What is Limited company?
A limited company is totally separate from the person or persons who form it. What that means in real terms is that you and your fellow directors or shareholders have ‘limited liability’ in that you are not personally liable for debts should your company have financial difficulties whereas a sole trader is. If you a setting up a business you have four options to consider what type of business you will be:
- Sole Trader – an Individual
- Ltd Company by share/guarantee
- Ltd Liability Partnership (LLP)
- Partnership – two or more people/companies
When deciding whether to act as a sole trader or form a limited company there are many things that will influence your final decision, but first and foremost consider the questions below:
- What type of business are you planning to run?
- What level of risk are you prepared to take?
- What are your future business & marketing strategies?
- What kind of team do you have?
- How do you wish to be perceived by your customers?
Sole Trader VS Limited Company – Key Tax & Legal Differences
| Sole Trader or Partnership | Limited Company: you are director & shareholder |
| § You are the business§ You are the owner
§ You are the manager or proprietor |
§ The business is a separate legal entity§ You are a shareholder; you hold all or part of the company’s share capital
§ You serve the company as its officer as a director (a company secretary is an officer too) |
| Employment status: | Employment status: |
| You are self-employed; you cannot be your own employee. | § A director is an office holder, this does not automatically make him 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. |
| Tax on profits: | Tax on profits: |
| § 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.§ Your tax rate: see Income Tax rates according to lower or higher rate taxpayer | § The company pays corporation tax on its taxable profits. Company tax rates are lower than higher rates of Income Tax.§ Employees and office holders are subject to PAYE and NICS on their earnings from employment and many benefits attract income tax too.
§ Shareholders who are higher rate taxpayers will pay additional tax on dividend income. § When IR35 and the Managed Service Company provisions apply, the company must deduct PAYE and NICs on its income. |
| Losses: | Losses: |
| § You can offset your trading losses against your other income. | § The company can offset its trading losses against its other income, but not against your income as an individual |
| Extracting profits | Extracting profits |
| § You may withdraw cash from the business without tax effect | § You are taxed on all income that is withdrawn from the company. If it is a distribution it is taxed as a dividend. If it is earnings it is under PAYE and subject to NICs.§ Most employment benefits received by you or your family and household are taxable (subject to tax-free exceptions).
§ Shares or securities in the company which are given to you at less than market value. |
| Borrowing | Borrowing |
| § 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 will be proportionately restricted. | § A director may borrow from his own company. Limits are set by Companies Act 2006, but there are tax costs§ The company will pay a tax charge of 25% if you borrow from the company and do not repay the loan within nine months of the year end.
§ If the loan is interest-free there will be a tax charge for the director based on beneficial loan interest. |
| Pension | Pension |
| You can only have a Personal Pension | § Company schemes may be far more generous in terms of benefits and limits than Personal Pension.§ A SIP or SAS, or an unapproved scheme may be used to hold assets used in the company and may have flexibility on borrowing multiples.
§ You are required to consider pension arrangements for employees. |
| Insolvency | Insolvency |
| If the business fails you will be personally (or jointly with your partners) liable for its debts. You may go bankrupt. | § If the company fails, your liability is limited to the amount unpaid on your shares (if any) unless you have made a personal guarantee (which is often required by banks).§ As a director you can be held personally accountable if you continue trading when your company is insolvent and thus cause financial loss to creditors. This could result in your personal bankruptcy.
§ See Insolvency FAQs for directors |
| Accounts | Accounts |
| § You prepare annual accounts for your personal tax return. They can be in a very basic (three line) format for a business which trades below the VAT threshold.§ Your accounts are not submitted to HMRC unless you are subject to an investigation. Some accountants submit them with Self Assessment returns; the practice is optional.
§ Your accounts must be prepared in accordance with Generally Accepted Accounting Practices (GAAP) for tax purposes. |
§ You prepare annual accounts under the provisions of the Companies Act, these can be abbreviated for filing with Companies House.§ HMRC require full accounts for Corporation Tax which must be submitted using its own or specialist software.
