Sole Trader vs Limited Company: Tax Differences & Savings (2023/24)
Sole Trader vs Limited Company: Which is right for you? It is common question for startups.
What are the key differences in running a business as a sole trader compared to as a company?
This handy guide is designed to help you decide what route is best for you and your business.
What are the definitions?
Sole Trader: You are ‘the business’ and its owner
Limited Company: Your company is a separate legal entity to its owner. If the company is limited by shares, and you hold those shares, you are a shareholder. As a director you are an officer of the company: you have a fiduciary duty to act in its best interests.
Sole Trader: In the event of any legal dispute, you will be sued personally unless you have suitable insurance e.g. products and services liability, professional indemnity, employer’s liability etc.
Limited Company: In the event of any legal dispute, the company will be sued unless it has suitable insurance cover. It is difficult under UK law to sue a director personally for a company’s wrongdoing. There are exceptions where the ‘corporate veil’ may be pierced and a director may be held personally accountable e.g:
- Where the director has perpetrated fraud.
- Where the director has committed specific offences such as corporate manslaughter, or under health and safety legislation, environmental acts, companies acts and listing rules.
- In tax, in cases of fraud by the directors and for penalties involving deliberate concealment and offences by Senior Accounting Officers of large companies.
A liquidator holds them accountable as a result of insolvency.
Accounting basis and tax returns
Sole Trader: Annual accounts are simple to prepare. Generally Accepted Accounting Practice (GAAP) is followed unless cash accounting is used.
You prepare one tax return under Self Assessment. If you are below the VAT threshold you may enter a three-line summary of your accounts in the self-employed section of the return. Otherwise, you enter the account details line-by-line version.
You must choose whether to use ‘Simple Accounting’ cash accounting or accruals accounting and then whether to claim fixed rate expenses for certain items.
You must make adjustments to change from one accounting basis to another.
If you make errors or mistakes in your tax returns you are personally accountable for them.
Limited Company: Your accounts are prepared in the format specified by the Companies Act, and Generally Accepted Accounting Practice (GAAP), generally under FRS 105 or FRS 102. Software makes this a pretty easy task for most small companies.
HMRC requires you to convert your accounts into a tagged iXBRL format (software does this part for you, but some hand coding may occasionally be required).
As a company is a separate legal entity, it prepares its own tax return and tax computations. You as a director (and possibly shareholder) also prepare a separate return for yourself.
**If the company makes errors or mistakes in its tax returns the directors are not generally personally accountable for them unless there is evidence of fraud or wrongdoing or if the company is large and the director has responsibilities as Senior Accounting Officer.
- You are self-employed; you cannot be your own employee.
- In difficult times, such as the COVID-19 crisis in 2020-22 government support was based on your trading profits.
- Members of a Limited Liability Partnership who are on fixed profit/no risk arrangements may be automatically classed as employees.
- A director is an office holder, this does not automatically make you an employee in terms of employment law, the National Minimum Wage or for Tax Credits.
- For Income Tax and National Insurance purposes, company officers are treated as employees.
- In the COVID-19 crisis in 2020-22, government support for directors was based on your payroll salary.
- If the Off-Payroll Working rules apply, fees paid to the company, in respect of its worker’s service are taxed under PAYE/NIC by the end client. Your worker is taxed as if being employed directly by the end client. No extra employment rights are created. This is purely a tax measure.
Tax On Profits
Sole Trader: You pay Class 2 & 4 National Insurance and Income Tax on the taxable profits of your business, or your share of profits if you are in partnership.
Limited Company: From April 2023, Corporation Tax is paid at different percentages depending on profits. Where the company’s profits are:
- <£50,000, the rate of Corporation Tax is 19%.
- >£250,000, the rate of Corporation Tax is 25%.
- Between £50,000 and £250,000, the rate of Corporation Tax is 25%, but marginal relief is given.
There are no NICs on company profits
Sole Trader: You can offset your trading losses against your other income. The extended three-year loss carry-back for COVID ended on 5 April 2022. There is a cap on the amount of relief that you may claim for losses and interest payments.
