When setting up business we have customers who ask us whether they should be a sole trader or a limited company.
Here’s a bit of basic information about each of them and what the obligations of each are:
A sole trader essentially refers to a business that is neither a partnership nor a Limited Company. It can be a business that has a number of employees, so doesn’t just refer to a single individual trading, although they would also be classed as a sole trader.
When you are a sole trader you have to register for Self Assessment with HMRC by 5 October in your second tax year. By registering with HMRC you are notifying them that you have started trading and so HMRC will require a Self Assessment Tax Return, in which you advise HMRC of your profits for the year, and calculate the Income Tax and Class 4 National Insurance due on those profits.
As a sole trader all of the profits remaining at the end of your accounting year (usually 12 months from when you started trading) are yours, and you will be taxed on the total profits for the year. Profits are taxed at 20% or 40% depending on the level of income. Class 4 National Insurance is 9% on profits up to £46,350 and 2% on profits over £46,350.
There is also Class 2 National Insurance which is included on your Tax Return, and is a set weekly rate of £2.95.
Your Self Assessment Tax Return, which includes the profits, has to be submitted to HM Revenue and Customs by 31 January (unless you are sending in a paper return in which case the deadline is 31 October). The tax liability is due by the 31 January. If your tax liability is over £1,000 you also have to make payments on account on the next year, which are paid in two instalments, one on 31 January and one on 31 July. The payments on account are based on the tax liability for the current tax year.
A Limited Company is a separate legal entity with which you carry out your trade. Limited Companies usually have a shareholder and a Director. Being a Shareholder and Director are two separate roles and come with their own responsibilities.
As the Company is a separate legal entity the profits made by the trade belong to the company. This is something that some company owners struggle with, especially if they started trading as a sole trader. The taxable profits of the company are then charged to Corporation Tax, which is currently 19%. The Corporation Tax to be paid is due 9 months after the accounting year end, and the Corporation Tax Return has to be filed 12 months after the company’s year end.
The only way for a Director to withdraw funds from the company is by way of remuneration – either salary or benefits. If the Director is also a shareholder then they can also receive dividends from the company. Dividends are paid out of after tax profits – therefore there needs to be sufficient company reserves for the company to pay dividends.
If a Director/shareholder takes money out of the company that is not remuneration, and there are no reserves to pay dividends, then essentially the Director/shareholder is being “loaned” money by the company. This is referred to as a Director’s Loan Account. There are various tax implications of having a Loan Account.
Limited Companies have to submit Accounts to Companies House and have 9 months from the accounting year end to do so (except for the year of incorporation where the company has 21 months to file its accounts). In addition, the company is required to notify Companies House of any changes to Directors particulars within 14 days of the change, and is also required to file a Confirmation Statement to Companies House, which confirms that the information held on the Company Register is correct.
There are many factors to take into consideration when deciding whether to be a Sole Trader or Limited Company and many factors are unique to each situation, so if you aren’t sure which is best for you then speak to your Accountant, who will be able to best advise on which route to take.