You’ve got a fantastic business idea and you can’t wait to get going with it and make it a success. But what type of business should you be? It’s not as exciting as sorting out your branding, or planning your marketing strategy, it’s definitely worth spending some time thinking about what type of business you’re building.
There are many structures to chose from, but the main two for most people to consider are sole trader vs limited company. Contrary to popular belief you can be VAT registered or employee staff with both, so you don’t necessarily need to rule out being a sole trader if you want to do either of these things. There’s no right or wrong choice (yep, I hate those types of decisions too), and it often comes down to your personal circumstances. To help with your decision, let’s look at the main differences.
Sole Trader: You do. Anything the business owns, including cash in the bank and equipment, is yours to use as you wish. The flip side of this is that any debts the business has are also yours. Every silver lining has a cloud!
Limited Company: Everything is owned by the company. Even if you’re the only director, anything owned by the business is not yours. That also means that you’re not personally liable for debts that the business owes. So you need to disciplined and not treat the business’s bank account as though it’s an extension of your own.
Sole Trader: As soon as you’re ready to. You do, however, need to tell HMRC that you’re self-employed and register for self assessment. This needs to be done by 5th October of your second tax year, so if you started your business between 6th April 2017 and 5th April 2018 you have until 5th October 2018 to register for self assessment.
Limited Company: The company does not exist until it is set up with Companies House. This is known as incorporation and normally takes only a few days. You cannot start trading until your company has been incorporated. Bear in mind that it often takes a few weeks for a business bank account to be set up, so build this in to your planning.
Sole Trader: You need to submit a self assessment tax return every year. This covers all of your personal income, including any from employment, self-employment, or property. You have until the end of the January after the tax year, so for tax year that ended 6th April 2018 you have until 31st January 2019 to both submit your return and pay any tax due.
Limited Company: Your paperwork requirements are a bit more involved. As well as a personal self assessment return you also need to submit annual accounts, a company tax return, and a confirmation statement. If you choose to pay yourself a salary you’ll also need to register as an employer and run payroll. You’re not required to have one by law, but many people chose to work with an accounting professional to help them with all of this.
Sole Trader: You have full access to any money the business has. In practice I’d always recommend having a separate bank account for the business, but there’s nothing stopping you from taking money directly from this for your personal use. I’d recommend treating this like you would a salary and transfer money over once a month, as lots of people find this easier to manage. Any money you take from the business is known as drawings, and you don’t need to register as an employer with HMRC or declare this as income.
Limited Company: You can’t use the company’s bank account as your personal funds. You can choose to take an income from the company in two ways: salary and dividends. It depends on personal circumstances, but a lot of directors will take a nominal salary and top this up with dividends. If you’re taking a salary, you must register as an employer with HMRC (even if there’s just you). Dividends are a distribution of any profit, after corporation tax, so you need to be careful that you don’t take more than is available. Again, this is an area where it’s best to speak to a professional about what would be best for you.
Sole Trader: As there’s no distinction between you and the business, your profits are treated as income and taxed as such. Even if you don’t physically take the money out of the bank account, you’re taxed on all the profits. You do, however, get your normal personal tax allowance (£11,850 for 2018-19) so only pay tax on your income above this amount. Tax is calculated using the normal personal tax bands of 20%, 40% and 45%.
Limited Company: The company pays tax on profit, currently at a rate of 19%. There is no tax allowance for companies, so this applies from the very first £1 of profit. You’lll also personally pay tax on any income you receive from the company. Tax on dividends is calculated at a lower rate than other personal income, which means that it can be more tax efficient to take income this way.
Several other options exist, including partnerships and community interest companies. If you’d like to have a chat about what would be best for your situation, get in touch for a no-obligation call.