Sole Trade -v- Limited Company

DFL · Mar 13, 2008

There has been a wealth of posts on this subject, some giving excellent advice and some giving not so good advice.

I am not sure what mine falls under but will give you my thoughts.

First things first, consider the IR35 question before moving on.

Once satisfied, tax considerations.

Currently, on annual net profits of £50,000, the company option will save you up to £3437 per year in tax. (I am working on the basis of personal allowance salary balance dividends)

Differential pension treatment between that of a company and as a sole trade or partnership will also benefit you.

So in tax terms it first appears to be a no brainer.

Unfortunately there is a lot more to consider.

If you go limited then your accountants fees will most likely rise by iro £1,000 compared to a non incorporated trade. This will reduce the tax gain.

If you run a car through the business then depending on the car you drive this will also have a significant impact on your tax bill. An older car would mmost likely be more attractive through a limited co - a gas guzzling 4x4 would be much more beneficial running through a sole trade or Partnership.

Tax credits can be adversely affected by your choice due to dividends being grossed up - so exactly the same actual income would be treated differently for tax credits and affect the amount received.

Corporation tax rates / income tax rates - The former is rising, the latter is falling.

This government has moved the goalposts with regard to taxation of small companies more in the last five years than in living memory - who knows what is next? Income shifting will be in in some shape or form in one year, and don't rule out NI on dividends for close companies (once the election is out of the way, of course)

And once you have incorporated and got all of the reliefs then you won't get any more, or find it as easy, to go back the other way should the above come to fruition.

Then there is all the other stuff that is always bought up:

Limitation of liability - How important is that to the business?
Perception - How important is that to the business?
Administration - How good are you at it?
Directors Duties - More onerous than that of a sole trader
Loss relief - Important consideration
Associated companies - If so could increase the company tax rate.
Profit extraction - In particular dividend paperwork must now be watertight and can only come from profit.
Critical illness cover - Los salary / high dividend, are dividends taken into account by your insurers? If not could be a nasty surprise when you most need the cash.

The trouble is that a lot of advice given is to go limited due to the immediately apparent tax advantages of low salary / high dividend, and people are quick to take it up due to them naturally wanting to retain more of their hard earned profit. Yet many of the above points are not always considered and they need to be.

Don't get me wrong - my opinion is that the limited company route remains an attractive solution to many, but those who decide to go into it should do so with their eyes open and aware of the full facts. And what suits one doesn't always suit another - there is no standard answer without knowing the full facts of someones business, and even their personal traits.

Don't make this decision lightly.

KM-Tiger · Mar 14, 2008

Thank you for a very useful summary of this question.

Mods: Please can this be stickied? The question does get asked a lot, and as DFL points out, there is never a quick and easy answer.

MikeH · Mar 14, 2008

An excellent overview that should reduce the number of repetitive posts on the subject. I am sure there will still be plenty of additional questions but hopefully they will be targeted to a specific issue raised by this thread rather than general questions.

Mike.

elaine@cheapaccounting · Mar 16, 2008

Could we add a few more things here which crop up regularly:

Preparing dividends vouchers:

http://www.ir35calc.co.uk/dividend_documentation.aspx

Dividends / Tax explained:

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/TaxOnSavingsAndInvestments/DG_4016453

Use of home as office - if you are a director

http://www.hmrc.gov.uk/manuals/eimanual/EIM32760.htm

Use of home as office - sole trader (self employed)

http://www.hmrc.gov.uk/manuals/bimmanual/BIM47800.htm

tax-sorted · Mar 20, 2008

And always seek professional advice before making a decision.

It amazes me how many people just "do it" and incorporate without any idea of the repurcussions! I agree with all that has been said above but would like to add - PLEASE SEEK PROFESSIONAL ADVICE BEFORE DOING THIS!

