Sole trader or limited company? The choice matters.

James Allsop, from our accounts department, looks at some of the legal and tax implications of the company structure you choose and offers some pointers for what is an important decision.

Making the right choice about your business structure can have major legal and tax consequences. There are many types of structure a business can choose, but in this blog I will briefly compare the differences between a limited company and a sole trader business.

The first, and arguably the most obvious and crucial difference between a limited company and a sole trader, is the fact that individual shareholders of a limited company are not held personally responsible for their company's debts. As a limited company is seen as its own legal entity, any financial claims against the company cannot be claimed against the directors or members if that company cannot pay the amount owed. Conversely, as a sole trader, if a business cannot pay its debts, the claimant can go after the business owner's personal assets. The limited liability acts as protection for the business owner should the business fail. You should note however, that there are specific occasions where the limited liability is not applicable, and directors and company members can be liable for a limited company's debts.

As a sole trader, all profits of the business are taxed as non-savings income for that individual. Under the presumption that you do not have any other sources of income, the personal allowance of £12,570 will be deducted from those trading profits to calculate the taxable income for that individual.

The remaining income is taxed at 20% up to £37,700. 40% is levied on income between £37,701 and £150,000 and 45% is charged on income over £150,000.

Taxation on income is calculated in a different way for a limited company. First of all, all profits of the company are subject to corporation tax at 19%. The individual is then liable to income tax on profits withdrawn from the business. This is taxed as dividend income, which has different rates to non-savings income.

It is relevant to note that the personal allowance is still available, meaning the first £12,570 of dividend income will not be charged to income tax, providing that you have no other sources of income. Furthermore, a dividend allowance of £2,000 is available to all UK taxpayers, which means that effectively the first £14,570 of all dividend income is tax free (so long as there are no other sources of taxable income in the tax year).

All other dividends are taxed at 8.75% up to £37,700, which is much lower than the income tax rate for non-savings income which would be applicable if the company was structured as a sole trader. However, on dividend income between £37,701 - £150,000 an individual will be taxed at 33.75% and 39.35% on dividend income over £150,000. It is important to note that dividends can only be withdrawn from the remaining profits of the business after corporation tax. It may also be advantageous to withdraw a salary from the business, as this can be an allowable deduction from trading profits before corporation tax.

Based on the above information, the limited liability of a limited company for members and directors should be an important consideration when choosing your business structure. Despite every business owner planning for their enterprise to succeed, it is important to consider what could happen if the business experienced financial difficulty. Furthermore, due to the lower rates of income tax on dividend income in comparison to non-savings income, it would appear to be advantageous for tax purposes to be a limited company. This is not always the case, however, as you must consider that profits will be taxed at 19% before you can remove them from the business. The tax consequences are also heavily affected by each person's individual circumstances.

I have not listed all the benefits and negatives of the different business structures, nor have I discussed the implications of partnerships/limited liability partnerships. Nevertheless, I hope this blog provides you with a basic understanding of the legal and tax consequences of different business structures, which should be a major point of consideration when starting a business.

If you're setting up a business and want advice on the best strategy, then do call us on 0115 955 5500 or email enquiries@pagekirk.co.uk.