Limited Company: The company can flexibly offset its trading losses against its other income, but not against your income as an individual shareholder. The extended three-year loss carry-back for COVID ended on 31 March 2022.
Sole Trader: You may withdraw cash from the business without tax effect.
Limited Company: As a company owner/director you are taxed on any income withdrawn from the company.
- Salary or bonuses are taxable as earnings and subject to PAYE Income Tax and NICs.
- If you or your family and household receive a taxable benefit your family and household are subject to further tax (subject to Tax-free exceptions).
- If you are given shares or securities in the company, the difference between the price you pay (if any) and market value is taxable either via PAYE or otherwise under Income Tax Self Assessment.
- If the Off-Payroll Working rules apply to a company’s contract, fees paid to the company are taxed under PAYE/NIC by the end client.
- If IR35 applies to its contracts, the company will receive its income gross but must account for PAYE and NICs on the deemed payment.
- Shareholders are subject to Income Tax on any dividends, which must be paid out of distributable reserves; payment follows the formalities of the Companies Act, see Dividend Index. Tax is payable by the recipient with exceptions for dividends paid to other companies and persons offshore.
- Capital distributions e.g. a qualifying Purchase of own shares or Capital reduction are taxed as capital.
- A disqualifying payment is taxed as income if it falls within the Transactions in Securities
Up to £25,000 may be extracted as a Capital distribution on striking off without concerns about the Transactions in Securities rules or Targeted Anti-Avoidance Rule (TAAR).
Loans & Borrowing
Sole Trader: You are the business and so any money you extract is yours in any case. You cannot make a loan to yourself. You are free to borrow from the business bank account, it is your account.
If your business bank runs at an overdraft due to the amount of funds that you have withdrawn personally, tax relief on bank charges and interest may be proportionately restricted
Limited Company: Borrowing by directors is permitted with limits are set by the Companies Act 2006. A tax charge may apply
- The company may make you an interest-free loan of up to £10,000 without a taxable benefit.
- Otherwise, If the loan is interest-free or interest is charged below the Official Rate of Interest, there will be a tax charge for the director based on beneficial loan interest.
- During 2023-24 the company pays a tax charge of 33.75% if you borrow from the company, are a shareholder, and do not repay the loan within nine months of the year-end.
Making Tax Digital (MTD)
Sole Trader: VAT-registered businesses have now all joined MTD for VAT, unless exempt.
- MTD for Income Tax applies from April 2026 where turnover is >£50,000, and April 2027 where turnover is >£30,000. A joining date for partnerships is yet to be determined.
Limited Company: MTD for Corporation Tax to be introduced from April 2026 at the earliest.
Private expenses and mixed-use of assets
Sole Trader: You must adjust your accounts for tax to exclude items not wholly and exclusively incurred for the business and apportion expenses, for tax, if there is mixed-use.
You may claim Fixed-rate allowances for certain expenses where there is mixed use which can give you a small tax advantage.
You may claim capital allowances on mixed-use assets, restricting the capital allowances claimed accordingly.
There can be a tax advantage on claiming mixed use of an asset that is sold as it is pooled separately from other assets and the disposal creates its own balancing event.
Limited Company: You do not need to adjust accounts for private expenses or use of assets, although you may wish to in order to avoid a personal tax charge.
If you incur private expenses via the company these expenses are either deducted via the payroll from your net salary, or they are offset against any credit balance you have on your directors’ loan account. Failing that you can report the expense as a benefit annually on form P11D and then pay tax on the benefit.
Sole Trader: It is a ‘taxable person’ (not a business) that is registered for VAT. This means that if you have two sole trade businesses, you cannot register only one of them for VAT.
You may cash account for VAT, provided that you are within the turnover limits.
Your turnover for VAT is determined on an invoice basis which can be confusing if you are using the cash accounting scheme for Income Tax and NICs.