I don't write my own will, perform my own surgery, do my own conveyancing or repair my own central heating boiler. I pay an expert. And if we all did that then we would all earn money for doing what we do best

In the long run the money you pay out for good advice should far outweigh the benefit.

derren · Mar 20, 2008

This is great advice. I am regularly asked by clients what to do, with the most common question/statement is "jim down the pub says i should be ltd because I will pay less tax so I want to go ltd".

I also have another friend who went ltd but now is regretting it and he can not work out why he went ltd now he has realised its not so good for his situation. He was another one who went with "jim - in the pub" advice. Might go down the pub and find "jim" and give him a kicking.

Also fees to companies house don't forget for annual returns etc.

Derren

lizzyllu · Mar 27, 2008

Are there any other options other than umbrellas or going ltd?

I have been combing the forums and websites but no one really saying if there is ir isnt?

tax-sorted · Mar 27, 2008

It depends! To answer your question an accountant or advisor would need to know a lot more about your business, your business plan, profit expectations, how much money you need to live and on......................................
there is no easy answer and if you get it wrong it can be very costly.
go to my website http://www.tax-sorted.biz/helpsheets/index_tax.php and download some information for free about how to trade

VickyShaw · Apr 18, 2008

This is a very good post on the subject of the difference between limited companies and sole traders. Does the savings calculation relate to the 2007/08 or 2008/09 financial year? If the former, then could someone update the amounts so that they relate to the new tax year figures and thereby keep the sticky current?

Vicky

tax-sorted · Apr 19, 2008

Thats a very dangerous statement mortgage broker! On what figures are you basing your assumptions? It depends on the profit, how much money you want to take from the company, what are your long term plans and much more.

You should NOT base a decison how to trade purely on tax reasons. An old saying "don't let the tax tail wag the dog" springs to mind!

I have seen so many people do this for the wrong tax reasons and regret it. My message is the same - always seek professional advice BEFORE deciding how to trade.

tax-sorted · Apr 19, 2008

It looks like mortgage broker withdrew their last post so it makes mine look a bit confusing! WHat mortgage broker said was "Its better from a taxation point of view to go down the LTD Company route" A very dangerous statement from someone not qualified to give that sort of advice! Stick to what you are good at my friend

elaine@cheapaccounting · Apr 30, 2008

This seems to come up time and again so added here:

When you register as an employer a free CD ROM is sent out and you receive automatic updates for budget changes etc. The CD ROM covers payroll, end of year forms etc

And go can get a free course on it, see here:

http://www.hmrc.gov.uk/bst/index.htm

Haydn1971 · May 7, 2008

elainec100 said:
Preparing dividends vouchers:

http://www.ir35calc.co.uk/dividend_documentation.aspx

Now this has me half worried - When I was working through my previous contract incarnation I used to recieve a weekly pay slip indicating pay, expences and dividend payments - Now as far as I'm aware I don't have to give myself a payslip, but should I be breaking down the payments made to me each week as a payslip (showing dividends) or is it simply enough to have this as a spreadsheet column covering each week of the year ?

i.e. how often do I legally need to issue a dividend voucher ?

P.S. Thanks for the heads up in the other thread about his thread

elaine@cheapaccounting · May 8, 2008

Haydn1971 said:
Now this has me half worried - When I was working through my previous contract incarnation I used to recieve a weekly pay slip indicating pay, expences and dividend payments - Now as far as I'm aware I don't have to give myself a payslip, but should I be breaking down the payments made to me each week as a payslip (showing dividends) or is it simply enough to have this as a spreadsheet column covering each week of the year ?

i.e. how often do I legally need to issue a dividend voucher ?

P.S. Thanks for the heads up in the other thread about his thread

Haydn - that shows liked a MSC which have now been outlawed!

Mark Lee · May 9, 2008

Great advice here but the savings quoted above are way out of date now as recent tax changes have significantly reduced the headline potential tax savings - that are not available across the board anyway as is clear in the rest of the first post above.

I'd add the following by way of background to help clarify things:

It is all too easy to make simplistic comparisons of the comparative tax burdens on an unincorporated business and an incorporated one. There are other tax and commercial issues to consider too.

