One phrase we like to steer away from here at Ember is "it depends". When starting a business, a decision that many struggle with is the choice between starting out as a Sole Trader or forming a Limited Company.

Whilst we can't make this decision for you, we have laid out a few key considerations below to help guide you through it.

Sole trader

Limited company

Legal Status

For the sole trader, there is no barrier between the individual’s business affairs and their private affairs. This means that the individual’s non-business assets may be at risk if the individual’s business fails or experiences difficulties.

The liability of a shareholder in a limited company is limited to the amount invested by that individual in the share capital of the company. This protects the shareholder’s other assets – for example, his/her home - in the event that the company is wound-up.

The benefits of limited liability may be reduced where the shareholder is required to give a personal guarantee to a creditor of the company (for example, a bank in respect of borrowing by the company).

Taxation of profits

The sole trader pays income tax and Class 4 NICs in respect of their profits as they are earned. As a rough guide, the combined rates of tax and NICs for profits are:

  • from £9,500 to £12,500 - 9%;

  • £12,500 to £50,000 - 29%;

  • £50,000 to £150,000 - 42%,

  • and above £150,000 is 47%.

The company pays corporation tax (CT) on its profits as they are earned. The current rate of corporation tax is 19%.

A second layer of tax is payable when the business owner withdraws some or all of the after-CT profits from the company. There is a degree of flexibility as to how and when the profits are paid to the business owner. This can give the limited company an advantage over the sole trader.

Losses

The sole trader may set a loss realised in the trade against their other income or gains for the current or previous tax year. In the first 4 years of the business, this relief is extended so that losses may be carried back three years.

It is not possible to set a loss realised by the company against the business owner’s income.

Administration

The sole trader must register with HMRC and from then on, submit a tax return each year. For small businesses, only three figures need to be returned to HMRC: income, expenses and profit/loss. Also, it is possible to calculate the tax liability by reference to cash received and paid out.

The company must be registered with Companies House. A company must prepare statutory accounts in the format prescribed by the Companies Acts, and those accounts must be filed with Companies House.

Further, a company must complete a Confirmation Statement each year and it must notify Companies House of certain developments, such as the appointment of new directors. The company’s accounts, etc. may be viewed on GOV.UK by members of the public.

The company must submit an annual tax return to HMRC, including supporting calculations. The shareholder records on his/her personal tax return any income received from the company.

Summary

Each business structure has different implications – tax and non-tax – and the best structure will depend on the particular circumstances. This decision should be made before the trade begins and it should be reviewed on a regular basis; remember it is possible to change business structure.

Some key questions to consider when making your decision.

  • How important to you is the ability to limit your exposure in the event of a claim against the business?

Limited liability is often the main reason for choosing to use a limited company.

  • Are you concerned that some company information is publicly available?

Privacy and/or data security concerns can rule out using a company for some people.

  • Do you expect to make a loss in the early years of trading?

This can be quite common due to the greater need to invest in the business in the early years, and as it will take time for the customer base to grow. Relief for the loss may be obtained at a higher rate of tax, and more quickly, for a sole trader.

  • Once established, how much do you expect to make each year in profits?

Although using a company can give rise to a tax advantage, this may not be enough to compensate for the additional administration fees. Profits of £30,000 may be a good guide.

  • Have you given any thought to how and when you will write up your business records?

Using a company historically has required a degree of financial discipline. For example, up-to-date accounts are required to support the payment of dividends. Here at Ember our mission is to simplifying this administration as far as possible allowing you to make informed decisions without requiring a degree in Accounting.

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