Corporate Tax Planning: Sole Trader or Limited Company?
Every business in the UK should strive to minimise its tax burden. After all, inefficiencies in your corporate tax planning could be costing your business hundreds, or even thousands, of pounds every year.
One of the first decisions to make when you set up a new business on your own is whether to register your business as a sole trader or limited company. It can be difficult to understand the complexities and implications of the issue, so read on to find out more information!
This Decision Was Once Much Simpler
Recent changes to Corporation Tax and other liabilities means that the financial differences between a limited company and sole trader are closer than they have ever been before.
Previously, there was a more straightforward answer for every business from a purely financial standpoint, and selecting the wrong one could impact your income by many thousands of pounds every year.
Now, it’s a little more nuanced. Generally, businesses with profits of less than £50,000 a year are better to set up as a sole trader, and those with profits of more than £50,000 are more efficient if set up as a limited company, but this can change based on your situation.
There are two main reasons for this distinction. The first is the range of tax benefits provided to sole traders under the £50,000 mark, including benefitting from the £12,570 personal allowance, tax-deductible business expenses, and cheaper National Insurance Contributions (NICs).
The second is the fact that a sole trader earning more than £50,000 a year would pay 40% Income Tax on all earnings above that figure, whereas Corporation Tax stands at 25% for companies, minus any available marginal relief.
There Are Other Benefits & Drawbacks to Both
Now that the two options are closer than they ever have been before, there is no clear-cut correct decision to be made that won’t have positives and negatives.
There is a fine line between them, and it is best to strategically review all aspects of your business with a specialist tax consultancy firm to choose the right one for you. Here are some things you may need to think about:
Profits
As mentioned previously, sole traders will pay Income Tax and NICs on their earnings, whereas limited companies will pay Corporation Tax and potentially Dividend Tax on profits, should they remunerate themselves via dividends.
Where profits exceed what the business owner requires as an income, excess profit can be sheltered in the company resulting in only 25% Corporation Tax, rather than 40%- or 45%-Income Tax.
Limited companies can benefit from marginal relief if they have profits of less than £250,000, which can help to reduce Corporation Tax liability.
Income Methods
Owning a limited company allows you to choose how much of your income you want to class as a salary and how much you want to attain through dividends, but this can be a complex process to set up and requires an analysis of your financial situation. Sole traders must always pay Income Tax and NICs on their earnings.
Selling Your Business
It’s typically more difficult to sell your business and bring in key employees when operating as a sole trader. This is because you must sell the goodwill, assets, and stock of your business individually as it is considered part of your personal assets.
Limited companies are considered their own individual entity, meaning that it can be purchased along with all accompanying assets for a single price. This makes the process significantly easier. It is also easier to obtain Business Asset Disposal Relief, previously known as Entrepreneurs Relief, on a sale of shares than it is on the sale of trade and assets.
Reliefs and Expenses
Sole traders can claim many different purchases as allowable expenses on the business, including travel costs, the running costs of your business premises, and training courses. This means you will be able to deduct these costs from your total profits when it comes to paying tax.
Limited companies benefit from a much broader range of available tax reliefs, including marginal relief, the patent box, and R&D tax credits, but the process of filing for and acquiring these is becoming increasingly complex.
Investment Opportunities
Sole traders are not able to register on the stock market, so cannot issue shares and therefore cannot generate outside investment. You will rely on your personal finances and loans to fund early business ventures.
When registered as a company, you could qualify for the Enterprise Investment Scheme (EIS) which will allow you to issue EIS shares, which are typically more attractive to investors, and benefit from additional funding.
Asset Responsibility
Lastly, but perhaps most importantly, sole traders are personally responsible for their business assets, debts, and legal obligations. For example, if you are unable to pay outstanding debt on your business, then your personal assets, including your home, car, or savings, may be at risk and used to pay it off.
Limited companies are considered a separate entity from the owner, and all assets within that business are owned by the business. Businesses can raise capital through the sale of shares, business loans, and more, which do not put the owner’s personal assets at risk.
Chartered Accountants in Birmingham
Edwards Accountants are one of the leading accounting companies in Birmingham and we offer our services nationwide, able to help business owners and sole traders alike ensure they are minimising their tax liability.
If you’re looking to set up your own business and are unsure whether to choose a sole trader or limited company, our expert corporate tax planning team can help. Read our guide on optimising tax liability for small businesses or call our team on 01922 743 100 to speak with an expert today!