There are a range of commercially available spreadsheet style programmes to assist the process, but they invariably require the user to make various assumptions. Nevertheless these programmes can be useful tools to demonstrate the potential tax savings that may follow from incorporation, or indeed now, from disincorporation. If you're interested in obtaining one of the best such programmes drop me a note and I'll let you have the details.

In practice the real difference in comparable tax burdens year on year will depend upon a range of issues, not all of which are catered for in typical spreadsheet programmes:

the relative level of salary and dividends to be paid by the company and any restriction on the potential timing or level of dividends;
the timing of dividend payments and the impact of these on annual income as regards entitlement to tax credits;
the level of non-deductible business related expenditure, eg: entertaining;
business use vs personal use of car or van and whether this is to be owned personally or by the company;
timing of incorporation and impact on self assessment tax payments re the final period of pre-incorporation trading;
the extent to which profits will be retained in the company to fund capital expenditure and expansion;
the extent to which post-corporation tax profits will be used to fund loan repayments rather than dividends.

It's also important to be aware that companies pay corporation tax on their profits. The taxable profits of a company are identified after deducting all salary payments including those paid or payable to the owner. Dividends however are not deducted. Company law requires that dividends are paid out of a company's reserves which means what's left after the corporation tax has been charged on the profits. Salaries are subject to tax and NICs at upto 41%. Dividends are only subject to income tax if the shareholders taxable income makes them liable to higher rate tax. In such cases 25% tax is payable on the amount of dividend received by the shareholder.

The level of corporation tax depends upon the level of profits (and the existence of any associated companies). Where one person only owns one company for instance, corporation tax is now payable at 21% on profits upto £300,000.

mahutchinson · May 13, 2008

I would say that the directors' duties (now codified in CA 2006) are mostly theoretical and common sense stuff which a sole trader should also follow, apart from recording board minutes.

limes_04 · May 28, 2008

This is very informative post between Sole Trade and Limited Company

.

Alexa42 · Jun 3, 2008

There is a lot to take into consideration when doing these calculations. You could end up making a detrimental mistake.

Alexa42 · Jun 3, 2008

I agree with tax-sorted he knows what he is talking about! Good overview too.

Jezclayton · Jun 13, 2008

For someone who has had a limited company for a number of years and never taken a dividend payment (long story) this thread has been a minefield of useful information. Whilst a completely different industry sector to my own, the link to Contractor Calculator was particularly useful.

There were however a couple of areas that I didn't immediately grasp, probably due to them being taken for granted by more experienced individuals:-

What format and content should the minutes of a dividend declaration take?
What is a tax voucher and where do you get one from? I initially assumed this was a prescribed form and not in effect a letter.

I eventually found answers to both of the above in the Contractor Calculator pages http://www.contractorcalculator.co.uk/declaring_dividends_paperwork.aspx

The other confusing area was over the tax credit. I understood that a shareholder may receive say a net dividend of £9,000, a tax voucher for £1,000 and thus a gross declarable dividend of £10,000. What I wasn't so sure of was the treatment within the Company accounts. Would reserves be reduced by £10,000, with corresponding entries of £9,000 paid to shareholders and £1,000 payable to HMRC, or are reserves just reduced by £9,000, the tax voucher being notional only? My current understanding is that it is the latter. Could someone please confirm this?

Finally, with the 10% personal tax rate now abolished, does this have an impact on the amount of future dividend vouchers or are they totally unrelated?

Jenni384 · Jun 14, 2008

Jezclayton said:
The other confusing area was over the tax credit. I understood that a shareholder may receive say a net dividend of £9,000, a tax voucher for £1,000 and thus a gross declarable dividend of £10,000. What I wasn't so sure of was the treatment within the Company accounts. Would reserves be reduced by £10,000, with corresponding entries of £9,000 paid to shareholders and £1,000 payable to HMRC, or are reserves just reduced by £9,000, the tax voucher being notional only? My current understanding is that it is the latter. Could someone please confirm this?

