We have written a number of articles on this subject in the past. When setting up a business it is important to consider a number of business factors and you should seek professional advice to work out the optimum business set up. We can advise whether it is more cost effective to set up as a:
- Sole trader
- Partnership
- Limited Liability Partnership
- Limited Company
You don’t have to be a limited company to trade as a business. You can operate a business successfully as an “unincorporated entity” either as a sole trader or partnership. The way unincorporated entities are taxed compared to limited companies is very different. We will consider the 4 most commonly used in the UK and give a brief summary of the main advantages and disadvantages.
Sole trader
A sole trader is considered to be ‘self-employed’ and you must be registered with HM Revenue & Customs (HMRC) for self-assessment. You will pay income tax and National Insurance in accordance with HMRC tax thresholds on profits generated.
Advantages
Owner of the business, entitled to keep all profits
Low cost, easy to set-up
Full control retained
Tax efficient for lower rate taxpayers
Disadvantages
Full liability for debt
Less tax efficient for high earners
Partnership
You and your partner(s) personally share responsibility for your business. Partners share the business profits, and each partner pays tax on their share. Similar to sole trader but more than 1 of you involved in the business.
Advantages
Easy to form, manage and run
Easier to raise finance
Disadvantages
Full liability, affecting all partners
Partnership disagreements
Limited liability partnership (LLP)
No limit to the number of Partners but at least 2 have to be ‘designated members’ responsible for filing annual accounts.
Advantages
Flexibility: can be incorporated in members’ agreement
Benefits of both limited company and partnership combined
Disadvantages
Partners must disclose income
LLP must start to trade within a year of registration – or be struck off
Limited Company
A private company is incorporated and limited by shares. This means that the company has shareholders and the liability of the shareholders to creditors of the company is limited to any money they originally invested. A shareholder’s personal assets are protected in the event of company insolvency, but money invested in the company may be lost.
Advantages
Less personal financial exposure
Limited liability protection
Responsible for its debts only to the extent of the amount of capital invested.
Tax efficient for high earners
Disadvantages
Involves set up costs
Annual accounts and financial reports must be placed in public domain
Other factors to consider
- If you operate your business through a limited company, the company itself will pay corporation tax on its profits. As a director, you’ll generally be paid through a mixture of salary and dividends. Flexibility on dividends and salary amounts provide opportunity for tax efficiency especially for high earning directors.
- Sole traders will generally pay two types of National Insurance contributions a flat rate Class 2 contribution of £158.60 for 2021/22 plus Class 4 contributions at a rate of 9% for annual profit between £9,568 and £50,270. A higher rate of 2% will be charged on profits above that level.
- Company Directors can avoid making NI contributions by taking dividends as they pay income tax on dividends but not NI.
- A downside to dividend taking is that most banks prefer seeing a steady salary income for mortgage lending rather than dividends. A steady salary income is more likely to help you get a mortgage than dividend income.
- For pension contributions the tax benefits for sole traders may not be as attractive as they can be for company directors.
- Sole traders can claim capital allowances in the same way as limited companies. However, the super-deduction capital allowance is only available to limited companies.
Contact:
Cheltenham: 01242 241998
Hammersmith: 020 7118 4422
Email: info@taxcompute.co.uk