§ Accounts must be prepared in accordance with accounting standards. § From 1 April 2011 companies must submit their accounts online in iXBRL. |
| § When the business or assets used in it are sold, you are personally taxed on any gain under the Capital Gains Tax (CGT) rules. A disposal of an interest in a business or a disposal of business assets may qualify for CGT Entrepreneurs’ Relief. | § When the business or the assets used in it are sold, there is a double tax charge on shareholders. The company pays corporation tax on any profit that it makes on disposal. The shareholders are taxed on the distribution of the proceeds.§ It may often be more efficient to sell the shares in a company, rather than its trade or business, or individual assets. Company shares can be gifted.
§ Providing you own more than 5% of a trading company, a disposal with gains of up to £5 million may qualify for Entrepreneurs’ relief. |
| Death | Death |
| § When you die your business ceases. You can pass all or part of it down to the next generation.§ In a partnership you can pass on your share of the partnership.
§ Business Property relief (PBR) will apply for inheritance tax (IHT) purposes if the business is a qualifying trade. |
§ When you die the company lives on: it is a separate legal entity.§ The company’s shares will qualify for BPR for IHT purposes, providing the company is engaged in trade.
§ There is no IHT relief on outstanding directors’ loans. § Assets that are held outside the business qualify for 50% BPR. |
| Paying yourself | Paying yourself |
| § You can withdraw any amount of profits, but it is not classed as remuneration as you are not an employee.§ Paying a salary to a spouse or family members must be commercially justified to be allowable for tax purposes. | § There is no restriction on the size of your salary, but it is subject to PAYE and NICs.§ Paying a salary to a spouse or family members must be commercially justified to be allowable for tax purposes.
§ If your contracts fall within the IR35 regime or the company is a managed service company PAYE and NICs will apply to income. |
| Expenses in general: | Expenses in general: |
| § You obtain tax relief for expenses that are incurred wholly and exclusively for the purposes of the trade.§ If you can identify a proportion of an expense that relates to business you can claim the same proportion against tax.
§ An adjustment must be made for tax to add back the proportion of any expense that relates to “private use”. § Most commonly private use will be in respect of your use of telephone or power, own consumption of goods, and motor running expenses. |
§ The company obtains tax relief for its expenses if they are incurred wholly and exclusively for the purposes of the trade.§ If a director incurs private expenses through the company, they may be treated as earnings, if he is a shareholder the amounts are treated as distributions. |
| Cars and fuel | Cars and fuel |
| § A sole trader or partner can claim capital allowances on a car, disallowing a proportion for private use. See Capital Allowances: vehicles (self-employed).§ Low-emission cars can be tax efficient for family members on the payroll.
§ There is no adjustment for fuel benefit for you as a sole trader, you merely disallow a proportion of your fuel costs in relation to private use. |
§ The company obtains full capital allowances on cars, irrespective of any private use by employees.§ Cars can be included as expenses of benefits in kind but this depends on list price and the CO2 emissions of the vehicle.
§ It may be better to run your own car and the company can reimburse using HMRC’s Authorised Mileage rates. § Low-emission cars can be a tax break for family members on the payroll. § It is not tax efficient to provide employees with rights to fuel for private use as employers are permitted to reimburse company car drivers for business mileage, but they must use special employer’s advisory rates. |
| Mobile phones | Mobile phones |
| § Mobile phones will be subject to private use so a tax add-back is expected on your tax return. | § Mobile phones can be provided if the contract is in the company’s name, tax free.§ Only one per household. |
| Computers | Computers |
| § You can obtain capital allowances on a computer. An add back of allowances will apply if there is substantial private use. | § Providing you need to use one to perform your role your company can provide a computer without any tax consequences. |
| Tax-free benefits and incentives | Tax-free benefits and incentives |
| These do not apply to the self-employed | Many different benefits and employment incentives can be provided free of tax (the company will obtain tax relief on the cost of providing these too). |
| Working from home | Working from home |
| § You will be able to claim a deduction for mortgage interest, rates and light and heat, if you have an office at home. | § You can claim £3 per week without receipts for home expenses.§ Alternatively, the company can reimburse you for light and heat, but not mortgage interest or council tax. |
| Charging rent for use of home | Charging rent for use of home |
| § A sole trader cannot charge himself rent. | § A director you may set up a licence between you and your company to rent an office (or other space) in your home or outbuildings. This will enable you to recharge a proportion of mortgage interest and council tax.§ You will need to declare this as income and prepare rental accounts as for Self Assessment tax purposes. |