Yes, you are right.
Nothing is payable to HMRC. The £1000 tax was already 'paid' when the company paid Corporation Tax. The company's reserves are reduced by £9000, which corresponds to the £9000 being paid out of the bank account to pay the dividend to the shareholder.

Finally, with the 10% personal tax rate now abolished, does this have an impact on the amount of future dividend vouchers or are they totally unrelated?

Tax on divis remains unchanged. They are taxed at 10% until the shareholder hits higher rate, and then they are taxed at 32.5%.

amybt23 · Jun 25, 2008

DFL said:
There has been a wealth of posts on this subject, some giving excellent advice and some giving not so good advice.

I am not sure what mine falls under but will give you my thoughts.

First things first, consider the IR35 question before moving on.

Once satisfied, tax considerations.

Currently, on annual net profits of £50,000, the company option will save you up to £3437 per year in tax. (I am working on the basis of personal allowance salary balance dividends)

Differential pension treatment between that of a company and as a sole trade or partnership will also benefit you.

So in tax terms it first appears to be a no brainer.

Unfortunately there is a lot more to consider.

If you go limited then your accountants fees will most likely rise by iro £1,000 compared to a non incorporated trade. This will reduce the tax gain.

If you run a car through the business then depending on the car you drive this will also have a significant impact on your tax bill. An older car would mmost likely be more attractive through a limited co - a gas guzzling 4x4 would be much more beneficial running through a sole trade or Partnership.

Tax credits can be adversely affected by your choice due to dividends being grossed up - so exactly the same actual income would be treated differently for tax credits and affect the amount received.

Corporation tax rates / income tax rates - The former is rising, the latter is falling.

This government has moved the goalposts with regard to taxation of small companies more in the last five years than in living memory - who knows what is next? Income shifting will be in in some shape or form in one year, and don't rule out NI on dividends for close companies (once the election is out of the way, of course)

And once you have incorporated and got all of the reliefs then you won't get any more, or find it as easy, to go back the other way should the above come to fruition.

Then there is all the other stuff that is always bought up:

Limitation of liability - How important is that to the business?
Perception - How important is that to the business?
Administration - How good are you at it?
Directors Duties - More onerous than that of a sole trader
Loss relief - Important consideration
Associated companies - If so could increase the company tax rate.
Profit extraction - In particular dividend paperwork must now be watertight and can only come from profit.
Critical illness cover - Los salary / high dividend, are dividends taken into account by your insurers? If not could be a nasty surprise when you most need the cash.

The trouble is that a lot of advice given is to go limited due to the immediately apparent tax advantages of low salary / high dividend, and people are quick to take it up due to them naturally wanting to retain more of their hard earned profit. Yet many of the above points are not always considered and they need to be.

Don't get me wrong - my opinion is that the limited company route remains an attractive solution to many, but those who decide to go into it should do so with their eyes open and aware of the full facts. And what suits one doesn't always suit another - there is no standard answer without knowing the full facts of someones business, and even their personal traits.

Don't make this decision lightly.

Thanks for the useful information.

Fernhurst Solutions Ltd · Aug 20, 2008

I know it's not related to this subject, but does anybody think a similar 'sticky' should be created for people starting up as a bookkeeper??

There seems to be a request for this sort of information at least once a week.

in-business · Aug 21, 2008

There is also the longer term view - I have just posted an article on the best way to extract funds from a limited company on my blog/forum at in-business.org.uk (new member so cannot include a direct link yet), but if you click on my signature below and go to the "Category" "tax advice for businesses" you will see my comments on this subject.

adventurelife · Sep 24, 2008

Leading on from the excellent advise from the OP a ?

If you sell your sole trader business to a new ltd company and become a 100% share holding director can you do the following?

Charge the company interest on the directors loan that is on the balance sheet? If so I would imagine that interest must be counted as income and hence taxed via paye?

Can you draw down payments back from the directors loan without having to pay tax? I would imagine this is okay?

