Sole traders and limited companies are some of the common business structures in the UK. Entrepreneurs who are just starting will often wonder which one is the most feasible option.
Choosing a proper legal structure for your business will determine how much taxes you need to pay. It can be tough for a new business owner to understand which one is the most feasible option.
Every business needs to develop a proper legal structure. Usually, businesses opt for choosing between sole trader or limited company. As per Department of Business, Innovation and Skills 2020 data, approximately 3.5 businesses were a sole proprietorship, 2.0 million were trading companies, and 414,000 were ordinary partnerships.
A sole trader is a self-employed person or the business's sole owner. Sole proprietorship is considered one of the simplest business structures. More and more people prefer the establishment of sole proprietorship these days. However, businesses opting for this need to register themselves with the UK government and get all documents for HMRC fulfilled.
Every limited company has its own business identity or structure. It is a business on its own and different from the managers and owners. This is separate from the entire identity of the owner. It will remain or function similarly whether a director or shareholder governs it.
When it comes to taxes, it is necessary to know your business structure. Switching from a sole trader to a limited company can bring significant tax-saving benefits. The sole traders need to pay the Income Tax on profits as per the Class 2 and 4 National Insurance. On the other hand, the limited companies are liable for paying taxes on Profit only to Corporation Tax. Therefore, the Income Tax is low for limited companies, and there is no need for National Insurance.
The limited companies don't need to make significant or higher income tax payments for accounts. However, the sole traders need to pay higher prices. Sole traders can't save much on taxes. Furthermore, the payment of the same needs to be maintained in a proper timeline. This deadline can often cause issues with cash flow for some small businesses.
Although limited companies pave the way for saving taxes, it is necessary to note that the benefits aren't the same as they used to be. The taxation of dividends was changed in April 2016. Therefore, these companies will not be entitled to any Personal Allowance.
Limited Companies need to discuss everything related to the tax-saving benefits with their respective accountants. The accountants being professionals will help you understand which areas you can save the money on. Nonetheless, the money-saving benefits will also depend on your business' situation and what are the other sources of income.
The sole traders need to pay 20-45% income tax. On the other hand, the limited companies need to pay only 19% corporation tax. This makes them tax efficient. Furthermore, the limited companies will be eligible for getting various tax-deductible benefits and allowances. Depending on the need, the shareholders can also derive dividends from businesses. Furthermore, businesses that do not have National Insurance will have a lesser income tax rate than salary.
A sole trader is one of the most prominent business options in the UK. With 3.5 million businesses becoming sole proprietors in 2020 is a great one to notice. Therefore, many businesses in the UK follow the sole proprietorship model.
Some of the common benefits of becoming a sole trader include the following:
As of 2020, there are 2 million businesses actively trading limited companies. The process of starting a limited company is referred to as incorporation. Nonetheless, before starting this type of company model, you need to understand how it can be beneficial.
While there are significant benefits of being a sole trader, limited companies are no less.
Some of the common benefits of starting a limited company which include the following:
When choosing a business structure, you need to consider the benefits and disadvantages between a limited company and a sole trader. Once you understand the difference, you will be able to make a better decision. Before starting any type of business, make sure to consult your accountant. They are professionals in the arena and will help you make better decisions in terms of tax. Nonetheless, make sure to do some research to find the perfect decision.
Get the best advice on tax savings, accounting services, payroll, self assessment, VAT and more, whether you want to call us directly, request a call back or chat online with our experts, rest assured that we will always give you the best advice.If you have any questions, or would like to speak to us in person, please do get in touch. We're here to help.
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