It is vital to have the right business structure when you first set up your business. Financially, commercially as well as tax-wise, business structure will have long-term and lasting impact on your business and it’s sustainability. Rather than discuss the different liability between sole trading and limited company, this blog will prefer the tax implications of trading as sole trader or limited company.  In general, this widely debated topic affects the owner-managed small businesses, contractors and freelancers.

Sole trader – a brief introduction

Different from Limited company, when an individual sells his or her services or products themselves, it will be classified as sole trade and the concerned individual as Sole Trader. From tax perspective, sole traders are required to register with HMRC to file an annual self-assessment or tax return to report their income and expenses for each tax year.

Following points are important when trading as sole trader:

  • Rate of tax sole traders pay depend on the level of profits for each tax year.
  • In term of VAT, HMRC requires businesses including sole traders to register for VAT once their turnover reaches the VAT registration threshold. For 2018-19 tax year, this threshold is set at £85,000.
  • VAT registration can also be voluntary when business turnover is under the set threshold. (This point will be discussed in our follows blog)
  • Sole Traders can also register as Employers if they hire any staff to work in the business.

Limited company – a brief introduction

An individual can register a limited company to do business. All limited companies need one or more director as it’s owner. For the purposes of this blog, we assume a single individual as sole director and shareholder of the limited company. It is also worth noting that limited company is treated as a separate legal entity from its owner (YOU). We shall explain this and relevant legal consequences further in a separate blog.

Being the director and shareholder of a limited company – you assume the responsibility of running, managing and developing the business. You can take the salary, and when the company is profitable, you are entitled to withdraw the profits as shareholder in the form of Dividends.

Following points are important when trading as Limited Company:

  • Company registration is required with Companies House.
  • Corporation tax registration and administration is dealt with by HMRC.
  • Director can withdraw salary as well as take dividends from company profits (dividends can only be withdrawn from profits after company expenses, salary and corporation tax are paid). There might be a personal tax liability of the Dividends withdrawn.
  • In term of VAT, HMRC requires companies to register for VAT once their turnover reaches the VAT registration threshold. For 2018-19 tax year, this threshold is set at £85,000.
  • VAT registration can also be voluntary when the company turnover is under the set threshold. (This point will be discussed in our follows blog)  

Tax Implications Sole trader vs Limited Company

After understanding the structural differences between the sole trader and limited company, let’s now look at the tax implications of choosing either of these business structures.

Sole Traders

Sole traders pay tax on their profits each tax year. Tax is paid on any profits earned above the personal tax allowance of an individual. Income tax rates start with 20% for basic rate taxpayers with additional rate of 45% for income over £150,000.  Sole traders also pay Class 2 and Class 4 NICs on their profits.

Class 4 national insurance

This is calculated on self-employment profits. For 2018-19, It is calculated and payable at 9% of profits between £8,424 & £46,350 and 2% for any profits above this.

Class 2 national insurance

It is payable at a rate of £2.95 per week when business profits are above £6,205.

Limited Company

Corporation Tax

For 2018/19, corporation tax rate for limited companies is 19%.

Tax on Salary and Dividends

Directors withdrawing salary and dividends will be taxed under relevant income tax rates depending on individual circumstances and level of income for each tax year.

For 2018/19, directors can draw a tax free salary of £8,424 in 2018/19 under the personal allowance of £11,850. In addition, rest of £3,426 from personal allowance can be withdrawn as Dividends along with £2,000 of tax free dividends above the personal allowance.

Business Structuring Cost

Registration

  • Sole trader structure is easy to set up with free registration with HMRC for self-assessment.
  • Limited Company is registered with Companies House and incurs a small registration fees.

Statutory Duties

Sole Traders

  • Sole traders file self-assessment for each tax year.
  • You will require business insurance if applicable in your profession or trade.
  • Register as Employer with HMRC if you have employees.
  • You are responsible to pay any Tax and NICs via self-assessment.

Limited Company

  • For limited company, director’s are legally responsible to file the annual accounts and file corporation tax returns.
  • Directors will have to file their own self-assessment (if required by HMRC) to account for their own taxes.
  • Limited company also needs to have designated registered address.
  • Limited company will also maintain its own business insurance.
  • PAYE scheme will be required to run staff payroll.
  • Confirmation statement to confirm the business address and shareholding details will need to be filed once a year.

Take Home Pay – Which structure wins?

Following table summarises the advantages of having a limited company over sole trader at various profit levels:

ProfitLTDSole TraderAdvantageous
40,00032,48931,375Ltd by £1,114
50,00039,92838,000Ltd by £1,982
60,00046,51243,800
Ltd by £2,712
70,00051,97949,600Ltd by £2,379
80,00057,44755,400Ltd by £2,047

Please note that there are other factors which might lessen the ultimate take home figure and expert advice should be obtained before making your decision.

Decision Time!

It is evident from the issues discussed in this blog that choosing between sole trader and limited company structure is a complex endeavour.

As a whole, limited company offers more tax-efficient business structure, nonetheless, all material factors should be factored in before making the final decision.

At UGS Accountants, offer specialised advice and support to new and developing small businesses. We recognise the importance of how different each business and its needs can be. For this reason, we proactively work with you to make the structuring of business, preparation of your accounts, bookkeeping, VAT and tax return a highly beneficial process, not merely a statutory one.