Should I be a sole trader or set up a limited company?

We are often asked to advise clients whether it’s more advantageous for them to set up their new businesses as a sole trader, or incorporated as a limited company.

The risk argument is fairly straight forward.

If the trade or service you provide involves risk, and a risk that it is difficult to fully insure against, then the limited company is the better route. The only assets at risk will be those owned by your company. Provide you don’t do anything illegal then your personal assets will be safeguarded should the business fail.

If there is no significant risk, the next criteria to look at is taxation.

Which route will generate the lower tax and NIC bill whilst still providing you with sufficient take home pay?

In situations where taxable business profits remain fairly low, up to say £20,000, it is usually more sensible to structure your affairs as a sole trader, as any perceived tax benefit will likely be offset by the increased costs involved in setting up and running a limited company.

Above that, where profits are say between £20,000 and £200,000, you will generally be in a position to save tax and NIC by trading as a limited company but when profits exceed around £200,000 the table turns back and you may be better off as a sole trader.

However, these assumptions would only be valid if you were to choose to withdraw all your profits from your business. Most businesses will grow to the point where an ever increasing percentage of the profits are retained in the business.

The picture then changes dramatically.

If your limited company were to make a trading profit of £200,000 and you drew out £50,000 in salary and dividends to live on,after paying the Corporation Tax due, £114,000 would still be left in the company.

This“fund” can be used by the company to invest on growing the business.

The combined take home pay and retained funds in the business would now be some £42,000 more than if you had withdrawn the whole £200,000 and paid tax and NIC on it as a self-employed person. The reason; as a self-employed sole trader you would be taxed at higher income tax rates on all your profits, even those you left in the business, whereas the company would only pay Corporation Tax at the lower 19% rate (2017-18).

There is no substitute for carrying out this this number crunching process regularly and on a case by case basis.

If you are contemplating a new business venture and you are unsure what structure you should choose, please call so we can look at all the options and advise you on the best way to go.