Sole trader or limited company – choosing the right business structure

For years, setting up a limited company has often been seen as the obvious choice for a profitable business owner looking to operate in a tax-efficient way. However, with changes to tax rates and the way different forms of income are taxed, it’s easy to see why the traditional assumption that limited companies are better for tax efficiency deserves a closer look.

We’ve pulled together a series of blogs about some of the best ways you can run and grow a business tax efficiently – and the most obvious place to start for part one is the set up.

Sole trader or limited company?

There are positives and negatives to both options.

Operating as a sole trader is often the simplest way to start a business. There is less administration, fewer formal reporting requirements, lower set up costs and a greater level of privacy.

However, as a sole trade is not a separate entity, you are personally responsible for the business and its debts and there is no flexibility over how and when you are subject to tax on any profits you make.

A limited company is a separate legal entity, providing a degree of separation between the business and its owners. You have limited liability which means that your assets are protected if the business falls into difficulty. A company structure can also offer tax planning advantages by providing flexibility over when and how you draw income from the business.

However, a company brings additional administration and costs and is required to file certain information to Companies House which is publicly available, making the company’s financials more transparent than the sole trade option.

Tax efficiency - don't compare the headline rates!

This is where business owners can sometimes be caught out. It is tempting to look at the Corporation Tax rate and assume that a limited company must therefore be more tax efficient but the tax calculation is more complicated than simply comparing corporation tax rates with income tax rates.

As a company is a separate legal entity, profits must be extracted before a business owner can benefit from them so the tax treatment of extraction methods such as salary, dividends and pension contributions also needs to be considered in addition to the headline corporation tax rate.

The comparison between the business structures available therefore needs to look at the overall tax position, rather than one tax rate in isolation.

Can I change my structure as my business grows?

It is very common for small business owners to start their journey as a sole trade as this is often the simplest option. As the business grows, it is possible to incorporate the sole trade into a limited company if there are sound tax, commercial and practical reasons to do so.

Those who start their business as a limited company cannot necessarily change the corporate structure but there are other advantages to encourage growth such as the ability to bring in new shareholders or expand business operations into a larger group structure.

Both options allow for changes to be made, if appropriate, as the business grows.

So which option is best for me?

There isn’t a one-size fits all answer and that’s where professional advice can really benefit a fledgling business.

The best option often doesn’t rest solely on tax-efficiency. Other crucial factors such as personal liability, financing and administration all play a part. Seeking professional guidance at the start of your business will be key to ensuring that you set off on the right foot.

In the next blog, we look at how growing businesses can attract and retain employees for the long term. In the meantime, if you would like any advice about tax efficient ways to set up your business, contact Monahans to see how we can help.