Zeno · Sep 24, 2008

adventurelife said:
Leading on from the excellent advise from the OP a ?

If you sell your sole trader business to a new ltd company and become a 100% share holding director can you do the following?

Charge the company interest on the directors loan that is on the balance sheet? If so I would imagine that interest must be counted as income and hence taxed via paye?

Can you draw down payments back from the directors loan without having to pay tax? I would imagine this is okay?

Yes, you can charge interest on the directors loan but it must be at a reasonable market rate and the company will have to hold back a tax deduction just like bank interest. This interest will be taxed on you personally in the usual manner on your self assement return and not through PAYE.

You can repay your directors loan anytime without any tax consequence.

cashboy · Sep 27, 2008

As an accountant; I would always advise the Ltd Company route.

Other considerations are:

Claiming Tax Credits (you show low salary and easy to show wage slips and P60's than self employed accounts; also private account does not show business transaction)

Liability against personal claims especially if doing building work and can damage client's property though you should have insurance cover anyway but often this insurance would not cover you.

Inland Revenue investigate more self-employed accounts than Ltd Corporation Tax Returns by about 10 times.

With the economic climate as it is and going to be in 2009; it is much easier to sign on if no work by issuing a P45.

DFL · Oct 4, 2008

cashboy said:
As an accountant; I would always advise the Ltd Company route.

With respect, this is not a sensible approach.

I had a new client come in this week wanting me to form a limited company for him. He had heard that this was the best way for him. Despite the increased fee that we could have charged him I talked him out of it and he is going self employed instead.

The reasons for this? Already in full time employment, doesn't like paperwork, profits no more than 10k, potential opening year losses to offset against PAYE, limited budget.

All in all a no-brainer.

To adopt a 'one size fits all approach is a dangerous one.

Jenni384 · Oct 4, 2008

DFL said:
With respect, this is not a sensible approach.
[...]
To adopt a 'one size fits all approach is a dangerous one.

Thank for this, I have to agree with you here.
Ltd Cos can be great but not for everyone and not all the time.

elaine@cheapaccounting · Oct 12, 2008

Totally agree - time and time again I see situation where a client has gone the limited route (through a cheap company set up) and then only are aware of the filing requirements when they get notices / fines from HMRC and Companies House.

If you do go limited make sure you know your filing responsibilities for:

Annual Stat Accounts (full for HMRC and abbreviated for co house)
Annual Return (different to the accounts - which not many seem to be aware of)
CT 600
Full P&L for HMRC
PAYE - P35, P14s, P11d etc (if applicable)
VAT
Self assessment for directors

I am sure there are some that I have missed.

200386 · Nov 12, 2008

Unless the limited liability is needed for the business, it is better to take the sole trader option, as it would mean:
1. Less beauracracy (with ltd company you have to deal with Companies House and HMRC).
2. Flexibilty for drawing money out of the business (without having to worry about paye and/or dividend paperwork).
3. Claiming motor expenses (sole trader just deducts a certain percentage for private use).
4. Simpler accounts can be submitted (Balance Sheet not required for the sole trader).
5. Accounts can't be seen by the public.
6. Less deadlines and penalties to worry about.

elaine@cheapaccounting · Nov 12, 2008

200386 said:
Unless the limited liability is needed for the business, it is better to take the sole trader option, as it would mean:
1. Less beauracracy (with ltd company you have to deal with Companies House and HMRC).
2. Flexibilty for drawing money out of the business (without having to worry about paye and/or dividend paperwork).
3. Claiming motor expenses (sole trader just deducts a certain percentage for private use).
4. Simpler accounts can be submitted (Balance Sheet not required for the sole trader).
5. Accounts can't be seen by the public.
6. Less deadlines and penalties to worry about.

