Limited company vs sole trader for the 2020/21 tax year

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There are a number of factors to consider when setting up your own business or deciding to incorporate an existing business. We  discuss below the tax position as well as the general advantages and disadvantages of a limited company vs sole trader for the 2020/21 tax year.

Running your business as a sole trader

The majority of new UK businesses frequently start as sole traders. This can sometimes be referred to as being self-employed.

Starting your business as a sole trader is a relatively straight forward process and there is less administration involved than a limited company. However it is essential that all business transactions are carried out through a separate designated bank account.

Should you be selected for a HMRC enquiry, HMRC’s default position is to assume that any payments from a bank account with mixed business and personal use are likely to be personal in nature and therefore are not tax-deductible business expenses. Equally if there any receipts into a mixed-use bank account HMRC will assume this is income generated by your business unless you are able to prove otherwise.

Dealing with HM Revenue as a sole trader is also relatively straight-forward. As a starting point you’ll need to be registered as self-employed with HMRC and file a Self-Assessment tax return each year. You’ll also need to make the appropriate tax payments on account by the correct due dates.

There are a number of factors to consider when setting up your own business or deciding to incorporate an existing business. We  discuss below the tax position as well as the general advantages and disadvantages of a limited company vs sole trader for the 2020/21 tax year.

Running your business as a sole trader

The majority of new UK businesses frequently start as sole traders. This can sometimes be referred to as being self-employed.

Starting your business as a sole trader is a relatively straight forward process and there is less administration involved than a limited company. However it is essential that all business transactions are carried out through a separate designated bank account.

Should you be selected for a HMRC enquiry, HMRC’s default position is to assume that any payments from a bank account with mixed business and personal use are likely to be personal in nature and therefore are not tax-deductible business expenses. Equally if there any receipts into a mixed-use bank account HMRC will assume this is income generated by your business unless you are able to prove otherwise.

Dealing with HM Revenue as a sole trader is also relatively straight-forward. As a starting point you’ll need to be registered as self-employed with HMRC and file a Self-Assessment tax return each year. You’ll also need to make the appropriate tax payments on account by the correct due dates

Trading as a limited company

Some businesses choose to start as a limited company because of the perception that this provides enhanced status in the marketplace, whilst others choose to incorporate their business later on, once they know their business model is successful.

Some of the advantages of trading as a limited company vs sole trader are as follows:

  • Limited liability– Any shareholders’ liability is limited to the amount of issued and paid up share capital. However it’s worth mentioning that a lot of banks require personal guarantees from the directors. A lender can therefore seek recovery of their debt from the directors/shareholders in the event the business becomes insolvent.
  • Planning for retirement – Trading through a limited company can prove advantageous, particularly if your planning to boost your pension provision significantly.
  • Separate legal identity – A company is regarded as a separate legal identity from you personally. This might be useful if you are working in a sector with a high risk of being sued
  • Changing ownership –The business ownership can be changed relatively easily by transferring shares though it’s always important to consider the tax considerations before undertaking this.

There are also some disadvantages to trading as a limited company and we set out a few examples below:

  • Administration –There’s a lot more administration involved. For example, a company is required to file a confirmation statement with Companies House. The company’s accounts must also be in a format which is prescribed by the Companies Act 2006. A sole trader does not have such restrictions. Typically there are also financial penalties for non-compliance with deadlines. The directors are at risk of prosecution if they don’t fulfil their statutory obligations correctly.
  • Losses –As a company is regarded as a separate legal person, any trading losses can only be set off against any profits made by the company in the prior year or future years. Typically some company’s make losses in their early years and this lack of flexibility can prove problematic for cash flow. Conversely the losses made by a sole trader in their first few years of trade can be offset against other (non-trading) income in current and prior years.
  • Withdrawal of funds –The company’s money and the owner’s money are completely separate and there can be adverse tax implications if this isn’t managed correctly. If you operate your business as a sole trader, you can generally introduce or withdraw cash from the business without any tax implications.
  • Public visibility – Because a company’s Statutory Accounts are required by law to be filed at Companies House, the results are freely available to the public (and your competitors).

Last and by no means least, the tax liability is one of the most important considerations if you are considering limited company vs sole trader. We set out the position for the 2020/21 tax year below.  These figures assume a salary to the lower earnings threshold and dividends on the balance of reserves.

2020/21
 

Profit Level £Sole TraderLimited CompanySaving
£10,000£204£230-£26
£20,000£2,604£2,661-£57
£30,000£5,504£5,168£336
£40,000£8,404£7,676£728
£50,000£11,304£10,184£1,120
£75,000£21,804£19,279£2,525
£100,000£32,304£30,610£1,694


We’ve also set out details for the 2019/20 tax year by way of a comparison.
 
 
2019/20
 

Profit Level £Sole TraderLimited CompanySaving
£10,000£279£260£19
£20,000£2,679£2,410£269
£30,000£5,579£4,918£661
£40,000£8,479£7,425£1,054
£50,000£11,379£9,933£1,446
£75,000£21,879£18,710£3,169
£100,000£32,379£30,041£2,338

Changes introduced over previous years have reduced the potential tax savings available as a limited company as the government has sought to harmonise the tax burdens imposed on sole traders and a limited company owners.  However, the limited company route still offers other tax advantages such as deferment of tax payments, tax efficient pension contributions and potential avoidance of the High Income Child Benefit Tax Charge.

SRC-Time are one of the South East’s leading accountancy firms in advising individuals and businesses in all aspects of their accounting and tax affairs and we are able to assist in any issue raised above.

Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at info@src-time.co.uk  or speak with an account manager to get any process started.

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