Limited company or sole trader - which is best for me?
How are Sole Traders taxed?
For sole traders all income is assessable for tax and so they are taxed on their business
profits, in addition to any other sources of income. There is little or no flexibility for
deferring some of those profits to another year if you happen to have a particularly good
year and are taxed at the higher rate.
How are Limited Company Profits Taxed?
Limited Companies are taxed on their trading profits also, in addition to other sources of
income such as interest and rent. Corporation tax is assessed after any owner’s salary has
been deducted. It is possible therefore to adjust the amount taken from the company in
any one tax year, as well as the way in which it is taken out. Some profits can be retained
in the company if the owner would otherwise be likely to pay higher rate tax personally.
Why should I think of Incorporating? (becoming a company)
Generally there are three reasons for doing this:
In some sectors (such as IT), it is hard to obtain contracts unless you trade through
a limited company. There is not always an obvious reason for this; it is just the way
things are.
If you are taking risks such as ordering a large amount of stock for an order that
could be cancelled, then there can be a real benefit in the limited liability offered by
trading as a company. Your own personal possessions are generally protected from
any claim against the company. However, in some circumstances, taking out a good
insurance policy is all you need.
There is more flexibility in handling the owner’s remuneration in such a way as to
minimise the tax liability. In recent budgets, this has become more apparent, making
incorporation an increasingly attractive option.
What are the disadvantages?
Your accountancy costs will increase, so you will need to be convinced that there are
sufficient savings to justify the cost. The company will be regulated by Companies House,
which has strict rules for reporting trading accounts (hence the price increase) and for the
conduct of directors and other company officials. You will need to be happy that you can
handle these regulations.
Can I change from one to another?
Yes. You can start as a sole trader and later incorporate. In fact, this is a common route
when a new business is unsure of how large it will grow and whether the saving will
outweigh the costs. You will need to consult a professional to ensure that any transition is
done properly.
Setting up a new business can be exciting. A business can operate as a soletrader or as a
company
Sole trader
Setting up as a sole trader is simple. In many ways you can just open a bank account and
away you go. There is no legal red tape to cut through or expansive legislation to deal
with. Consequently the annual cost required to run a sole trader business is relatively
cheap compared to other types of business of similar size.
However there are some major pitfalls. Firstly you have unlimited liability for all the
debts of the business. This is not only to trade creditors but also to customers who would
want to sue you as a result of a faulty products or service. If the business gets into
financial trouble the owner may have to sell personal assets to pay the bills.
There are also tax issues to consider. A sole trader is taxable on the actual profits of the
business and not just on the funds you withdraw. Drawings are not allowed as a
deduction before calculating tax. This can result in paying tax even if no money has been
withdrawn from the business. There are also reduced options in relation to pension
entitlements
(dependent on age), the use of civil service mileage rates and other issues.
Limited Companies
Setting up a limited company costs perhaps €500 between the registration and other
professional fees. Once set up, a limited company is classified in law as a separate legal
entity from its owners or shareholders. This effectively means in most circumstances, the
shareholders of a limited company have limited liability from all the debts of the
company. If the business goes broke they can only lose the value of the capital they have
invested.
Limited companies in general also tend to give a better impression of an established
owners of a limited company can be easily identified and some record of
the performance of the company is usually publicly available from the Companies
Registration Office. This does give a level of comfort to anyone who may wish to deal
with the company.
However all companies are subject to extensive Company Legislation which imposes
significant responsibilities on how the company is run. Banks often ask for personal
guarantees before giving loans which effectively gets around the company’s limited
liability status.
Accountancy costs are higher as a company’s accounts generally require significantly
more disclosure then a sole trader’s. In some cases a statutory audit of a company is
required which will further increase the costs.
There are many tax advantages to a company. For example, money not withdrawn in the
form of wages, is subject to corporation tax currently at 12.5%. There is also incentive
schemes where new start up companies are exempt from corporation tax and very large
tax savings for corporate pension schemes.
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