If you’re a sole trader, you may have heard that you can save tax by running your business through a limited company. This could indeed be the case, but there are many factors you should consider before you decide what to do.
Let’s take a look at the advantages and disadvantages of trading through a limited company.
Setting Up A Limited Company
In The UK
When you’re a sole trader, you and your small business are legally one and the same. But if you turn your business into a limited company (a process known as ‘business incorporation’), then the company becomes a separate legal entity from you.
This legal separation can work as both an advantage and disadvantage of incorporation, as we’ll now see.
The Advantages Of Incorporation:
– Switching from sole trader to limited company could save you tax
There are indeed some tax savings to be made by switching from sole trader to limited company. Limited companies don’t have to make UK Income Tax payments on account, for example, but sole traders do.
And while sole traders pay Income Tax on profits and make National Insurance contributions, limited companies pay Corporation Tax – which is a lower rate than Income Tax – on the profits, and make no National Insurance payments.
However, it’s important to bear in mind that UK limited companies are not entitled to a personal allowance, nor are their tax savings as significant since the taxation of dividends was changed in April 2016.
It’s important to discuss any potential tax savings carefully with your accountant, and to ask them to calculate what you could save by incorporating. The answer will depend on your business’ circumstances, and (in particular) whether you have any other sources of income.
– You could claim more tax relief on certain costs
When you run your business through a limited company, you’re given more tax relief for certain costs than sole traders are.
For example, a limited company can pay for food and drink for employees (including you!) whenever they’re out and about on business. But on the other hand, sole traders can only claim tax relief on these costs in certain circumstances – like when the business trip involves an overnight stay, for example.
– Limited companies can attract investment more easily
If you are looking for investment in your business, incorporation could give you an advantage.
As a limited company, you will be able to sell shares in your business to investors relatively easily. But sole traders cannot seek investment unless they go through the complex process of turning their business into a partnership.
– You would have limited liability protection
Because a limited company is a separate legal entity from its directors, the company can own equipment, incur debts, and pay bills in its own right.
This means that if the company is sued, your personal assets – such as your house and car etc. – cannot be seized to pay the debt, unless you have given a personal guarantee to a company creditor.
However, if you are a sole trader, your own assets could indeed be seized to pay a business debt, because you and the business are legally the same entity.
The Disadvantages Of Incorporation:
– Running a limited company means more paperwork
Sole traders only have to file one document with government bodies each year: their tax return.
However, a limited company has to file:
- a set of accounts
- a confirmation statement
- a Corporation Tax return
And in addition, each director will nearly always have to file a personal tax return with HMRC. So if you are an employee of your company and take a salary, you will also have to register the company as an employer and set up a payroll system.
As a consequence, after incorporating your business you will either have to spend more time preparing and filing paperwork, or will need to pay your accountant more to do this for you.
– Trading through a limited company involves potential tax costs
As the director of a UK limited company, you would no longer be able to draw money freely out of your business bank account.
The company could pay you a salary, pay dividends on the shares you own, and reimburse you for any expenses you incur on its behalf. However, if you were to take money out of the company for any other reason, you may have to pay extra tax.
Another potential tax implication is that when a limited company makes a loss, it can only use that loss against its own profits. Sole traders, on the other hand, may be able to use any loss their business makes to save tax on their other income.
For example, if a sole trader is also employed elsewhere, they may be able to use their business losses to reduce the tax they pay on their employment income.
– As the director of a limited company, you will have legal duties to fulfil
Your legal responsibilities as company director would include safeguarding the company’s assets, and making the decision to cease trading if you knew the company couldn’t survive.
If you fail in your legal responsibilities as a UK director, the consequences can be serious: you could be fined or even go to prison!
– Limited companies have less privacy than sole traders
When you file your company’s accounts and Confirmation Statement, these documents will be in the public domain, available for anyone to view on websites such as Duedil and Companies House.
This means your figures will be visible to the public, along with your company’s office address – although you could put your accountant’s address on the paperwork, instead of your own home.
Weighing Up The Pros And Cons
As you can see, when it comes to deciding whether or not to incorporate your company, it’s not a clear-cut choice!
The best option for your UK business will depend on your particular circumstances, and the matter should be discussed in detail with your accountant before any decisions are made.