they are trading as themselves, a limited company must have a company bank account with fees currently at around £7.50 per month - the first 12 months of bank fees are generally free.
Larger Fines - The fines for late submission of documents are a lot higher.
Expenses (Pros & Cons)
Expenses - there are different ways in which to claim expenses for each business structure:-
- (Con) Cars - taxed more through a company - we suggest claiming mileage instead to avoid personal tax & the adminastrive burden of reporting this annually on a P11D form.
- (Pro) Annual/Christmas Party - can be claimed as an expense through a company.
- (Pro) Mobile Phone - can be claimed 100% through a company, must be claimed as a proportion of business/personal use as a sole trader.
- (Con) Use of Home - you can claim a proportion of your mortgage interest and council tax as a sole trader in addition to other costs. You can only claim the other costs as a limited company (such as a proportion of gas, electric, water, home broadband/phone).
- (Pro) Travel - you are able to claim for travel and subsistence for up to 24 months to a temporary workplace through a company. If you're a sole trader you will only be allowed to claim for occasional journeys outside the normal pattern (e.g. you can’t claim for going to the same place every Monday for a year) and itinerant trades (i.e. trades where there is no set travel pattern).
- (Pro) Entertaining - If you provide hospitality (e.g. food, drink, accommodation, theatre/sporting tickets) and you're discussing a particular business project or forming/maintaining a business connection it is usually tax efficient to pay this through the company (especially if you're a higher rate taxpayer). A sole trader cannot claim for entertaining.
The graph below shows how much tax is deducted for varying profit figures (from 5k to £120k) for both limited companies (yellow line) and sole trades (red line).
The blue line shows the difference in tax between a limited company and a sole trade.
Tax Comparison - 2017/18 *
* The graph above assumes that:
- The company profits are paid out as £8,164 (the point at which you start paying national insurance) salary and the rest in dividends.
- You are not of pensionable age and so you still pay national insurance contributions.
- You are the sole owner of the company (i.e. you own 100% of the company shares).
- All profits are paid out as dividends in the year that they are earned - in reality it may be more efficient to hold the money within the company and pay it out in later years.