Looking at setting up a new business? Not sure whether to be a sole trader (self-employed) or use a limited company? Royston Parkin’s Andy Froggatt offers up some background information you should consider when starting your new business…
Limited Company
A company must be formally incorporated with a written constitution in the form of a Memorandum and Articles of Incorporation, so there is an initial setup cost.
Companies are governed by the Companies Acts. A company must keep accounting records; have the accounts audited; file accounts and an Confirmation Statement with the Registrar of Companies (this information is available to the public) and keep Statutory Books showing details of shareholders and directors.
Companies may have greater borrowing potential. They can use current assets as security by creating a floating charge.
Tax is payable on directors’ remuneration paid via PAYE on the 19th of the following month. Tax is paid by shareholders on dividends under the self-assessment rules, although the first £2,000 of dividends are tax free each year. Unless profits exceed £1,500,000, corporation tax is payable nine months after the year-end.
First year losses in a company can only be carried forward to set against future profits.
The corporation tax rate is currently 19% irrespective of the level of company profits. The main rate will be increased to 25% from 1 April 2023 where profits exceed £250,000 a year. From that date the 19% rate would only apply to profits up to £50,000 a year with a marginal rate of 26.5% for profits between the two new thresholds. If you have connected limited companies with “common ownership and control” you only have one £50,000 profit threshold, so two connected companies can make £25,000 profit each to pay 19% Corporation Tax.
There is both employers’ and employees’ national insurance payable on directors’ salaries and bonuses. The NI charge is greater than that paid by a sole trader/partner, but there is no NI charge on dividends. There is also a £5,000 Employment Allowance to set off against employers NIC although that is not available where the total employers NIC liability exceeds £100,000 and where the director is the only employee.
Where the business owner is both a shareholder and a director, they only pay tax personally on what they draw out of the company. Many director shareholders pay themselves a low salary to minimise national insurance and extract the bulk of their income by paying themselves dividends.
Sole Trader/Partnership
There are no formation costs, but a written partnership agreement is advised. Sole traders and partnerships are not required by law to have annual accounts nor to file accounts for inspection. However, annual accounts are necessary for the HM Revenue and Customs tax returns.
Sole traders and partners are unrestricted in the amount and purpose of borrowings but cannot create floating charges.
For a sole trader or partnership, tax is generally paid by instalments on the 31 January in the tax year and the 31 July following the tax year.
Start-up losses generated by a sole trader or a partner in the first four tax years can be set against other income of the year or carried back to the three previous tax years, potentially resulting in a tax refund.
Profits are taxed at 20% on taxable income up to £37,700 for 2022/23 and 40% thereafter with a 45% rate on income over £150,000. The Finance Act 2021 has frozen the personal allowance and income tax thresholds until 2025/26.
A partner/sole trader will pay Class 2 NI of £3.15 p.w. (2022/23) and Class 4 NI dependent on the level of profits: 10.25% on profits between £11,908 and £50,270 and 3.25% thereafter. This includes the 1.25% health and social care levy for 2022/23.
Sole traders and partners are taxed on their share of business profits irrespective of the amount that they draw out of their business. Consequently, they are less able to control the level of their taxable income compared to a director/shareholder of their own company.
To discuss any of these issues, email andyfroggatt@roystonparkin.co.uk, call on 0114 272 0306 or 01302 or visit roystonparkin.co.uk.
