Becoming self-employed is a career-changing decision. The need to conform to an employer’s standards is exchanged to being your own boss at the cost of handling all of the legal and financial aspects of your business. Hence, most business enthusiasts consider teaming up with a few individuals or with a relatively large group of people to ease the responsibility of keeping the business afloat. As a sole trader, you are the business itself. In a limited company, however, the business is an independent body where you are a director and a shareholder holding a portion of the company’s capital. However, success in business is a case-to-case basis. Some may find themselves paying more tax than necessary which is why it is imperative to decide on the best business structure early on and carefully plan out the course you want your business to take.
1. Legal Disputes
Sole traders are personally sued unless they are covered with applicable insurance such as employer’s liability. Limited companies can also be covered by insurance and more often, it is difficult and rarely a case in the UK to directly sue the chief executive of the company. Unless they are proven to have perpetrated fraud (as employers, as service providers or as taxpayers) and have committed offences against the law such as violating environmental acts.
Corporate taxes are considerably lower than income tax. Shareholders and employees are subject to PAYE (pay-as-you-earn) and NICs (National Insurance Contributions) based on their individual earnings where many other benefits may attract tax as well. An income tax based on dividends and other distribution types are rules among shareholders with a £5,000 tax-free allowance.
Sole traders can negate their trading losses against their other means income. However, in 2013-2014 in UK, there has been a restriction on the respite that may be claimed for losses and interest payments. On the other hand, limited companies can still neutralize their losses to other revenue sources but without compensating their income as an individual.
Withdrawing cash from a sole proprietorship include no taxes while any income from a company, be it a dividend, a distribution or personal earnings, are subject to respective tax collection. Employment benefits received by a shareholder or their family and household are also taxable as with the shares and securities.
As a sole owner, you are free to run the funds of your business considering that tax relief and bank charges will be comparably controlled. On the contrary, a director may borrow business funds subject to the limits set by the Companies Act of 2006 where a tax charge of 25% is paid by the company if the loan is not paid within nine months. If the loan is interest-free, an individual tax is charged against the director based on their beneficial loan interest.
There is no requirement to maintain accounts if you are a sole trader (although it is difficult to manage your business without keeping some). But you have the leisure of choosing cash or conventional accounting if you decide to do so. Further, you may need annual accounts to provide your personal tax return even if these accounts are not required by the HMRC (Her Majesty’s Revenue & Customs). Your taxable earnings must also be filed in accordance with the GAAP (Generally Accepted Accounting Practices) where you must hire a business accountant unless you can do the job yourself.
For limited companies, annual accounts are required in accordance with the Companies Act for filing with Companies House and should be in par with UK’s accounting standards. HMRC is imperative on the full accounts for Corporation Tax which should be submitted through the government’s provided format.
7. Selling the Business
Sole traders are personally taxed on any gain from selling the business under the CGT (Capital Gains Tax) while shareholders are taxed twice: corporation tax and dividend tax but may consider selling company shares than selling the trade or business itself.
The sole proprietorship terminates when its owner dies unless they transfer all ownership to another. Limited companies can still continue to operate even when the executive officer dies because the business is an independent legal entity.
9. Personal Earnings
As you hold the funds of the business, a sole trader may withdraw any amount he wishes although paying a family member must be commercially supported for tax purposes. Members of limited companies have no limits on the amount of earnings they can receive. But these are subject to PAYE and NICs where service payment given to family members follow the same tax rules.
10. Expenses in General
Tax reliefs are obtained by declaring expenses exclusively incurred for sole proprietorship operations. The same can be said in a limited company, however, the private expenses of the director can be declared as a company earning, or a distribution if incurred by a shareholder.
With all the items presented above that show the differences between a business run by one person and a company shared by a group. A business enthusiast should be guided on which option to choose to make the best out of their planned business (this can also be a guideline for ongoing businesses that wish to restructure their operations) to maximize profits, minimize tax returns and ultimately, avoid bankruptcy.
GM Professional Accountants are Accountants in London that specialise in small businesses and self employed tax returns.