Q: What are the tax advantages and disadvantages of status as a limited company or as a sole trader?
Sep 24 2006
Answered by: Clive Lewis Ask a question
You do not give any details of the business you intend to start or your aspirations in terms of business growth and ultimate size, so this answer must be very general.
Whether you trade as a sole trader or as a limited company is a key decision when starting a business. If the decision is to start as a sole trader, it is prudent to review the situation after the business has become established. Basically, a limited company provides opportunities for saving tax but it involves a higher level of bureaucracy which you must either undertake yourself or pay others to do so on your behalf. Limited liability might also be advisable if the business venture is particularly high risk.
Forming a limited company has a number of implications, particularly in terms of taxation of profits. There are a small number of ways you can take money out of a limited company – dividends out of profits, a salary which is subject to Pay As You Earn (PAYE) and National Insurance Contributions (NIC) or by repaying a directors loan account which is in credit. A sole trader on the other hand can take money out of the business as frequently as they like, provided it does not leave the business short of funding.
The forms required will also be different. A limited company will be required to file a corporation tax return with HMRC and annual accounts in the proscribed legal format must be prepared and delivered to Companies House. The accounts filed must comply with the statutory requirements. You would need to be aware of the deadlines for completion and submission of the company’s returns to as there are penalties for late filing. A sole trader on the other hand needs to prepare the “Self Employment” return as part of their annual Tax Return. This requires a profit and loss account and balance sheet but if the turnover (sales) is less than £15,000 the requirements are simplified.
Finally, the payments of tax are different. Corporation Tax (for a company) is paid 9 months after the end of the financial year whereas payments of Income Tax and Class 4 National Insurance Contributions are made twice a year –on 31 July and 31st January, based on a payments on account system.
For example, for a self employed person, an accounting year to 31 March 2005 forms the basis of the 2004/5 tax liability and you would make payments on account on 31 January 2005 and 31 July 2005 (based on the total payable directly for the previous year), with a balancing payment or repayment on 31 January 2006 (together with the payment on account for the year ended 31 March 2006). The balancing figure for 2004/5 is calculated after submission of the 2005 Tax Return which would include the self assessment trading figures for the business to 31 March 2005. Basic Class 2 National Insurance contributions are paid monthly usually by direct debit.
Being a limited company has other advantages too. For example, it makes it easier to transfer a share of the business to a new investor. A limited company format is probably appropriate where a venture is high risk. When selling a business run by a limited company there may be a choice of (a) selling the shares (generally no VAT consequences other than a block on input tax relief on purchases directly related to the (exempt) sale of the shares) or (b) the sale of a business by the company (which may be a tax-free transfer of a going concern if all the conditions are met).
You would be well advised to discuss your particular circumstances with a chartered accountant who can advise you in detail. To find a chartered accountant click here.
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