Sole Trade or Limited Company?
When starting a business one of the first things you need to do is decide whether you will operate as a sole trader or through a limited company. There are pros and cons to each option and the decision needs to be made on what is most suited to your own circumstances. Factors to consider include:
With a limited company, any liabilities remain within the company, meaning that the company holds the responsibility. None of your personal assets are at risk, like your house, as they could be if you were operating as a sole trader as the company is responsible for any losses and not you personally.
With a limited company the money does not belong to you personally but to the limited company. If you are a self-employed sole trader, your customers make a contract with you either for your product or your service, and you are personally responsible for any losses your business makes or loans taken out.
A limited company needs to have its own business bank account as the business is legally separate to you personally. A sole trader can, dependent upon the bank’s terms and conditions, use their own personal account for business transactions. It is always, however, a good idea to have a separate bank account for your sole trader business as it makes things easier when you do your Self-Assessment tax return.
With a limited company, your company will need to submit its own tax return and accounts within nine months of its year end to HMRC and pay any corporation tax due this is tax on your profit. The best way to keep your limited company accounts is either through spread sheets such as excel or a software package.
There are many software packages you can keep your company accounts on, such as Sage, Quickbooks etc. It is easier if you have an accountant who will file your accounts and calculate what corporation tax your limited company owes to HMRC but you can file yourself on the HMRC website. If you file your accounts and tax return late, you will be given a penalty to pay.
Accounts also must be filed to Companies House where they become public for anyone to see. It will also list your personal information as a director and shareholder of the company.
For sole traders, self-assessments tax returns, where you declare how much turnover and profits you have made and any expenses, have to be completed and filed by 31 January the following year, so for the tax year 6 April 2020 to 5 April 2021 you would have to complete your tax return by 31 January 2022.
If you are the sole director of a limited company, and do not have any employees, you can choose to take just dividends from the company, which are covered through your company’s corporation tax. If you have any employees, or you also wish to take a salary via PAYE in addition to dividends, you must register for PAYE with HMRC. This enables the correct amount of tax and national insurance contributions to be calculated and paid to HMRC.
By taking dividends your tax is usually lower. A dividend is a share of the company’s profits. If your company doesn’t make a profit, you can’t get dividends. Dividends can be paid to directors and other shareholders, according to how many shares they hold. There is no requirement to pay all the profits as dividends, or even any of them. A company can keep its profits over the years and distribute them later.
The benefits of taking dividends.
- Dividends attract lower rates of income tax than salary
- No NICs are payable on dividends (neither employer’s nor employee’s)
If you are a sole trader and self-employed, you can take whatever money you want from the business. If your company makes £100.00 for example, and you have spent £30.00 on supplies or expenses you can take out £70.00. This is your profit and the amount you will be taxed on so you need to ensure you put aside some of it for tax, and national insurance if applicable. You must register as self-employed with HMRC by the 5 October of the year after you began trading. This means that if you began trading in June 2020 for example, you have until 5 October 2021 to tell HMRC.
VAT thresholds and the registration process is the same however you operate your business. Once your turnover exceeds £85,000 in any one year you will need to register for VAT regardless as to whether you are self-employed or a limited company.
If you exceeded the VAT threshold in the past 12 months, you must register if, by the end of any month, your total VAT taxable turnover for the last 12 months was over £85,000. You must register within 30 days of the end of the month when you went over the threshold. Your effective date of registration is the first day of the second month after you go over the threshold.
Business expenses and what you can claim back are more or less the same for a sole trader and a limited company. As a sole trader you will want to claim as many expenses back as you can, so you pay less tax, but the expense has to be for the business and not for a new pair of shoes. If you use your mobile for your business for example and the contract is not in the business name you can only claim half your bill as an expense.
All businesses should have insurance. Public liability insurance protects you if there is an accident in your premises or if you kill or injure someone or damage someone’s property. If you get took to court this will cover your costs and any compensation you may have to pay.
Public liability insurance usually covers:
- Compensation payments to the person injured.
- The cost of repairing damage.
- Legal fees involved in a court case.
- Any costs for hospital treatment and ambulance services that can be recovered by the NHS, where personal injury compensation is payable in the Injury Costs Recovery scheme.
The cost of your policy will depend on the type of business you have and the risks involved and how many employees you have. Good news is though that your insurance is an allowable expense so this would go in your expenses and reduce your profit which brings your tax down.
Employers’ Liability Insurance
If you employ people, you are responsible to protect them. This insurance will cover them against compensation claims if they hurt themselves or get sick from working for you. It will cover previous employees who later become ill from working for you also. So get yourself some Employers’ Liability if you meet the criteria below.
- You deduct income tax and National Insurance from employees' salaries.
- You control where, when and how they work.
- You supply their work materials and equipment.
- You have a right to any profit your workers make.
- You require them to carry out the service you employ them for, and they cannot employ a substitute if they are unable to work.
- They do the same work under the same conditions as other people you employ.