You may operate the VAT Flat Rate Scheme, subject to turnover limits, but this may lead to you being caught out if you also make money from any other activity as an individual which would not usually be VATable (rental income etc), or if you sell assets that have had some business use (cars/homes etc).
You must be aware of the Limited cost trader rules if using the Flat Rate Scheme.
**If you make Errors or mistakes in your VAT you are personally accountable for them.
Limited Company: You may cash account for VAT (within the turnover limit). As a company is a separate legal entity it can operate the VAT Flat Rate Scheme (subject to turnover limits) with no effect on any business that you run as an individual. This is subject to anti-avoidance measures if you Artificially split up a business.
The limited cost trader rules should be considered for the Flat Rate Scheme.
As with direct tax, if your company commits VAT fraud, any VAT penalties payable can be transferred to the directors personally.
Sole Trader: A sole trader can split their income by joining in business with a partner. The result is that the business is then a partnership. Each partner will then pay tax and NICs on each’s share of the partnership’s profits.
Paying a Salary to a spouse or family members must be commercially justified to be allowable for tax purposes
Limited Company: Company dividend income can be split with a spouse, partner or family by transferring ownership of shares to them. There are anti-avoidance rules which may need to be considered.
Paying a salary to a spouse or family members must be commercially justified to be allowable for tax purposes.
Sole Trader: You can occupy premises owned by yourself. You cannot claim tax relief for rent paid to yourself.
You may claim tax relief on the costs of operating your business from your home or another property owned by you.
You may claim a use of home deduction or a flat rate deduction.
Limited Company: If you own a property personally you may rent it to your company. This includes granting a licence to your company for non-exclusive* use of part of your home if you operate from there.
You will need then to account for the rental income, less your expenses in providing the property on your personal tax return.
*to preserve CGT Private Residence Relief (PRR)
The restriction in interest tax relief for landlords applies to directors who rent out their own property to their companies and then claim tax relief on their finance costs against that income.
Sole Trader: You do not have any special rules for benefits as personal expenses or personal use of assets are disallowed for tax.
Limited Company: As an employee of your own company, you may receive a large range of tax-free benefits.
Top benefits for 2023-24 are electric vehicles which carry a very low Benefit In Kind.
Exempt benefits include equipment such as a phone, iPod, laptop, pensions advice, and parties. Directors and members of their families have a cap on £300 of trivial benefits.
Other benefits: As a director, you are taxed as an employee and subject to tax if you receive taxable benefits.
There are different rules to tax different types of asset, for example, cars and vans have set Benefit In Kind charges and there are special rules also where the benefit is accommodation, an interest-free loan in excess of £10,000 and where the benefits are shares and securities.
For other assets, your annual benefit is calculated at 20% of the cost of the asset (inc VAT).
Passing on the business
Sole Trader: A sale of a sole trade will be a disposal for CGT purposes. The incorporation of a sole trade will also be a disposal for CGT purposes.
CGT Business Asset Disposal Relief (BADR) is not available on the disposal of the goodwill of a sole trade on incorporation.
Some care is required to ensure that the disposal of assets used in the business should be able to qualify for CGT BADR.
From 11 March 2020, the lifetime allowance for BADR is reduced to £1 million for all types of disposal.
Limited Company: The company’s shares may be sold, or its assets.
The sale may be back to the company (a Purchase of own shares), to a third party, or by employee buyout.
There is double taxation if there is an asset sale, as the company will pay tax on its gain and its owners will pay tax when they extract the remaining funds from the company.
CGT Business Asset Disposal Relief (BADR), will apply on the disposal of shares in an individual’s trading company, provided that qualifying conditions are met.
From 11 March 2020, the lifetime allowance for BADR is reduced to £1 million for all types of disposal.
BADR applies on the disposal of land and property used by an individual’s company, provided that the trade has ceased, no rent was paid for the use of the asset and the land/property is sold within a qualifying period.
A sale to an all Employee-owned trust can be exempt from CGT.
If you have any questions on which is right for you, speak to the Robinsons team
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