A private limited company advantages versus sole trader basic accounts
A private limited company advantages and disadvantages compared with retaining sole trader status extends beyond purely tax advantages. There are other private limited company advantages and also disadvantages particularly in regard to limited company accounts and administration compared to producing a simple set of sole trader basic accounts.
A private limited company advantages include:
1. Limitation of Liability
There is no distinction between business money and personal money for anyone self employed as all business debts are the personal responsibility of the sole trader. The private limited company advantages are that the company is a separate corporate body and liability for payment of debts stops with the pvt ltd company, the owners, shareholders are not personally liable. The directors are only liable if they continue to trade and incur liabilities after it becomes apparent the ltd company is insolvent.
2. Lower Taxes
Lower corporation tax offered a private limited company advantages over self employment in recent years. The £10,000 tax free limit was cancelled several years ago. Corporation tax rates have increased from 20 per cent to 22 per cent for small ltd companies over the last three years compared with the basic rate tax for a sole trader which has reduced from 22 per cent to 20 per cent Incorporation does still offer tax saving advantages dependent upon the net profit before tax.
The private limited company advantages come from the flexibility of being able to determine the proportions of salary and dividends taken compared with a sole trader whose basic accounts are subject to tax at fixed tax rates and thresholds.
A sole trader receives a £6,035 personal allowance and pays basic rate tax of 20 per cent on the next £34,800 of earnings up to the higher threshold limit and 40 per cent tax thereafter. Class 4 national insurance is 8 per cent of earnings up to the upper primary threshold and 1 per cent thereafter.
Dividends are taxed at 10 per cent on total income up to the higher threshold and 32.5 per cent above. The dividend is a distribution of company profit after corporation tax has been deducted and so the shareholder also receives a dividend tax credit from the pvt ltd company of 10 per cent.
There are significant private limited company advantages regarding tax liability compared to a sole trader where net income is below the upper earnings threshold.
For example assuming the limited company net profit before salary is £35,000. A sole trader would pay income tax of £5,793 plus national insurance of £2,317.20, a total of £8,107.20.
If a salary of £6.035 is taken and the rest is taken in dividends a private limited company would pay £6,372.30 corporation tax, after deducting the salary from net taxable profit and the sole trader now the shareholder would pay no income tax.
The advantages increase where net taxable profit is above the self employment upper earnings limit as money can be left in the business and therefore only subject to the 22 per cent corporation tax rate thereby avoiding the sole trader 40 per cent tax rate. Another possibility is to distribute the shares among family members to reduce the risk of 40 per cent tax.
3. Limited Company accounts and Sole Trader basic accounts
Sole trader basic accounts can be quite simple as a formal accounting system is not required and can be reduced to simple lists of income and expenditure supported by documentary evidence of sales and purchase invoices, effectively single entry bookkeeping. Producing a balance sheet is optional. Due to the simplicity then an accountant may not be required saving a significant cost.
Ltd company accounts have to use double entry bookkeeping to produce the year end accounts including a balance sheet with statutory notes and statements. Unless accounting software is employed to produce the company accounts in this format then accounting knowledge is required and an accountants fee may well be in the region of £500 to £1,000. An accountant is not essential for a small pvt ltd company but is the normal approach and offsets some of the tax advantages.
4. Additional financial considerations
Because a director is also officially an employee of the pvt ltd company this gives rise to a number of considerations in determining the extent of a private limited company advantages.
Pension contributions of a sole trader are personal and while may be deducted from the personal income liability do not form part of the basic accounts. The pension costs including any company contribution to a pension scheme by a private limited company is a deductible business expense as an employee cost.
Using a car for business purposes may have an impact. The sole trader basic accounts would include the business proportion of the vehicle running costs or the mileage allowance. If that vehicle is used by a director then that director is receiving a taxable benefit potentially resulting in a higher tax burden depending upon the type of vehicle as taxable benefits vary. An alternative may be to leave the company vehicle privately owned and the director claim mileage allowances rather than vehicle running costs.
Potentially small issues but there differences in the accounting treatment of deductible expenses such as charitable donations, entertaining expenses and use of home as office. A private limited company advantages consist of being able to claim such expenses as valid business expenses which would not be claimable in the sole trader basic accounts as treated as personal not business.
If the director and main shareholder have other associated companies then the corporation basic tax rate could be affected.
5. Administration, management and business standing
A sole trader basically pleases themselves with regard to the administration and management of the business. A company director is responsible for adhering to company administration according to statutory regulations in regard to both the limited company accounts, statutory books and management as stated in the articles of association. The duties of a director are more formal than a sole trader.
Forming a private limited company is an indication that a business is both serious, has a long term objective and is correctly managed. This psychological perception can increase the business standing of a business. In addition funding requirements are more likely to be met as the lender to a sole trader has to consider the absence of a balance sheet statement in the basic accounts and the financial influences personally affecting the sole trader. A private limited company advantages concern the published financial statements, protection of the financial position from personal influences and the option of increasing security by virtue of asking directors to provide additional personal guarantees.
A private limited company advantages over self employment also extends to long term finance. Companies tend to retain more funds within the business to meet future financial commitments which aids year on year growth, a more sustainable business and medium term profits growth over a sole trader.
Great post, i would add though that the benefits of limited liability are usually very small though for most small business owners, as the major creditor is usually the bank, who usually take a personal guarantee from the directors/shareholders for all loans and overdrafts, and negates much of the benefit of the Ltd liability.
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I found this post excellent. I started a limited company purely for the limited liability aspect and have since found myself drown in the world of forms for companies house etc. Was seriously considering changing to self employed but from the above I think I'll stick with ltd company.
Meeting an accountant next week to talk through all benefits...
Tax rules and rates change every year and from 1st April will be slightly different to those quoted in the original post but would not make a material difference.
Personal allowance from 6 April 2009 is increasing from 6035 to 6475
Corporation tax from 1 April 2009 is staying at 21 per cent for another year before going up to 22 per cent next year
Excellent article Terry. It confirms why I chose to become a limited company right at the start of the launch of the business nearly 3 years previous. The tax benefits are much better but I agree that the perception and standing of the business is also vastly improved compared to being a sole trader.
Excellent article Terry. It confirms why I chose to become a limited company right at the start of the launch of the business nearly 3 years previous. The tax benefits are much better but I agree that the perception and standing of the business is also vastly improved compared to being a sole trader.
I think the main benefit is in the perception of status rather than anything else. There can be tax benefits but these have to be handled with care as this is an area HMRC will be increasingly looking at as the government runs out of cash. Remember all these banks and multi nationals who two years ago were posting massive profits were paying huge amounts of tax. No doubt that was a good reason for Gordon Brown to turn a blind eye (no pun was intended but it is rather appropriate) on some of the "iffy" financial products. Now GB will be looking to the small guys to make up some of the loss of tax income.
Thanks Terry, a great post on the Ltd Company V Sole Trader scenario.
I thought I would just add a link to this blog page which contains a video and a link to a spreadsheet that can be downloaded.
The spreadsheet compares Sole Trader V Limited V LLP V Paye and we originally designed it for Professional Contractors and Freelancers to calculate the difference between various structures , but it can be used by anyone in buisness to see the difference in net income between various structures, assuming all income is distributed.
Excellent post. I see this coming up all the time on various forums and so many people just jump head first into a LTD where there is simply no need...
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A private limited company advantages versus sole trader basic accounts
