Creating and setting up a new business, especially one that, initially, you’ll be solely responsible for, involves a great deal of consideration. But once you make that momentous decision to go ahead, watching your business develop and grow will bring you a well earned sense of achievement.
The most popular types of legal structure chosen by new businesses in the UK are those of the sole trader and the limited company. Your choice of one over the other will be helped if you explore some facts, and up to date information about them both, and this article aims to help you do that.
What does being a sole trader mean?
Legally, if you’re working for yourself, even if you haven’t registered your business directly with HMRC, (Her Majesty’s Revenue & Customs), you’re classed as a self-employed sole trader. Within the structure of the sole trader, you will be running your business as an individual who keeps all his/her business’s profits after tax. Sole traders don’t have to work alone, they can employ people. They are personally responsible for any losses that their business makes.
New sole traders must register their businesses with HMRC by October 5th in their businesses second tax year to avoid penalties and so they can register for their self-assessment tax returns and Class 2 National Insurance using form CWF1 at the same time.
You will be responsible for the following as a sole trader:
- Keeping the sales and expense accounts records for your business.
- Sending self-assessment tax returns annually. (In 2015-2016 you will pay personal tax of 20% on all income over £10,600. Could be 40% or even 45% depending on your profits as a sole trader’s profits are classed as income). See here for more details on tax changes.
- Making Class 2 and Class 4 NIC payments. (Class 2 NIC rate for 2015-2016 of £2.80 per week. Class 4 is calculated by HMRC at 9% on profits between £8,060 and £42,385, then at 2% thereafter).
- Your business debts.
- Bills for your business.
- Registering with the CIS (Construction Industry Scheme) if you are a contractor or subcontractor in the construction industry.
Registering a name for your business
You do not need to register your business name with Companies House if you are a sole trader, but there are rules you still need to follow when choosing a business name. Your name must be unique, not similar to any other registered/existing name. A search of the Companies House register will let you know if a name has already been taken.
Summary – Sole trader
As a sole trader you won’t get the same tax benefits that you could have if you were a company director of your own business, and your profits and pension payments do not incur the same tax benefits either, but if you are just venturing out, so to speak, the structure of sole trader may suit your business.
However, if you’re already trading as a sole trader, and your business is growing, you may feel that the next naturally progressive beneficial step for your business is to change its structure from one of sole trader to that of a limited company, and that’s perfectly possible. All you have to do is:
- Inform HMRC that you are no longer going to be self employed, and they will cancel your Class 2 NICs.
- Set up your limited company.
- Simply complete your self assessment tax return as usual, and then next year submit tax returns for your new business structure.
So what are the benefits of setting up a limited company? Let’s take a look.
Forming your own limited company
You can have your own limited company name set up and registered online very quickly, for little cost, and your business up and running within hours if you provide the necessary information needed by Companies House, who recommend using the services of an online company formation agent for your incorporation. You can form your company through an agent such as Company Formations 24/7, from £16.99.
You must appoint at least one Director and a Company Secretary, but both these positions can be held legally by the same person. There are a few advantages to setting up a limited company as opposed to becoming a sole trader, and they are important considerations for anyone setting up a new business. So let’s look at them in more depth.
- Tax and the limited company director
For tax purposes, as a limited company director, you will be classed as an employee of the company and therefore liable to pay the primary Class 1 of NICs on your earnings. The company itself, as your employer, will pay the secondary Class 1 NICs on your behalf that it is liable for.
- Corporation tax
All limited companies of any size are liable to pay Corporation Tax on profits made so limited companies must register for corporation tax within 3 months of starting to do business as a limited company. From April 2015, tax on profits has been set at 20%, but the UK government intends to reduce this to 18% by April 2020. (Sole traders and/or partnerships profits are taxed at 40% on taxable income of over £31,785 (2015/2016), and 45% of over £150,000 (2015/2016)).
- Pension funds
Executive employees pension funds are a legitimate business expense to a limited company, offering a tax advantage over the sole trader.
- Professional prestige
Forming your own incorporated limited company reflects the professional prestige of your business to other organisations, contractors, and agencies, who prefer working with limited companies, rather than sole traders, because of the legal protection a limited company provides. This is advantageous, especially when you are seeking funding for your business.
- Shareholding and succession
Various types of shares can be issued by a limited company and this means you can easily sell shares in your business or transfer ownership of them. The ownership of a limited company is also easier to transfer than that of a non-registered business structure, should you, or any shareholder, wish to retire, or leave the company.
- Limited liability
Your business, as a limited company, is legally distinct from its owners and shareholders, protecting you from personal liability if things go wrong. Any losses within your limited company can be carried forward and set against future profits or against the previous year’s profits.
As a sole trader, you have no such protection because both you and your business are seen as a single entity, meaning that your own personal assets, (yes, including your house), are at risk if your business fails.
As a company director you must ensure that your company is run in accordance with the Companies Act 2006 and complies with company law, full disclosure, is adequately insured, and meets health and safety obligations. Filing company accounts, arranging payment of Corporation tax, NIC and PAYE obligations, and/or your VAT returns, all have imposed deadlines that you will be informed about if you set up a limited company. Your accountant will keep you right about these.
Summary – Forming a limited company
Forming a limited company not only provides more tax planning options for your business, its structure allows you to professionally build your business into a valuable asset.