Choosing the right business structure for your startup: Limited Company vs. Sole Trader
Written by Sam Morris - Ballards LLP
Choosing the right business model is crucial for the long-term success of a new business. The decisions you make early on can have a significant impact later on. In this article, we will discuss two common options for starting a business: setting up as a Sole Trader or incorporating a Limited Company.
Sole Trader
Being a sole trader is the most common and simplest business structure in the UK. It involves fewer legal formalities compared to setting up a Limited Company, allowing you to start trading right away. As a sole trader, you also have fewer administrative responsibilities, which means lower administrative expenses. Taxation is generally simpler too, with the same tax rates applied as for employment income (20%, 40%, or 45%).
Limited Company
A Limited Company is a separate legal entity from its owners. This means that the business owner's personal assets are usually protected if the company faces financial difficulties or legal proceedings.
Operating as a Limited Company can enhance your professional image and make it easier to establish business relationships. However, establishing and running a Limited Company can be more costly compared to being a sole trader. There are also more annual deadlines to meet, but a good accountant can help you stay on top of them.
Taxation for Limited Companies is a bit more complex. They pay Corporation tax at a rate up to 25%, although if the profits are lower than £50,000 then the rate could be as low as 19%. The business owners are then personally taxed on any money they extract from the company. The advantage is that this cash can be taken as a 'dividend,' which is currently taxed at lower rates (8.75%, 33.75%, or 39.35%) compared to the income tax rates (20%, 40%, or 45%).
Choosing Between the Two Options
To make this decision easier, ask yourself if you need to take out all the profits from your business. If the answer is yes and you intend to live off all the business income, being a sole trader is likely the most tax-efficient option for you.
On the other hand, if you plan to reinvest profits in the business for growth, a Limited Company may be better.
The leftover profits can be extracted later in a more tax-efficient way, such as through pension contributions.
There are other factors to consider as well
If you are already a sole trader and paying tax at a higher rate or expect your business profits to exceed £50,000, a Limited Company may result in lower taxes. However, if you are expecting losses in the early years due to investment, you may be able to offset those losses against your other income and get a tax refund.
If you have family members who could benefit from the income, owning a Limited Company allows you to share ownership and distribute income to individuals who pay lower tax rates.
If your business pays for lifestyle assets like a car, being a sole trader provides better tax relief for cars compared to a Limited Company.
Long-term planning should also consider Inheritance Tax. For example, a premises used in a Sole Trader business qualifies for 100% Business Property Relief from Inheritance Tax, whereas the rate drops to 50% when operating through a Limited Company.
Other Business Structures
While partnerships and limited liability partnerships (LLPs) are other options, sole traders and limited companies are the most used business structures in the UK.
Always seek professional advice
Remember, every business is unique, and what works for one may not work for another.
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