Start Ups - Sole Trader or Limited Company

So you have decided to start up your own business, assuming you are going to earn more than £641 per month (the point at which tax & NI kicks in), many people will tell you to form a Limited Company to save tax, is that the best decision?

National Insurance

National Insurance on Business Profits

The main tax advantage from a limited company is that you only pay 20% corporation tax on business profits, where as a soletrader you have to pay 20% income tax and 9% national insurance and a weekly £2.70 class 2 national insurance. 

Losses

Using losses to claim Tax Refunds

Hopefully your business won’t make a trading loss in the 1st year, but because of tax allowances like capital allowances, you could make a trading profit but a taxable loss. This is very likely if you have a lot of set up costs.

For example if you are employed and self-employed during a tax year, as a sole trader you can offset any losses from your trade against your employment income, and so receive a tax refund, as a Limited Company you cannot do this, all you do is carry the losses forward against hopeful future profits.

Motor Vehicles

In a limited company, if your business buys a motor vehicle you do get tax relief, but for you to use it for non-business use you have to pay tax and national insurance based on the CO2 emissions of the vehicle.

Normally this costs more than you save, so this is why most people with a Limited Company claim business mileage for using their own vehicle. See our blog on claiming VAT on business mileage.

As a soletrader all you do is add back a private use percentage of the vehicle costs. And so normally get slightly more tax relief on the vehicle costs.

Incorporate after a couple of years

Tax refund from incorportion

This is a really good tax planning option. You build up a business as a soletrader and then sell it to your own Limited Company. You pay capital gains tax at 10% on the sale less your Capital Gains Allowance, BUT you can claim 20% corporation tax relief on the cost. So if you build a business worth £50,000, you would pay about £4,000 capital gains tax, and get £10,000 taken off your Corporation Tax bill.

Summary

As I said at the beginning, all this assumes you are going to make more than your tax free allowance and so considering the above examples sometimes the Limited Company route does not suit every situation. Sometimes it is better to take advice before you commit so you can work in the most tax efficient manner.

Contact us for free advice that is specific to your situation.