In this article I will be discussing the benefits and drawbacks associated with operating as a sole trader or via a Ltd company.
Sole Trader
When starting out in your own business it’s common to be a one-person operation, fulfilling all the roles required to provide the service to your client. Many businesses start life like this and the main benefit of operating as a sole trader is the simplicity in setting up the business like this. As far as the tax side of things is concerned you simply need to register with HMRC to notify them you are now self-employed https://www.gov.uk/register-for-self-assessment/self-employed.
Once a year from that point the sole trader then needs to file a self-assessment tax return declaring the income and expenses associated with the business. The profit made will be liable to relevant income tax and national insurance rates accordingly.
As a sole trader however, there is no separation of the business assets and liabilities from your own personal assets and liabilities. The result of this is all profits are taxed on you as an individual whether or not you have any funds left in the business or not. In short you have unlimited liability.
Ltd Company
A Ltd company is a completely separate legal identity from an individual. It has shareholders and directors, but these can both be just one person. The one person would be remunerated by either a salary or dividends, or most likely a mix of both. Deciding on this mix can be complex but I can advise accordingly.
Setting up a Ltd company is a different process from that of a sole trader. You need to register with Companies House, which means some personal information such as your name and address will become visible to the public. When registering you are agreeing to file an annual confirmation statement and annual company accounts to Companies House, as well as an annual corporation tax return to HMRC.
Sole Trader vs Ltd Company - what are the differences?
Looking at the advantages and disadvantages of both can help understand what’s best for you.
Sole Trader:
+ It’s easy to setup and there is less paperwork involved in running your business.
+ There is a greater level of privacy as there will be no records at Companies House. However, as a sole trader you will need to make some information available in the public domain if you to market your business successfully.
- The unlimited liability associated with being a sole trader can lead to a loss of personal assets (such as your house) in an extreme case. Some of the risks can be reduced with things like professional indemnity or payment protection insurance, but keep in mind that the liability of your sole-trader business ultimately lies with you.
- Perceptions matter in business and that can have an influence over whether clients hire you or not. Sole traders are often seen as smaller than Ltd companies and less official. If you believe this may be a factor for your potential clients then this may be a factor for you.
Ltd Company:
+ A Ltd company can give the impression of greater success or being more established in the business community. Do your potential clients wish to work with a Ltd company rather than a sole trader?
+ As the name suggests the Ltd company will have limited liability. Liabilities are placed on the company rather than the individual running the company. In general that means any personal assets (such as your house) held outside of the business aren’t at risk if you run a Ltd company.
+ Profitability is often a key factor in deciding how to operate. As your earnings increase it can be financially advantageous to operate as a Ltd company. Ltd companies pay Corporation Tax rather than Income Tax and there is more flexibility in how you remunerate yourself, giving more tax-planning opportunities.
- The reporting requirements are certainly more onerous for a Ltd company, with the annual confirmation statement and accounts to Companies House, as well as the tax return to HMRC. The directors and, potentially, the shareholders will have to declare any personal income extracted from the company by way of a salary or dividend on their own personal tax returns. A sole trader can often handle their own accounts without much help so long as they’re organised, however it is often advisable for Ltd companies to engage an accountant to keep abreast of the financial reporting requirements.
It is common for people to start small as a sole trader and gradually grow into operating via a Ltd company. To give a rough guide, once your profits start exceeding £30k the tax savings of operating via a Ltd company rather than as a sole trader start to grow. Your decision is not fixed though and you can change how you operate in the future depending on your circumstances.
A Word About VAT and IR35
Whether you decide to register as a sole trader or via a Ltd company, you also need to consider the separate question of whether to register for VAT. VAT registration is compulsory if your business annual turnover exceeds the VAT threshold, which is currently £85k in 2022. You can voluntarily register if your turnover is below the compulsory threshold, which can be advantageous in certain scenarios such as if your business incurs a lot of VAT expenses you wish to claim back or you wish to appear a more established business in your industry. Registering for VAT will also mean signing up to HMRC’s “making tax digital” legislation which includes the compulsory purchase and use of approved accounting software, such as Xero, and keeping more robust records of all business transactions.
Be wary of the more stringent IR35 legislation, in particular if your Ltd company is essentially operating as a personal service company. These rules have been in place since 2017 in the public sector but since April 2021 they have also applied to most of the private sector, with the exception of small companies as defined by Companies House thresholds. IR35 affects all people who do not meet HMRC’s definition of self-employment with the legislation designed to stop subcontractors working as “disguised employees”. The IR35 legislation allows HMRC to tax these workers at a similar rate to employment, and counteract people avoiding their employers and employees national insurance contributions in particular.
Summary
This article is designed as brief introduction to the topic and there could be other tax planning issues to consider in your circumstance, such as landlord or other investment income. Everyone’s situation is always unique. If you have any questions or would like some advice on your own situation, please submit a message on the contact page (https://www.mallardaccounting.co.uk/contact-us) accordingly and I will be happy to help.
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