Your income is a key determining factor, but it is also worth considering your appetite for risk, your future plans for your business and the amount of administration you are happy with.
This guide will examine the key differences between operating as a sole trader – commonly referred to as ‘self-employed’ – and as a company Director. So first thing’s first – what’s the difference?
What is a Sole Trader?
If you are a sole trader, you register as self-employed with HMRC. At the end of the year, you report your income, expenses and tax/National Insurance liability with HMRC on your self-assessment personal tax return. All income you earn is taxed based on your personal tax allowance and income tax bandings.
A sole trader is not a separate legal entity to the contractor. As such, the contractor is personally liable for any debts or losses their business makes.
What is a Limited Company?
A Limited Company is a separate legal entity and so is taxed separately to its directors, shareholders and employees. In a one-man-band Limited Company, the contractor is all three!
A Limited Company is subject to Corporation Tax and pays money both as salary (to any employee) and dividends (to a shareholder). As the name suggests, liability in a Limited Company is limited – which means that only the company is liable for genuine debts and losses incurred by the company.
Limited or Sole Trader?
If your contract income is low – typically under £25,000 per year – then the tax efficiencies available to Limited Companies are usually outweighed by the administrative costs. If your income is stable and won’t fluctuate much, there is also no need to leave profit in your business and spread it out. There is additional administration involved in operating a Limited Company – quarterly VAT returns for VAT-registered businesses and company accounts, as well as a personal tax return at the end of the year. In these cases, operating as a sole trader is likely to be the best option.
If you are earning over £25,000 per year, or your income will vary from one year to the next, the additional tax efficiencies available in a Limited Company will be your friend. If the day-to-day running of your business has lots of additional costs and expenses, you will benefit from the wider business expenses allowable. If your contracts are higher-risk or put you at personal liability, you will certainly want the protection offered by a Limited Company – if worst comes to worst, you are not risking your personal assets. In these situations, a Limited Company will be the best choice for you.
Other things to consider.
Credibility. Operating a Limited Company can make you more respectable in the eyes of many clients and suppliers. Indeed, some businesses will refuse to deal with a sole trader and will only engage with a Limited Company.
Tax planning. The structure of a Limited Company offers a much greater scope for tax planning. If you are planning to be in business for a few years and can afford to take a long-term view, you will extract much more value from a Limited Company, than as a sole trader.
Scalability. If you are hoping to grow your business, including hiring staff, working with a partner or increasing future income, a Limited Company offers a ready-made structure to do this.
Succession. If you ever want to sell your business, or decide to retire, it is far more difficult to pass on a self-employed business structure than a Limited Company. Being able to appoint Directors and sell shares, makes transferring ownership much simpler.
We hope this guide has been helpful. If you are a sole trader planning on setting up a Limited Company, our guide to moving from self-employed to Limited will be useful.
If you are looking for more information, one of our specialist contractor accountants will be happy to discuss your options – give us a call on 01442 795 100 or email sophie.lewis@dolanaccountancy.com.
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