With the changes to NICs, dividend allowances and corporation tax rates, now is an excellent time to review whether you would be better off operating as a sole trader or a limited company.
Selecting the appropriate business structure is an important decision for business owners in Rochdale and Leeds, as it significantly impacts how their business is run, regulated, and taxed. This blog reminds us of the consequences of being a sole trader or a limited company. We will outline the differences between these structures and discuss the tax consequences associated with each.
Sole trader
The sole trader or self-employed structure is the most straightforward option for small businesses. In this setup, an individual operates as the business's sole owner, assuming full responsibility for its success and debts. The advantages of being a sole trader include ease of setup, minimal administrative requirements, and complete control over business decisions.
However, there are potential downsides. Sole traders have unlimited personal liability, meaning their personal assets are at risk if the business incurs debts or faces legal issues. Additionally, the tax implications of being a sole trader involve paying income tax and National Insurance contributions* on profits generated by the business. While the sole trader structure may be suitable for small enterprises with low-risk profiles, individuals should carefully consider potential personal financial exposure.
Limited company
Limited companies are separate legal entities from their owners, offering limited liability and protecting personal assets. This structure can be more complex to set up and maintain, involving statutory requirements, company registration, and annual filings. Limited companies issue shares to owners (shareholders), and directors manage the company.
Limited companies can be private or public, with the key distinction being that public companies can offer shares to the public. The majority of small to medium sized companies operate as private companies.
Business owners and directors can increase their income by becoming shareholders of their limited companies and paying dividends to themselves. However, dividends can only be paid from the retained profits in the company and after all current tax liabilities have been met.
The primary advantage of a limited company is the protection of personal assets, making it an attractive option for businesses with higher risk profiles.
Regarding taxation, limited companies are subject to corporation tax on their profits. Shareholders are then taxed on any dividends they receive from the company. While this may result in double taxation at the corporate and individual levels, the overall tax burden can sometimes be lower than other structures, especially for businesses with substantial profits.
* NIC changes were announced in the 2023 Autumn Statement; see below.
Recent tax changes affecting sole traders and limited companies
The following recent tax changes could impact which business model is suitable for you.
Personal tax allowances – the rate from which you start to pay income tax is currently fixed at £12,570 per person and will remain at this level until April 2028. In addition, the additional rate income threshold was reduced from £150,000 to £125,140 per year.
Commentary: These changes to personal tax allowances make the limited company option more advantageous for some business owners, who can take the minimum amount of drawings/salary from their business but then top up their income with regular dividend payments.
Dividends – up to the 22/23 tax year, shareholders in limited companies could receive up to £2,000 per year in dividends before paying any income tax. From April 2023, this was reduced to £1,000; from April 2024, this will be further reduced to £500. The rates at which you pay tax on dividends are:
- Basic rate taxpayers – 8.75%
- Higher rate taxpayers – 33.75%
- Additional rate taxpayers – 39.35%
Commentary: Reducing the dividend allowance may make the limited company route less attractive to some business owners, and therefore, self-employed/sole trader status may be more suitable.
Corporation tax – for businesses with profits over £250,000 corporation tax rose from 19% to 25% from April 2023. Small companies with annual profits less than £50,000 will continue to pay 19%.
Businesses that have profits between £50-001 to £250,000 will pay the 25% corporation tax rate, which is reduced by a marginal relief and then increased gradually to the 25% tax rate.
Commentary: The calculation of corporation tax for businesses with a turnover under £50,000 or over £250,001 is relatively straightforward. However, the tax computation becomes more complex for those businesses caught in the middle 'marginal rate relief band' (£50,001 to £250,000). There could be grounds to disincorporate depending on where the profits are within this range.
National insurance contributions – in the 2023 Autumn Statement, the Chancellor announced a reduction of 2 percentage points on employee NICs, from 12% to 10%. This change will be effective from 6 January 2024.
From April 2024, Class 4 NICs for the self-employed will reduce from 9% to 8%, and Class 2 NICs for the self-employed will start to be abolished.
Commentary: These recent changes to NIC may not make a significant difference to business owners but are worth considering when looking at which business model currently works best.
Conclusion
Invariably, the decision on whether to trade as self-employed or as a limited company comes down to each business case, and there isn't a 'one size fits all' approach that can be taken.
Although we have outlined the recent tax changes that have directly impacted sole traders and limited companies, the type of business structure you choose will also depend on other factors outlined in this blog.
Sole traders and limited companies each have advantages and disadvantages, with differences in liability, control, and taxation. Business owners must weigh these factors against their business needs, risk tolerance, and long-term objectives to make an informed decision that aligns with their vision for success.
How can DWilkinson&Company help?
We have a vast amount of experience in advising business owners on what structure is best for them. We learn more about your business, its operations, and your personal and business objectives. From those discussions, we can then 'crunch the numbers' to give you the different options from a financial and tax point of view and provide recommendations on which business structure would be most suitable.
As we have seen in the past couple of years, tax rates and allowances change, and this can mean your current business structure also needs to change. We proactively advise you of what changes, if any, need to be made to your business.
To arrange a free consultation to discuss your business (or a new business you are looking to start), please get in touch with us on 0113 320 0001 or email office@dwco.co.uk
.