Limited company or sole trader - which is best for me?

How are Sole Traders taxed?

For sole traders all income is assessable for tax and so they are taxed on their business profits, in addition to any other sources of income. There is little or no flexibility for deferring some of those profits to another year if you happen to have a particularly good year and are taxed at the higher rate.

How are Limited Company Profits Taxed?

Limited Companies are taxed on their trading profits also, in addition to other sources of income such as interest and rent. Corporation tax is assessed after any owner’s salary and dividends have been deducted. It is possible therefore to adjust the amount taken from the company in any one tax year, as well as the way in which it is taken out. Some profits can be retained in the company if the owner would otherwise be likely to pay higher rate tax personally.

Why should I think of Incorporating?

Generally there are three reasons for doing this:

• In some sectors (such as IT), it is hard to obtain contracts unless you trade through a limited company. There is not always an obvious reason for this; it is just the way things are.

• If you are taking risks such as ordering a large amount of stock for an order that could be cancelled, then there can be a real benefit in the limited liability offered by trading as a company. Your own personal possessions are generally protected from any claim against the company. However, in some circumstances, taking out a good insurance policy is all you need.

• There is more flexibility in handling the owner’s remuneration in such a way as to minimise the tax liability. In recent budgets, this has become more apparent, making incorporation an increasingly attractive option.

Your accountancy costs will increase, so you will need to be convinced that there are sufficient savings to justify the cost. The company will be regulated by Companies House, which has strict rules for reporting trading accounts (hence the price increase) and for the conduct of directors and other company officials. You will need to be happy that you can handle these regulations.

Can I change from one to another?

Yes. You can start as a sole trader and later incorporate. In fact, this is a common route when a new business is unsure of how large it will grow and whether the saving will outweigh the costs. You will need to consult a professional to ensure that any transition is done properly.

This article was provided for Bytestart readers by HfM Tax and Business Services