We regularly get asked about the benefits of becoming a Limited Company from existing clients who operate as sole traders and from new clients that are embarking on a new business venture.
The most important part of the decision is to take expert advice, as although there are many advantages to going Limited, there can be a few downsides that need to be considered.
This guide will cover not only the main differences in accounting and taxation of Limited Companies compared with sole traders, but will detail all the benefits of going Limited along with the downsides.
Summary of Self-Employed Taxation
Let’s start by looking at the taxation of self-employed taxpayers.
Being self-employed usually means that you are operating as a sole trader, or a partner in a partnership. Both situations give the same result for you as an individual.
When you’re self-employed, you pay tax and National Insurance on all your business profits, or your share of business profits if you are a partner.
Another important point is that it is you who is in business, so you are personally responsible for any liabilities or debts in your business.
In terms of administration, it couldn’t be simpler – you will normally just need to prepare a set of business accounts, usually up to 5th April, and submit these figures on your personal tax return along with any other income you have earned. Unless you have any employees or you’re VAT registered, this is all you are required to do: one submission deadline a year.
The tax and National Insurance is based on the business profits submitted on your personal tax return and paid over in 2 instalments, being July and January each year.
Let’s now move on to Limited Companies.
The first difference relates to Limited Liability; your Limited Company and yourself are two separate legal entities.
That means that if your business is sued, it is your company and not yourself that is sued, meaning the directors and shareholders will not be liable for the debts of the company unless you’ve given personal guarantees or it can be shown the directors have been negligent.
Summary of Limited Company Taxation
Now let’s move onto the most important part of the decision – Tax.
As a Limited Company, after taking a salary for yourself, your remaining profits are subject to corporation tax at a rate of 20%. The resulting balance can then be paid out as dividends to you as a shareholder with roughly the first £30,000 being tax – free.
Another advantage is flexibility; you have the option to pay out all the remaining profit as dividends or leave some or all in the company, you will only be taxed on what you take out.
If we take an example of a business with profits of £30,000, operating as a Limited Company would give an overall tax saving of approximately £1,500 per annum compared to trading as a sole trader; larger savings can be achieved with higher profits.
There are other advantages to operating as a Limited Company, these are:
Being seen by customers and more importantly potential customers as a Limited Company will portray your organisation as a larger
business. Some businesses are less likely to work with companies which are not limited.
It is often easier to obtain finance as a Limited Company, especially when you have a few years trading history.
As a Limited Company you do not suffer any effect on your own personal credit rating should your company not be able to settle its debts.
It is often easier to obtain investment as a Limited Company.
Sale of Business
It is much easier to sell your business to a third party if you are a Limited Company.
Now, let’s move onto the disadvantages of operating as a Limited Company, many of which can be mitigated by getting a good accountant to help with your accounts.
Extra Administrative Work:
Each year, you will need to prepare and file the following documents:
& Customs (HMRC) along with a company tax return.
Extra Professional Fees:
Operating a Payroll Scheme:
Other disadvantages that may be applicable are as follows:
Directors of a Limited company have certain legal responsibilities, which are laid down by Companies House. Failing to meet these responsibilities can result in the directors being disqualified from acting as a company director again, hefty fines, or in the worst case a prison sentence.
If you use a car for business then as a Limited Company there are strict rules on the taxation of company cars. Unless you own a low emission vehicle this will usually result in an extra tax liability compared with trading as a sole trader.
Nobody goes into business to lose money, but if you do happen to lose money the tax treatment between self-employed and Limited Companies do differ. As a Limited Company, you have the option to carry this back against previous year profits or carry forward against future year’s profits. You can do the same as a sole trader, with the added benefit of being able to set off any trading losses against your total income. This could include rental income or salary income.