Company or sole trader – no longer a tax-driven choice?

John Tooth, Chartered Tax Adviser at Paish Tooth

John Tooth, Chartered Tax Adviser at Paish Tooth - Credit: Archant

The number of small businesses in the UK is currently at a record level. But if you own one of these many small businesses, what drives you as an entrepreneur to choose between trading under your own name or via a limited company? And what impact does that choice have on your post-tax income?

For a while now the ‘smart money’ has been on setting up a limited company, which leaves you with more cash in your pocket. And while that remains broadly the case today amongst businesses making up to £100k of annual profits, the tax savings are now continuing to fall thanks to HMRC actively pursuing its agenda of everyone ‘paying their fair share’ (in this case via changes to dividend taxation). For instance, at an income level of £40,000 a year, a one-person company could save £1,100 in 2018/19 tax liability, compared with a saving of £1,350 in 2017/18. When you take these earnings up to £80,000 a year, in 2017/18 savings were £2,700 compared to only £2,000 in this tax year.

Other considerations for setting up a company:

Tax saving has often distorted people’s choice of business structure, so perhaps it’s no bad thing that today, with a reduced tax incentive, the focus should shift onto what best suits the circumstances of the business. The range of possible considerations is a wide one, but recurring themes include the following:

Limited companies:

• A key attribute is protection for personal assets that could otherwise be exposed to claims from creditors

• In certain instances it may be possible to benefit from enhanced-rate R & D tax reliefs

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• Tax savings may be possible as highlighted above

• A downside is regulation/formality. Requirements include registering a name, appointing at least one director, and routinely putting annual accounts onto the public record at Companies House (albeit in simplified form).

Sole traders:

• Simplicity and absence of limited company formalities are likely to be the chief attractions

• Scope exists for income tax repayments where losses are suffered in the early stages of the business

• It’s entirely feasible to transfer the business to a limited company at a later stage (perhaps once the loss-making phase is complete)

The value of a second opinion:

An experienced accountant or tax adviser knows the ropes. He/she wants you to succeed in your business and wants to be along for the ride. Taking time to think through the range of options with someone who’s been there before is a vital element in financial planning, and ought not to be dismissed if you’re serious about getting your business off to the best possible start – or perhaps you’re even wondering whether the choice you’ve made is the right one.

You should be aware that different tax rules apply in Scotland, and different considerations also apply in certain specific circumstances, e.g. property businesses or professional contractors.

Greater tax savings may be available where a limited company is jointly owned by a spouse or civil partner, but the attraction of such arrangements – where they’re possible – have again been diluted by the changes to taxation of dividends.

John Tooth is a Chartered Tax Adviser with 35 years of qualified experience in accountancy and tax consultancy.

For more information visit the Paish Tooth website.