There are many advantages of having a sole trader structure for your business with the main one being the simplicity of business administration versus a limited company set-up. However, as your business thrives and grows the potential next step to limited company status can provide credibility and attractiveness as an established business to your customers, whilst also very importantly providing an opportunity to review your tax position.
There is a balance to be struck when considering the change from sole trader to limited company. At a certain point you will need to consider if you are overpaying tax as a sole trader and it may be more tax efficient to move to a limited company structure. The rule of thumb is when your turnover reaches around £30,000 per year, you should start to consider limited company status. At this relatively low threshold of turnover you may still wait before making the transition, as there are various other deciding factors to consider as well as your business’ turnover.
The benefits of limited company status
One of the main benefits of being a limited company versus a sole trader, above and beyond tax savings, is limited liability protection whereby you separate business activities from personal ones and your personal assets are protected from any business losses that may occur. As a sole trader, all your finances are considered in the whole when looking at your tax position.
As a limited company, another great benefit is greater power to borrow against your business to push forward with your business ambitions if you wish, whether it be growth in existing markets, expanding your reach globally or adding new product lines.
Your business perception in the market will also grow and you will more likely be perceived as a success story by your customers and an established and credible business.
Is the burden too high for me if I move to a limited company structure?
The following are the main changes you should consider when moving to limited company status. We suggest speaking with an accountant, like Southside Accountants, to get bespoke tax and accounting advice for this important decision and to make sure you are aware of the responsibilities you will have as a limited director of your company.
Get a business bank account
As a sole trader of a viable and thriving business, you will already be familiar with reviewing your business transactions for onward tax reporting to HMRC and review of your business profitability.
By having a standalone business bank account you can ensure that when you make a move from sole trader to a limited company structure, you separate your business and personal transactions as dictated by your new legal structure. With limited company status, you have limited liability which means the requirement to report and declare your personal finances is no longer required and there is a clear divide between business and personal transactions.
The benefit of separation of business and personal activities under a limited company structure means that you are not personally liable for your business’ losses as you would have been as a sole trader.
As a limited company, you are required to keep all your business transactions under your company name so we recommend you set up a dedicated business account when a move to limited company structure is decided upon. This is not a legal requirement, however, if you do not heed this advice, there would be some serious tax consequences which means you may end up paying far more tax than required. As a sole trader, your profit is taxed at a personal tax rate versus a limited company, where you can extract a salary and/or dividends from your profits at a much better tax rate. See our article for further information on the optimum level to pay yourself a salary within a limited company structure.
Claiming business expenses
Another major benefit of working under a limited company structure is the opportunity to claim tax relief on a variety of business-related expenses, including those expenses incurred while working from home.
As the rules are complex, you can find more detail on what you can claim for here and what you are allowed to claim for while working from home, here.
Introduction to corporation tax
Sole traders are required to report their business activities and profits to HMRC via a Self-Assessment Tax Return (SA), and the tax implications as a sole trader could amount to as much as 47% for both Income tax and National Insurance combined.
Limited companies in contrast are liable for corporation tax on their business profits at a current rate of 19%, so clearly a huge decrease in your tax bill potentially if you move to a limited company structure. There is also a planned decrease to 17% corporation tax on 1st April 2020.
Please be aware as an appointed director of your limited company, you will still need to submit a SA for any salary and dividends you pay yourself as an employee of your limited company. This means you will stay pay income tax and national insurance, but only on any salary you pay yourself, and if planned carefully, the amount of tax you pay can be minimal. See full details here on the optimum level of salary and dividends you should pay yourself as a director of a limited company to avoid paying too much.
Your relationship with HMRC
When you are ready to move to a limited company structure, the onus is on you to advice HMRC of the change.
IR35
If you are a contractor or you plan to hire contractors as your business grows, you should get familiar with the IR35 tax legislation, already in place in the public sector and will be rolled out to the private sector in April 2020.
This new tax regulation in the private sector is being introduced to help HMRC detect tax avoidance by contractors who supply services via an intermediary, such as a limited company structure set-up, who would otherwise be considered an employee if the intermediary was not used.
HMRC are imposing this tax regulation heavily in the public sector and have taken several public figures to court, winning over half the cases. As a result, IR35 is being met with much controversy and there is much concern on implementation of the legislation in the private sector in 2020, as IR35 rules are considered complex and opaque.
Specialists tax advice is strongly recommended and here at Southside Accountants we offer support on determining the status of limited companies and/or the contractors it employs within the IR35 rules.
Changes in accounting processes
In the age of cloud accounting, and with Southside Accountants a Xero Pro Advisor, the perception of limited company tax reporting as being complex and time consuming no longer stands.
The benefits of cloud accounting includes online and automatic tax calculations, expenses management and automatic invoice processing, as well as all business data safely stored and uploaded to the cloud rather than manual recording keeping. HMRC require companies to retain the last 6 years of business transactions at any time and so clearly the benefit of cloud accounting cannot be overestimated.
HMRC themselves advocate digital tax and you may already be aware of the government’s Making Tax Digital Initiative (MTD) which will eventually require all businesses to file their tax information online quarterly. Currently, MTD has been rolled out to VAT registered businesses with turnover above £85,000.
It goes without saying that using technology in your business will allow for efficiencies and reduce costs, such as using Artificial Intelligence to carry out repetitive back office processes rather than increase headcount in your business.
Do I need an accountant?
With cloud accounting now accessible directly online to small business owners at very little cost, do you need an accountant?
The advent of cloud accounting has meant that accountants continue to satisfy the core accountancy needs of busy business owners, such as keeping finances in good order, managing business expenses and ensuring regular tax deadlines are met, which will increase to quarterly with the government’s MTD Initiative in time.
But there is no doubt that with cloud accounting, an accountant also has time to partner with you as a business advisor, working with you with the finance knowledge to help you realise your business ambitions, whilst maintaining your profitability and effective tax position. Having real time knowledge of your business finances in real time via cloud accounting is a hugely powerful tool, and having an accountant to help you make the most of the numbers means your road to success is much clearer and achievable.
Taking the next step, a timely move
We understand that taking such a decision will take some serious thought and consideration and we would strongly recommend you seek professional advice.
Southside Accountants offer a free consultation where we can provide bespoke and tailored options for your business.
Written by Shaima Todd.
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