Sole Trader or Limited Company?
Wednesday, 21 September 2011 09:32
The following is an article published by Brand Yorkshire Magazine, Sept/Oct 2011.
The legal status of your business can have an effect on your finances, so it’s worth thinking about from the beginning, say Claire Turner and Jane Tindall of Winburn Glass Norfolk, WGN.
There are a number of different legal entities your business could take on and it’s essential to take the time to understand the pros and cons of these before making a decision about what form your business should take.
For many start-ups, the logical way to go might be to form a limited company, but this may not always be the best route – and don’t fall into the trap of thinking it’s all about saving tax. Other factors to consider include your attitude to risk and liability limitation, directors’ responsibilities and compliance with the Companies Act, record keeping and administration, additional accountancy fees and the external perception of your business.
When it comes to tax, consider effi cient extraction of funds or profi ts, the effect of personal and corporation tax, national insurance, pension contributions, losses, any other companies under common control and the rules about personal service companies.
"Some people start their own businesses whilst still earning elsewhere," says Jane Tindall. "They might begin part-time from home for example, to see whether or not it’s viable". In these circumstances, says Jane, it can be better to operate – at least in the early days – as a sole trader. "As a sole trader you’re taxed on profi ts, not on what you take out of the business, a common misconception. Often start-ups suffer losses in the beginning, so it can be more tax effi cient to register as a sole trader in order to obtain relief against other current or prior year income."
However, this should be taken with a word of caution. If the business is a relatively risky one, being a limited company from the start could be the best way forward. Claire Turner explains: "Measuring risk is a diffi cult thing," she says. "Remember, a signifi cant percentage of new businesses fail in the early days so a limited company gives peace of mind, and may limit your liability should anything go wrong."
However, as a general rule of thumb, Claire and Jane advise that even if you don’t need to limit liability for your business, because the fi nancial risks are minimal, it can be more tax effi cient for profi table business to incorporate even when profi ts are relatively low. "At £50,000 of profi t there is about £4,000 to be saved in tax," says Claire. "However, a limited company is usually more costly, so making this decision should be done in conjunction with your accountant, who’ll be able to advise you about tax efficiency."
Claire’s referring to the costs of running a limited company, which are higher than operating as a sole trader. "This is because there are more reporting requirements, for example, in fi ling statutory accounts and ensuring you have robust record keeping in place," says Jane. "Accurate record keeping is absolutely essential for all businesses but for a limited company there is a lot more to consider, and without it, you are also at risk of HMRC compliance checks and possible penalties for incomplete records."
Claire Turner and Jane Tindall are both partners at Leeds-based WGN
Key Points to Consider...
Obviously there are a number of other legal entities your business could adopt – these range from partnerships, which come in a range of guises, through to private and public limited companies. Jane and Claire advise discussing the different options with an accountant. "Deciding which sort of legal entity your business should be is not necessarily straightforward and it’s worth discussing all the options with a good accountant right at the outset," says Jane. Claire adds that planning at all stages of your business is important for example if you are considering an exit route your business structure should be revisited. "There may be ways in which you can maximise your return particularly with the availability of Entrepreneurs Relief," she says