Agree to the above except it does not consider any tax advantages which can be gained by a limited company both during its operation and on exit (e.g. selling of the business)

DFL · Nov 12, 2008

200386 said:
Unless the limited liability is needed for the business, it is better to take the sole trader option, as it would mean:
1. Less beauracracy (with ltd company you have to deal with Companies House and HMRC).
2. Flexibilty for drawing money out of the business (without having to worry about paye and/or dividend paperwork).
3. Claiming motor expenses (sole trader just deducts a certain percentage for private use).
4. Simpler accounts can be submitted (Balance Sheet not required for the sole trader).
5. Accounts can't be seen by the public.
6. Less deadlines and penalties to worry about.

With respect, better for who? The business or the taxman?

The whole point of the post was that there is no 'best' way - the decision should always be made on the unique business and what is important to it's owner(s). There are a whole host of considerations to be taken into account before such an inportant decision is made.

200386 · Nov 12, 2008

DFL said:
With respect, better for who? The business or the taxman?

The whole point of the post was that there is no 'best' way - the decision should always be made on the unique business and what is important to it's owner(s). There are a whole host of considerations to be taken into account before such an inportant decision is made.

Since the £10k zero tax band was taken away from small ltd companies, it is better for most small businesses to be sole traders or partnerships (unless the ltd liability is a big issue). It is very easy to tell clients to take a small salary and the rest as dividends, until the taxman comes along. Not to mention company car tax, fuel benefits and dealing with ltd company regulatory demands by Companies House.

David Griffiths · Nov 12, 2008

200386 said:
It is very easy to tell clients to take a small salary and the rest as dividends, until the taxman comes along. .

What has the taxman got to do with it? Nothing.

dp0848 · Nov 13, 2008

David Griffiths said:
What has the taxman got to do with it? Nothing.

Exactly. Nothing wrong with the small salary / dividend top up approach. Perfectly legal and you won't get hassle from the taxman if you keep your paperwork in good order.

elaine@cheapaccounting · Nov 13, 2008

Everyone is entitled to their opinion - it is what this forum is about.

My opinion is that this is no right and wrong answer to limited v sole trader. Each situation needs to be looked at to understand the needs of and projections for the business coupled with the business owners tax planning.

IMO this sticky is aimed at giving some pointers to look at when assessing the situation rather than to reach a conclusion where one hat fits all.

MikeH · Nov 13, 2008

elainec100 said:
Everyone is entitled to their opinion - it is what this forum is about.

If only this was understood by some members.

elainec100 said:
My opinion is that this is no right and wrong answer to limited v sole trader. Each situation needs to be looked at to understand the needs of and projections for the business coupled with the business owners tax planning.

IMO this sticky is aimed at giving some pointers to look at when assessing the situation rather than to reach a conclusion where one hat fits all.

Spot on. One size does not fit all. I have spoken to 2 forum members recently and in my humble opinion I suggested that they may not need to go limited at first. As I did not know their personal circumstances I was not able to make an informed decision and I recommended that they contacted an accountant (suggesting several on here). A small profit from a forum member is worth far less than my reputation.

It is not always protecting liability. It is not always about PAYE and dividends. It is not always about reducing tax (not avoiding). It is not always about fear of accounts and regulation. It is not always about the perception a company offers clients.

It is about finding the right business format for the individuals involved. If you are not sure, GET ADVICE. (Had to shout that bit)

BristolBiz · Nov 13, 2008

Interesting thread. If statistics are to be believed, most businesses (about 80% if I remember rightly) don't make it past 5 years. One of the key benefits of a limited company is limited personal liability, am I right in thinking that trading as a sole trader leaves you personally liable for all the businesses debts?

While you don't start a business anticipating failure, failure happens frequently, sometimes for reasons that are totally beyond the control of the business.

It seems to me to be a no-brainer, you should always look to limit your exposure to risk whenever possible, tax issues are very small beer in the great scheme of things, losing your home isn't.

Learning how to run a limited company is just part of the business skills set needed, its not that difficult really!

MikeH · Nov 13, 2008

I agree with some of your post. But the limited liability is only part of the mix. Your post implies that you should go LTD as it offers the protection. Not all businesses are likely to require liability protection. Yes it is important, but one size does not fit all.

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