Sorry for not having posted for few days. I was busy with university’s duties.
To quickly get back on track, what I want to talk about today is whether to run your business as a Self-Employed or as a Limited Company.
Having started my business as a Architectural and Structural Consultant one year and a half ago I have recently looked into the pros and cons of working as a limited company. According to Freelanceuk.com switching to a Limited Company instead of a Sole Trader Business can produce quite a tax saving that can be extremely useful for the growth of small/young businesses such as mine.
The savings depend on profit and individual circumstances, but this table gives an indication of the savings in tax and national insurance you are likely to make:
||Total tax if trading with Ltd Co
||Tax & NI sole trader
Advantages and Drawback, Quick Summary. UK Circumstances.
Tax & National Insurance differences
Self Employed - the profit (receipts less expenses) that your business makes will be subject to income tax and national insurance contributions (Class 4) and the amount you pay will depend on how much profit you make.
The rate of income tax you pay is essentially the same as that payable on a salary – you still get your personal tax free allowance and then pay income tax at the basic rate (20%), higher rate (40%) and if you are making substantial profits the additional rate (50%).
Class 4 – National Insurance Contributions are also paid on the amount of profit and are again similar to a salary – you will get an exempt amount and then pay at the lower rate (8%) and upper rate (2%).
Additionally, you will have to pay Class 2 National Insurance Contributions – these are not based on profit but are a fixed weekly amount, currently £2.50.
Limited Company – the profit (receipts less expenses) that your business makes now belongs to the company and as such will be subject to corporation tax and the amount your company pays will depend on how much profit it makes.
Currently if the profit is less than £300k it will be subject to the small companies rate of 20%, whereas larger companies would pay the main rate of 26%.
Your own circumstances differ too, as you become a company director and a company shareholder.
In your capacity of company director you will be entitled to pay yourself a salary which will be subject to income tax and National Insurance Contributions (Class 1).
In your capacity of company shareholder you will be entitled to receive dividend income, which the company can pay you from the profit after corporation tax. Dividend income is not subject to National Insurance Contributions and whilst it is subject to income tax the rates are lower; basic rate (10%) ,higher rate (32.5%) and additional rate (42.5%).
It is the taxation of dividend income that generally means this is a more tax efficient way to operate.
Legal Liability differences
Self Employed – the business is effectively you and any loan undertakings or credit arrangements are taken out in your name. If you default on the repayments the lenders can take legal action against you personally, which can ultimately lead to the repossession of your personal assets.
Limited Company – in the eyes of the law the limited company is a separate legal entity and any loan undertakings or credit arrangements are taken out in the name of the company. If the event of defaulting on the repayments the lenders can take legal action against the company but only have recourse to the company’s assets.
As a shareholder your liability is limited to the cost you paid for your company shares, although in some circumstances the directors may be asked to give personal guarantees on company loans.
Setup, Paper work & Cost differences
Self Employed – set up is relatively straight forward as you simply have to register as self employed with HM Revenue & Customs (HMRC) and then each year HMRC will require you to complete a personal tax return to declare your profit.
You will need to keep copies of all sales invoices, bank statements and expense receipts to allow your accountant to prepare a set of basic trading accounts for your personal records.
Limited Company – as this is a separate legal entity the company has to be formally incorporated at Companies House (which involves a small fee). The Company has to be registered with HMRC for corporation tax and for PAYE (as you will need to operate a payroll to pay your salary).
Each year Companies House requires you to submit formal statutory accounts and HMRC require you to submit annual corporation tax and PAYE returns. In addition, as the director, HMRC will require you to complete a personal tax return to declare your income.
By submitting your accounts to Companies House they are visible to the general public, although small companies can submit abbreviated accounts which keep the information you make available to a minimum.
You will need to keep copies of all sales invoices, bank statements and expense receipts to allow your accountant to prepare the formal statutory accounts and the corporation tax returns. In addition you may pay your accountant to prepare the company payroll and annual PAYE returns.
As there are additional documents to be submitted to HMRC and Companies House your accountant’s costs will be higher.
Self Employed – even though you may have a number of employees and have to be registered for VAT, the sole trader is still perceived as being a small business. You will find that due to certain tax legislation many recruitment agencies will not deal with you in a self employed capacity and will insist on limited company status.
Limited Company – in addition to having the personal kudos of being a director, the general perception of a limited company is that it is a larger operation than a sole trader. In turn this perception could create more business opportunities and/or allow you to charge higher rates.
In terms of longer term finance the limited company is seen as a safer bet than self employed for lenders, as the limited company often retains profits within the business which can be used to meet future financial commitments.