Starting a new business?
If you have taken the decision to start your own business, you may be overwhelmed by the sheer number of choices when it comes to how you should organise your business. Whilst it can be invaluable to take advice from people who have experience of running their own business, financial arrangements can vary hugely from one sector to the next or depending on your income and tax arrangements.
When making your decision it is always recommended that you consult an expert so your decision is as well-informed as possible. We’ve outlined some of the main options when it comes to setting up your business so you can be confident about what each entails and if it’s the right choice for you.
Structure
Before you take that first step, it is important to consider the various structures and decide which is the best for you and your business plan.
Limited company
A limited company is a separate entity which is established for the sole purpose of running your business. The company will appoint a director at incorporation (you), and as a director, you will be responsible for paying taxes and keeping accounts up to date. All earnings from your limited company will sit in a separate bank account and these profits can be withdrawn by means of dividends.
Trading through a limited company means that it is the company, not the individual who can enter into contracts and take responsibility for its finances.
Is a limited company right for me?
For those who want to enjoy as much of their income as they can, trading through a limited company that you set up and run yourself is usually the most lucrative way to do business. As the director of a limited company, you can benefit from a range of tax efficiencies which are not available to those who are operating as sole traders or through other structures. You can also choose to draw dividends as well as a salary from a limited company, and because dividends do not attract National Insurance, this can help you to save money on your annual bills. Tax Free Dividends and reduced tax rates apply (subject to changes).
It is also a good way to minimise the risks to your personal assets as you and your company will be considered as separate entities, which means that generally you will not be personally liable for business debts, even if you are the sole shareholder.
As a limited company director, you will have the option to organise your limited company and manage your expenses in the most effective way.
Free Limited Company Formation
Most accountants will charge a fee, typically around £100 to set up a limited company for their clients. At Lexicon Tax, we provide a limited company formation service to all our clients free of charge. If you’re considering starting a new company, give us a call and we’ll get you set up with the right structure, share ownership, directors and mechanism. Fancy a prestigious address for your new company in the city? Knightsbridge, Canary Wharf, Kensington and the like? We can arrange that for you too at a small cost to setup a virtual office. Call us now on 0114 4000192 to take the first step in planting the seed to success.
Sole Trader
If you work as a sole trader, you will need to register as self-employed and will be required to submit your earnings via a self-assessment tax return providing you are not taxed under PAYE. As the exclusive owner of the business, you will be entitled to all earnings but you will also be solely responsible for any debts that may be incurred. A sole trader works in much the same way as a limited company, the main differences being your liability and the work you will need to complete.
Is setting up as a sole trader right for me?
When you are just starting out and establishing yourself in business, being a sole trader can be the simplest and easiest way to work. You can register with HM Revenue and Customs (HMRC) for free using their online form or over the phone, and they will provide you with all the information you need to get started. You will be responsible for completing an annual self-assessment tax return and paying your own tax bill, but the process is relatively simple and the form will calculate how much tax you owe. You will also have to pay your own National Insurance at the appropriate rate.
Offshore tax schemes
This kind of scheme constitutes tax avoidance and operating under such could leave you vulnerable to penalties.
If you live and run a business in the UK, there must be a very specific set of circumstances which would allow you to forgo paying taxes and any scheme which involves you moving money out of the country should be met with caution.
There are schemes which utilise offshore accounts and promise investors the chance to take home a relatively high proportion of their income. Those who sell these schemes often promise to reduce your tax bill by paying a low salary and offering the rest as a ‘loan’. Some will claim to be HMRC approved tax vehicles or state that they are ‘legally backed’ in order to seem legitimate, but using such a scheme would be unadvised by most.
Is an offshore tax scheme right for me?
Lexicon Tax does not offer any schemes and would remind our self-employed clients to remain wary of such arrangements. Since legislation updates in 2011, the government has taken a stance to make the benefits of these companies useless in a bid to deflect any attractiveness.
Partnership
A partnership is an arrangement whereby two or more sole traders choose to work together. The sole traders will submit their own self-assessment tax returns and pay National Insurance as individuals. However, the business will be treated as one entity when it comes to VAT registration.
Profits are calculated at the partnership level and then distributed amongst partners by agreement and taxed on the individual partners by way of self-assessment. So you must include your share of the partnership profit in your own tax return.
Is a partnership right for me?
Partnerships can be a good way of working with others to build a business whilst still having your financial independence. However, you should bear in mind that each partner is considered jointly liable for any debts which the business may incur. This means that if one partner can’t pay their share of the debts, it will be the responsibility of the other to make up the amount.
Limited Liability Partnership
A Limited Liability Partnership (LLP) works as a hybrid between a normal partnership and a limited company. Under this arrangement, business owners can enjoy the freedom and flexibility of a partnership with the security of having limited liability similar to a company. Each partner will become a member who is self-employed and remunerated in the way of ‘drawings’. These profits do not affect the level of profits declared for tax purposes.
Is a limited liability partnership right for me?
An LLP is an alternative corporate business vehicle, giving the benefits of limited liability but allowing its members the flexibility of organising their internal structure as a traditional partnership. If you and a partner are looking for flexibility but want to keep your business modest and secure, a limited liability could be a good compromise
So which one should I go for?
Most small businesses within the UK will either operate as a sole trader or a limited company. Each has their positives and drawbacks, so it’s important to examine both structures in order to help you decide what is best for your business. As part of our tailored service, we are happy to advise you on the most suitable method specific to meet your business needs.
What are the differences between a sole trader and limited company?
