If you're starting a new business, this article will guide you with the options of operating as a sole trader or limited company for the new tax year and takes into account the changes in the 2024 Spring Budget.
Sole trader or limited company - overview
The amount of tax you save by running your business as a sole trader, or a company can depend on many variables.
If you run a straightforward small business and plan to take all the income each year, then operating as a sole trader may be less expensive and easier to manage from an administrative point of view.
However, if you plan to take advantage of company-only tax reliefs such as tax-free benefits, employer pension contributions, or plan to exit the business after a short period, there may be substantial cost-savings achieved from running your business as a limited company.
Advantages of a limited company structure
There are a number of advantages of operating as a limited company which need to be considered when deciding whether to start a business as a sole trader or limited company. Some examples are covered below:
- It is easier to raise funds for investment into a company If the business is being built up in anticipation of a trade sale, it may require external investors, if so then only investment in a company attracts any form of investment relief for example SEIS.
- A company can save you tax if you intend to retain profits in the business. Those profits generated for sole traders and partners are subject to Income Tax and NICs regardless of whether they are withdrawn or not. Conversely, with a company, profits that are retained in the company are only subject to corporation tax.
- You can always retain a company, as a 'money box'/pension. A former trading company can often be turned into Family Investment Company once you retire. This may allow you to share the profits with other family members to use up unused personal allowances and basic rate tax bands.
- A company can provide you with numerous tax-free perks and benefits. If you are self-employed you are subject to a different tax regime than a company director. So you don't have the ability to enjoy the same tax-free benefits which the tax rules bring them. These include lunches and refreshments, mobile phones, computers, training costs, low-emission cars, plus company pension and medical schemes.
- It is generally cheaper to extract profits by dividend rather than by paying salaries. National Insurance costs are reduced, and the top rate of tax for a dividend is lower than the top rate of Income Tax. You'll need to work out the optimum balance of salary compared with dividends to suit you. It is even more tax-efficient to split dividends between a spouse, partner or other adult family members if you can use up their otherwise unused tax allowances and basic rate band, see
Operating as a sole trader
Some of the advantages of operating as a sole trader are as follows:
- It is very easy to set up a new business as a sole trader. This is the recommended route if you're starting up a small business on your own for the first time
- Once you have set up as a sole trader, it's easy to change into a partnership (say if a friend comes to join your business) or into a company (if you get bigger and want the protection of limited liability).
- There is no legislation that directly describes the operation of a sole trader. If you're as sole trader you run your business according to the principles of general law and are not governed by the Companies Act.
- Only sole traders are eligible to use the cash basis of accounting for their business. This can make accounting for business transactions more straight-forward than for a limited company.
The potential tax savings
No article on a sole trader or limited company structure for a new business would be complete without discussing the potential tax savings which are covered below.
On the surface of it, this would suggest that you pay more tax not less tax if you decide to operate as a limited company. However this does not represent the whole story because the following assumptions have been made:
- This is your sole source of income and the full personal allowance and basic rate tax bands are available.
- You take a modest salary to reduce NI contributions and you can claim the Employer Allowance.
- All remaining profits are taken as dividends.
We would stress that a number of variables will affect the above calculations and potential tax savings:
- Whether you can split the company's income with a spouse or around the family.
- Specific tax reliefs and allowances which may apply to the business - for example R&D tax reliefs
- Whether you have income from other sources.
- The level of employer pension contributions that are made
- How much profit is retained and paid out as a capital distribution when your company is wound up.
As with all tax planning, there is rarely if ever a 'one size fits all' approach when decided whether to start a new business as a limited company rather than as a sole trader - a number of factors have to be considered.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
Alternatively, please feel free to complete our Business Questionnaire here.
