Setting  up your business

Starting a business can be both exciting and daunting. There is lots to think about including whether to be a sole trader or set up a limited company. Bob from the pub will tell you it is best to do one thing and Sue on Facebook will tell you something else. Truth is, it’s a personal choice and dependant on your circumstances and your new business- there is no one rule fits all. Let’s have a look at some of the differences…

-       Legal entity. When you are a sole trader, YOU are the business. All the money the business makes belongs to you. The same for any debts. The debts of the business are personal debts so if you cannot pay them, you (and your assets) may be at risk.

A limited company is a separate legal entity to you. This lowers your personal risk if anyone were to take legal action against the company. Any money received by the limited company belongs to the company. It only becomes yours when you pay yourself either via a wage or dividend. The same with the debts of the limited company – your liability should be limited to the investment you have made in your business (loans you have made, shares you hold etc).

-       Compliance. As a sole trader your main responsibility is to send a tax return to HMRC to show them your profit or loss for the year. You may wish to send in accounts to support your figures but it is not compulsory.

A limited company has a lot more boxes to tick. A corporation tax return will need to be send to HMRC as well as accounts. Accounts will also need to be sent to Companies House along with an annual compliance statement. Company shareholders receiving dividends may also have to send a personal tax return to HMRC.

-       Getting paid. As a sole trader, all the profits are yours so you can take whatever money you like from the business (don’t forget to save some for tax!).

If you run a limited company, the profits are not yours so you need to take money out in a more formal way. You can pay yourself either via a salary or dividends or quite often a mixture of both. How you get paid will depend on your other income. Taking a salary means you can continue to pay national insurance (which goes towards your state pension and other benefits), but as dividends are taxed at a lower rate it’s worth looking into the best mix for your circumstances.

-       Tax. As a sole trader you pay income tax and national insurance on your business profits. This is paid via your self-assessment tax return. 

The amount you need to pay depends on your profit levels and any other income. If you are employed then your profits are added onto your employment income and depending on the level of your salary, may result in you paying tax at a higher rate. The standard personal allowance means you get the first £12,500 of income tax free (19/20, 20/21).

The company pays Corporation Tax on all it’s profits (no personal allowance) but your salary is an allowable deduction to get to those taxable profits. Dividends are not an allowable expense and are paid from the profits left after tax. You only pay tax on the money you have physically taken out of the business.

Although the company pays corporation tax and then you will pay tax on the dividends it can still be more tax efficient.

-       Dates. As a sole trader, your tax return will be based on the tax year to 5 April and needs to be submitted by 31 January. The relevant tax and national insurance will be due by 31 January and if you have a payment on account, the second one will be due by 31 July.  Payments on account kick in when your tax liability exceeds £1,000. I’ll attempt a blog on that at a later date. 

Companies need to pay their corporation tax 9 months after the year end. Shareholders who have taken dividends will need to pay personal tax as above.

So as you can see there is no one size fits all answer. What is right for Bob at the pub may not be right for you and your business. Tax savings are quite often the reason people will choose to set up a limited company but with that comes the additional compliance and higher accountancy costs (if you were to use an accountant – and yes I recommend you do!).

Run the numbers, see how you feel about it all and go from there. There is always the option to start off as a sole trader and then as your business grows you can set up a limited company. (Doing it the other way and closing a limited company to run as self employed is a bit more complicated).

As always, we are here if you want to chat through things.