Setting up as a sole trader is the easiest and simplest way to set up your own business. When an individual registers themselves as a sole trader, that person alone becomes the sole owner of that business, and is responsible for all actions, financing and transactions that business takes. Setting up as a sole trader is relatively straightforward: you register your business on the GOV.UK website, and you will be able to commence trading.
Creating and running a limited company is a little more complex – when you register a limited company, that business then creates its own legal identity. Whereas a sole trader becomes directly responsible for any actions that organisation takes, a limited company director’s assets outside the business do not become liable. If you decide to go down the company route, remember, we offer free company formation for all our clients.
What are the advantages and disadvantages of setting up as a sole trader?
Both business structures have their own advantages & drawbacks. Below we will examine the benefits and pitfalls of setting up as a sole trader.
Advantages
- Becoming a sole trader is relatively easy and is not a complicated process. It involves minimal paperwork and admin.
- As a sole trader you have more freedom when accessing the organisation finances. For example, you can borrow from the organisation’s business account, as it is essentially yours.
- You have greater privacy as a sole trader. Whereas limited organisations have to register their accounts each year, sole traders do not.
Disadvantages
- Sole traders are not viewed as a separate entity within UK law. This means that sole traders have unlimited liability and if the organisation goes into debt, the owner’s personal possessions & assets become liable.
- When setting up as a sole trader, you may only have a personal pension. Limited companies, on the other hand, can potentially design pension schemes which are far more generous than personal pensions.
- In comparison to limited companies, tax on sole traders is a lot higher. When you begin to go over a certain salary threshold, it would not be advisable to still be set up as a sole trader.
What are the advantages and disadvantages of setting up as a limited company?
Like with sole traders, there are advantages & disadvantages to setting up a limited company. We have outlined some of the main pros & cons below.
Advantages
- As mentioned earlier, limited companies have limited liability. This means that the business itself is a separate entity to the individual’s that run the organisation, therefore if the organisation has debts owed, the organisation is responsible for it, not the directors & shareholders.
- Limited organisations face a ‘kinder’ tax rate than sole traders once they get past a certain threshold. Whereas sole traders pay income tax, limited organisations will pay corporation tax, which is more often than not, a lot smaller than income tax. This means that a limited organisation will typically be more profitable than a sole trader.
- There are greater allowances & tax deductible costs available for limited companies, which would not be available to sole traders.
Disadvantages
- Unlike sole traders, limited companies will need to file yearly account with Companies House. This can be complicated, but can be made easier with a dedicated accountant such as Lexicon Tax. Filing your accounts also takes away the level of privacy you receive.
- Whereas setting up a sole trader is fairly straightforward and features minimal paperwork, setting up a limited company takes time and effort – and often requires a dedicated accountant to do this.
The main tax differences between sole traders vs limited companies
Sole traders
When an individual sets up as a sole trader, it is important to consider that the sole trader will be paying income tax, rather than corporation tax.
In England, income tax will be applicable when a sole trader exceeds their personal allowance (£12,570 between 6 April 2021 to 5 April 2022), where they will pay 20% tax up until they reach the higher rate tax band. This is then increased further to 40% on annual earnings for the higher rate tax band and 45% for additional rate band which in 2021 starts at income over £150,000.
There are also considerations to be made on National Insurance costs, as you may be liable to Class 2 contributions (in 2020-21 tax year; £3.05 per week) and Class 4 National Insurance contributions (in 2020-21 tax year; 9% on profits between £9,500 and £50,000. For profits in excess of £50,000 you will pay Class 4 National Insurance contributions of 2%.)
Finally, it’s important to realise the considerations with benefits and incentives you could potentially lose as a sole trader, such as child benefit, which begins to be reduced once you pass an income of £50,000 (correct at February 2021).
Note that the tax rates and allowances may be different for people living in Scotland or Wales. Please contact us for more information on these rates.
Limited companies
As a limited company director, you and the business will be viewed as separate entities for tax purposes. Your business would be taxed on the income it makes (via corporation tax), whilst you would be taxed personally on your personal income from the company (in the form of income tax, National Insurance and dividend tax).
In comparison to operating as a sole trader, your limited company will pay corporation tax on its taxable profits. Company tax rates are lower than rates of income tax and corporation tax is charged at a flat rate (19% for most companies in 2021)
Unlike sole traders, limited company directors do not pay Class 2 or Class 4 National Insurance. Directors are classed as company employees, so they pay Class 1 National Insurance. Both employer’s and employee’s National Insurance is payable on directors’ salaries and bonuses.
If you operate as a limited company director, it is likely that your tax liabilities will be less than as a sole trader. This is because most directors with the advice from accountants will choose to pay themselves a small salary and take the rest of the profit as dividends. The rate of tax on dividends is currently 7.5% income below £35,000, 32.5% up to £150,000 and 38.1% on anything above £150,000.
So, what is best for me?
There is a lot to consider when you make the decision to work either as a sole trader or through your own limited company as both routes have their own pros and cons. Ultimately, the decision will fall to what works for your unique circumstances. That’s why it’s important to consider how each business structure will work for you and your business. Call us on 0114 4000192 to discuss your personal circumstances.
DISCLAIMER
The above is provided for guidance only and may not cover your personal circumstances so you should not rely on them. It is important that you seek appropriate professional advice which takes into account your personal circumstances where you can provide the full facts of the case and all documents related to your case. Lexicon Tax Ltd t/a Lexicon Taxi cannot be held responsible for the consequences of any action or the consequences of deciding not to act.
