_edited_edited_edited.png){kind=small}
Understanding Business Structures: Sole Trader vs. Limited Company
When starting your journey as an entrepreneur, one of the first big choices you'll face is picking the right way to set up your business. In the UK, if you're going into business for yourself, the first thing you need to do is sign up for self-assessment with HM Revenue & Customs (HMRC). This puts you in the category of a 'sole trader'. This setup is especially popular among small business owners who work alone, like plumbers, beauticians, personal assistants and trainers etc. ....
Being a sole trader is a practical option if you expect to earn a moderate income, staying below the basic rate tax band, which is currently set at £50,270 per year. However, if you foresee earning more than this amount or aim for significant business growth, it's important to consider other business structures.
Another common choice is to establish a 'limited company'. Unlike being a sole trader, a limited company is considered a distinct legal entity separate from you. It operates under its own tax regulations and is responsible for its own paperwork.
When you set up a limited company, you take on the roles of owner (shareholder) and the director of the company. As the owner, you possess the company's assets, and as the director, you oversee operations and ensure compliance with regulations, such as filing accounts and paying taxes.
One significant difference between sole traders and limited companies is how they are taxed. Sole traders pay taxes based on their yearly profits, calculated from April to April. In contrast, limited companies are taxed on the profits they make throughout their financial year, depending on when they were incorporated.
Another thing to know is that with a limited company, the profits stay in the company. If you want to access the money, you have to take it out as either a salary or dividends.
The good thing about limited companies is that they usually pay lower taxes compared to sole traders. They pay something called 'corporation tax', which is currently 19% and 25% ( companies with profits over £250,000) Sole traders can end up paying up to 45% in taxes on their profits. But there's a catch with limited companies: when you take money out, you'll need to pay income tax on it, depending on how much you take and whether it's salary or dividends.
To make the most of your limited company's money, it's common to take a small salary, maybe around £ 1047 ( £12570/12) , and then take the rest as dividends. But figuring out the best way to pay yourself from your company can be tricky and might need some help from your accountant.
The tax you pay on the dividends you receive depends on the amount you withdraw.
First £1000 - 0%
Basic rate (£12,571 to £50,270 ) - 8.75 %
Higher rate ( £50,271 to £125,140) -33.75%
Additional rate ( over £125,140) - 39,35 %
If you have more than one shareholder in the company, such as a spouse or partner, you can divide the profits taken out to help reduce your overall taxes.
Other advantages of having a limited company
Owning a company adds a certain level of prestige. This can be advantageous when pursuing sponsorship deals as it portrays you as a serious business entity. It lends an air of professionalism and legitimacy to your endeavors, making you appear more official and reputable in the eyes of potential sponsors.
Reduced risk
When you run your business through a company, there's a protective layer around you. This means that if the company faces financial troubles, like being unable to pay off a large debt, your personal assets are typically safe from legal action. For example, if the company receives a debt demand that it can't meet and you haven't given a personal guarantee, creditors generally can't pursue your personal belongings. This protection isn't available if you're operating as a sole trader.
Objective
It's essential to seek advice on whether setting up a limited company is the right choice for you and to understand the potential tax savings it could offer. Taking action on this sooner rather than later is crucial to avoid facing a substantial personal tax bill.
Beware of
Once you establish a company, as a Director, you're responsible for ensuring that all financial accounts are filed and statutory obligations are met. If you haven't hired an accountant to handle this for you, failing to meet deadlines could lead to penalties for non-compliance.
Please note that as of April 1, 2024, the VAT registration threshold will increase to £90,000, and the VAT deregistration threshold will rise to £88,000. This marks the first change to the VAT registration threshold in seven years.
Tax avoidance vs tax evasion
In the last years tax avoidance has been the subject of considerable public concern, even thought there is no statutory definition of what tax avoidance consists of. Tax avoidance is permissible within legal borders. There are legal ways to reduce a tax bill encouraged by the Government. A simple tax planning is legal and involves using the rules to reduce your tax bill in the way they intended, For example paying into a pension scheme would reduce your tax bill. While aggressive or abusive avoidance will seek to comply with the law but undermine its purpose and lead to legal and ethical complications. Some businesses and individuals go much further to minimize their tax liabilities, which can give rise to accusations of tax avoidance, if not outright tax evasion. As an example we can take the umbrella companies. Many of these companies operate within the tax rules, however, some umbrella companies promote tax avoidance schemes. These schemes claim to be a ‘legitimate’ or a ‘tax efficient’ way of keeping more of your income by reducing tax liability.
Tax evasion- this is illegal and involves clearly breaking the law tax, for example failing to declare profits of a business.
Furthermore, states GOV.UK: “Most tax avoidance schemes simply do not work, and those who use them may end up having to pay much more than the tax they tried to avoid, including penalties.”