Structures: Sole trader vs Ltd company
Posted on 6th July 2023 at 15:09
We get asked about this a lot and there isn’t always a straightforward answer: “It depends." Whilst that seems like unhelpful answer, in many situations it’s the only answer until we delve a little deeper.
Many clients want to change into a Limited structure based on their business income increasing. Some think they should do it as it will make them look more profession or established. There are of course tax advantages in any situation but let me explain some other things to consider when deciding if it's time to make the switch.
Paying taxes:
Sole traders pay income tax (20% or 40%) and Class 4 NICs (2% and 9%) on their taxable profits from the trade.
Limited companies pay corporation tax which is charged on the profits as they are earned (19% or 25%)
However, that is not the end of it as at some point the individual will want to withdraw the profits from the company and this is done through dividends as a Limited company.
Current rates of income tax on dividends are as follows:
8.75% for basic rate taxpayers;
33.75% for higher rate taxpayers; and
39.35% for additional rate taxpayers.
As you can see, there is a tax % saving with a Limited company structure.
Liability
Using a company means that an individual’s risk is limited to the amount invested in the company, giving the business owner valuable peace of mind. Compare this with the sole trader whose liability is unlimited. No business owner wants to be taken to court over anything but it's certainly something to keep on your radar for your own protection.
Who are you doing business with:
We have found that some companies prefer to deal with other Limited companies as opposed to an individual, believing that the limited company is more likely to be an established business with more resources.
Funding:
A Limited company may benefit from improved access to funding but one of the main things we ask when looking at transitioning is “are you refinancing, mortgaging in the next XX months”. We have found the panel of lenders may be reduced if you have X many years at one structure and a much less amount of time in another. We always advise you speak to your mortgage adviser to ensure no issues further down the road if this change was to happen.
Timing:
This is an important consideration. It’s not impossible to do at any time but we have found clients to do prefer to do it with a fairly clean break. April 6th to April 5th is the usual time scale for accounts to be prepared for Sole traders but when you register for a Limited company that’s when your 12 months start. You will also have an annual confirmation statement to do around the same time too.
Some adjustments will need to be made if its not a stop start change over in April but with PBT supporting you it will all be made simple.
Paying yourself:
I bet like most business owners you haven’t paid yourself properly. Have you just been drawing out money here and there? Would you like something a little more structured? Well as a Limited company you can legitimately pay yourself via PAYE where as a Sole trader can have a Payroll scheme but you can’t go on it.
There are also tax advantages to paying into a private pension directly from the Limited company and this will reduce your profits. You can still pay into a pension as a sole trader but its not deductible for tax, you will get a small amount of relief on it in your self-assessment tax return.
Other options and thoughts:
When thinking of business protection many think about the business name. The thought of having to rebrand causes some to worry so we have clients who have set up the Limited company just to protect their name. Then as and when the time comes they can easily switch structures with just a bit of admin rather than have to change so much more.
Overall the bookkeeping of both structures remain largely the same. There will be a little more paperwork as well as more responsibilities for Directors in accordance with Companies house guidelines but this is explained to you once the company is set up.
So in short, this is why we use “it depends” as each structure has different implications both tax and non-tax. We look at all of our clients' needs and thoughts on this matter as this is not a one size fits all scenario.
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